The Commonwealth Government has issued a Green Paper titled "Financial Services and Credit Reform". This report summarises the proposals in the Green Paper. The Green Paper can be accessed at by clicking here .
Background discussed in the paper
- non-deposit taking institutions have grown and provide competition. The current credit crisis may improve the banks' market share, but it is unclear how much market share will be lost and for how long
- despite the increase in low documentation loans over the last seven years, full documentation home loans make up over 90% of the total Australian market. Unlike the US, the Australian sub-prime or non-conforming loan segment remains very small
- brokers now originate approximately 40% of housing loans
- reverse mortgages have experienced strong growth in recent years
- there is some concern over consumers' understanding of reverse mortgages
- predatory practices of fringe lenders and brokers need to be addressed to prevent the possibilities of any problems reaching the dimensions currently seen in the US
- entry and exit fees are high compared to the UK
- some fringe brokers engage in "equity stripping" by inappropriately refinancing defaulting borrowers
- there is some evidence of circumventing the Uniform Consumer Credit Code (UCCC) by the use of a business purpose declaration.
Current regulatory landscape
- practically uniform regulation of credit provided to individuals for predominantly private purposes by the UCCC
- the licensing of finance brokers in respect of all types of credit in WA
- a weak broker registration scheme in the ACT
- registration of credit providers in the ACT and Victoria and licensing of credit providers in WA (in all cases UCCC lending only)
- disclosure requirements (finance broking contract) in NSW, Victoria, and WA
- the Mortgage and Finance Association of Australia (MFAA) requires all members of an Australian Securities & Investment Commission (ASIC) approved external dispute resolution scheme and to deal only with lenders who are members of an External Dispute Resolution in respect of UCCC regulated loans
- advice in relation to credit given by Authorised Deposit-taking Institutes (ADIs) and non-ADIs is not specifically regulated.
Three options for reform
- maintain the status quo. Under this option it is likely that the current NSW Draft National Finance Broking Bill will be adopted by all states and territories, thus achieving a degree of uniformity. However, there are risks of delay. Lenders would still only be regulated by the UCCC which may be insufficient to control fringe lenders
- the Commonwealth Government to regulate all forms of consumer credit (ie mortgages, unsecured loans and credit cards, etc) and brokers
- the Commonwealth Government to regulate mortgages (and therefore lenders and brokers).
The Green Paper favours Option 3 because it concludes that small consumer lending such as credit cards, personal loans, and pay day loans may be affected by regional differences which may need to be accounted for in different regulatory regimes. Most industry observers agree that it is impractical to separate the regulation of loans secured by mortgages from unsecured lending. Option 3 will create a more complex regulatory regime than that which currently exists, as both brokers and lenders will need to comply with both state and Commonwealth laws.
The Green Paper is unclear whether the proposal is to regulate "consumer mortgages" only – ie those subject to the UCCC – or all loans secured by mortgages. On balance, it appears the former is the case. This will leave unregulated investment loans to individuals and business lending both of which were to be regulated under the draft National Finance Broking Bill.
The Green Paper proposes regulating mortgage brokers and lenders by adopting the approach in Chapter 7 of the Corporations Act – ie the Financial Services Reform (FSR) regime. This would cover non-ADIs as well as ADIs. Industry is concerned that dumping lending and finance broking into the FSR regime is totally inappropriate as lending is quite different from investing.
The following statement from the Green Paper is interesting: "It is important to note the government does not intend to regulate bank fees and charges as part of this option. Regulation of bank fees and charges discourage new investment and innovation, increases compliance costs for industry and may actually lead to an increase in prices for consumers. The government considers a competitive market to be a more effective means for driving down fees and charges."
What should happen to the regulation of finance brokers and lenders?
Industry is likely to support sensible national regulation of consumer and investment credit, involving a national licensing scheme and a uniform simple disclosure regime. Such a regime would involve:
- national licensing of finance brokers as contemplated by the NSW draft Finance Broking Bill (subject to some fine tuning and simplification of that Bill);
- compulsory membership by lenders of an ASIC approved ADR; and
- a Commonwealth Government take over of the UCCC.
Another proposal of the Green Paper is that the Commonwealth Government takes over the regulation of public trustees. Public trustee companies are currently regulated by the states in respect of their traditional trust duties. An analysis of this proposal is outside the scope of this report.
Margin lending has grown strongly in recent years. Although margin loans were originally sold through financial advisers, lenders now often sell directly to consumers, often online.
Currently there are serious concerns that consumers are not necessarily aware of the risks associated with margin loans, particularly the mechanism for margin calls where often less than 24 hours is given for the investor to cover the loan.
Some industry players have backed calls for standardising the timing of margin calls and disclosure requirements across the industry.
There are three options for reform:
- maintain the status quo (largely unregulated);
- include margin loans as a financial product under the FSR regime; or
- establish a new Commonwealth regulatory regime separate from the FSR regime involving the licensing of margin loan providers, new disclosure requirements, prohibit certain forms of conduct, and prohibit market misconduct.
This regulation will not cover all lending for the purpose of buying shares or secured by shares, but will only cover lending where margin calls can be made.
Many commentators consider that product disclosure in relation to credit, including specialised credit such as reverse mortgages and margin loans, should all form part of the same regime.
The Green Paper notes that over the last few years there have been a number of high profile collapses of companies that raised money by debentures. Debentures are already regulated as a financial product. Debenture issues can be listed or unlisted.
The Green Paper concludes that unlisted debentures pose an increased risk for retail investors, as there is no readily available value for the debenture, and there is reduced public scrutiny of the ongoing performance of the issuer.
Even after the fall-out from the high profile collapses of these companies, it appears retail investors still have a high degree of confidence in their own ability to make appropriate investment decisions. The Green Paper considers that the confidence is misplaced despite ASIC's attempts to educate.
As an Australian Financial Services Licence (AFSL) is only required for issuing debentures to retail investors if the issuers carry on an investment business, not all issuers need to be licensed. Further, the trustees of the debenture issue do not always have to be licensed.
It is proposed that:
- the exception for promissory notes is removed (currently promissory notes for $50,000 or more are excluded from the definition of debenture);
- all issuers need an AFSL;
- all debenture trustee companies must be licensed; and
- trustee's duties will be reviewed.
Australians have a relatively high rate of investment in real estate and therefore there is a large exposure to the risks associated with this type of investment.
Property investment advice refers to the actual or reasonably stated intention to influence consumers' and investors' decisions about property investment. This advice can be provided by a range of individuals including real estate agents, valuers, developers, accountants, financial planners, mortgage brokers.
The area of concern relates to "property spruikers". This term tends to be used in a derogatory fashion and refers to an activity which often has characters such as:
- high pressure, fast paced presentations;
- misrepresentation or exaggeration of the benefits; and
- aggressive or harassing behaviour.
The Green Paper asks stakeholders to submit views on possible options for reform to address the risk of "property spruikers".
Gadens lawyers will be working with the MFAA to develop detailed submissions in relation to these proposals.
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