'There will be a single, standard, national regulation and supervision of margin lending by July 1, 2009.' - Minister for Superannuation & Corporate Law, Senator the Hon Nick Sherry, 18 January 2009.
Historically financial advisers have been the main promoters of margin lending products. In more recent times distribution channels for the products have expanded to include online brokers linking loans with 'execution only' internet services and banks 'selling' loans directly to customers and stock brokers. The new distribution channels have produced a corresponding increase in the number of clients with margin loans to the extent that by 2008 there were over 202,000 clients and over $32 billion in margin loans in existence within Australia.
The turbulent stock market over the last year has resulted in increased volatility in share values and this has triggered margin calls and the sale of underlying shares. The increased number of triggered margin calls has resulted in many retail investors discovering that their understanding of margin loan products was very limited.
Additionally, the use of shares as collateral for loans by directors of listed companies has caused volumes of trading to occur that have had an immediate impact on the company's share price and triggered instability for those listed companies. High profile directors including Eddy Groves from ABC Learning Centres received margin calls, which in turn triggered dramatic drops in share prices when the stock was sold. Press reports indicate that in October 2008 the Commonwealth Bank's CommSec made 2,000 margin calls in just one day.
The impact of margin calls on both investors and the share market has led the federal government to issue a Green Paper on Financial Services and Credit Reforms. One of the reforms recommended in the Green Paper was the regulation of margin lending products. Since then the Minister has made several announcements confirming that margin lending products will be regulated.
On the 17th of March 2009, the Senate advised the House of Representatives that the Parliamentary Joint Committee on Corporations and Financial Services is investigating the practices of banks and other financial intuitions in relation to margin lending associated with Storm Financial, Opes Prime and other similar business. The 'Inquiry into Financial Products and Services in Australia' will review the current regulatory framework, as well as the role that financial planners and margin lenders played in the recent collapses. It will also investigate whether conflicts in relation to remuneration have encouraged advisers to offer their clients inappropriate products and advice. The inquiry is due to report back to Parliament on November 23, 2009, with details of any recommended legislative changes.
AFS LICENSING: 1 JULY 2009
In early 2009, the Rudd government announced that margin lenders would be required to have AFS licences and be regulated by ASIC. Chapter 7 of the Corporations Act (Act) is to be amended to include 'margin lending' as a financial product. The time frame for the reforms is very short and there will be no public consultation before implementation although eight margin lenders have been consulted.
'It will become a Chapter 7 financial product; its disclosure will be clear, succinct and contain information on commissions. It will also have its own tailored responsible lending obligations including the requirement for the ultimate lender to know whether the capital being brought to the table by the retail borrower is in fact their own or whether it is self debt, such as equity from a home.' - Hon Nick Sherry.
As a consequence of margin lending being defined as a financial product there will be implications for margin lenders, advisors and arrangers of margin loans as follows:
- a requirement for margin lenders to hold an AFS licence with relevant authorisations.
- all representatives of AFS licensees will require training in the provision of financial services in an FSR regulated environment.
- retail clients will have to be provided with a Product Disclosure Statement (PDS) and Statement of Advice (SOA) prepared in accordance with the Act, explaining, among other things, why the margin loan is being recommended, the risks and benefits of the margin loan and the fees payable for the loan, in dollar amounts.
- retail clients will have to be provided with a Financial Services Guide (FSG) which will include details of commissions and other payments to advisors by the lender, in dollar amounts.
- retail consumers will have to be given access to external dispute resolution.
- margin lenders will be required to have adequate arrangements in place for the management of conflicts of interest.
- margin lenders will be exposed to enforcement provisions in relation to the following:
- market manipulation.
- false and misleading statements.
- introducing investors to deals using misleading information.
- engagement in dishonest, misleading or deceptive conduct.
Additionally, all margin lending providers and intermediaries will be subject to responsible lending conduct provisions as part of the Government's broader consumer credit reforms, which are also being phased in during 2009.
As margin loans are likely to be a specified financial product, it is assumed that existing AFS licensees will be required to obtain licence variations to include authorisations to advise or deal in margin loans. Specialist intermediaries providing services involving advice or arranging margin loans who do not have AFS licences will require licences to continue to provide advice or dealing services in this area or will have to be appointed as the authorised representative of an AFS licensee with the relevant authorisations.
Treasury has indicated informally that the margin lending reform regulations will be drafted by April - May and everything will be in place by 29 June 2009. There is unlikely to be any further public consultation before implementation. It has been suggested to the Corporations and Markets Advisory Committee (CAMAC) that Section 205G of the Corporations Act be amended to confirm that directors' obligations to disclose material personal interests in a company include an obligation to disclose security interests or third party interests in their shares and that the company be obliged to disclose such interests to the market.
DISCLOSURE OF DIRECTORS' MARGIN LOANS
In November 2008, the Minister referred several issues related to margin lending to CAMAC. The use and disclosure of margin lending by company directors was raised as one issue of major concern to the Government as well as investors.
CAMAC is considering whether there should be compulsory disclosure to the market of a security interest or other third party right over a director's shareholding where it is of a size that a forced sale (such as that triggered by a margin call) would be likely to have a material effect on the price of the company's securities.
This issue has been the subject of debate as to whether or not an entity would be required to disclose under ASX Listing Rule 3.1 key terms of a margin loan or similar arrangement where a 'material' number of securities are impacted. In June 2008, the AICD Policy and Advocacy Position Paper No 9 Director Margin Loans gave support to disclosure being part of each company's continuous disclosure obligation as this provides the company with sufficient flexibility to decide whether or not the relevant margin loan issues are material and in need of market disclosure.
The difficulty with this position is the company's dependence on directors determining the materiality of individual director's financial arrangements. There is presently no specific requirement imposed on directors to disclose such arrangements and so disclosure is an issue for the corporate governance arrangements in place for each company. However, in practice they will be required to do so in order for the company to analyse whether they are sufficiently material to require disclosure under Listing Rule 3.1.
DLA PHILLIPS FOX EXPERTISE
Since the original reforms were made to Chapter 7 of the Corporations Act, we have been assisting clients to prepare and obtain AFS licences and with ongoing compliance. In fact, the first AFS licence in Australia was issued to one of our clients. We have also been assisting with the preparation of clear and concise disclosure documents for AFS licencees and their representatives.
The AFS licensing regime is highly regulated and 'principles' based. The onus is on the applicant to prepare an application that details the processes that will be in place to ensure the financial services business is conducted in accordance with the Act and the terms of the licence. The applicant must also submit and have ASIC approve at least one senior person as the responsible manager for the purposes of the licence. In addition to licensing, the appointment of representatives in an FSR environment is also challenging.
Supplementing our expertise in the AFS licensing and disclosure area, we have a specialist corporate governance - compliance unit and we can assist in reviewing Board Charters and director's disclosure documents to assist companies to achieve a transparent and effective corporate governance program.
The impact of operating either as a margin lender or a representative of a margin lender in an FSR environment should not be underestimated. Nearly a decade after it was first introduced financial product issuers and service providers are still negotiating refinements to the legislation and modifications to laws and regulations that have unintended consequences.
We have advised both issuers and representatives across a diverse range of financial products and services including on products which were not obviously financial ones. We have insight into the practical problems of FSR implementation that is both commercial and legally focused.
Phillips Fox has changed its name to DLA Phillips Fox because the firm entered into an exclusive alliance with DLA Piper, one of the largest legal services organisations in the world. We will retain our offices in every major commercial centre in Australia and New Zealand, with no operational change to your relationship with the firm. DLA Phillips Fox can now take your business one step further − by connecting you to a global network of legal experience, talent and knowledge.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.