Margin lending on the chopping block

There is certainly a lot going on in the area of law reform and there is no doubt margin loans have been targeted as an area of concern, especially in light of the collapse of Storm Financial.

But one cannot help but ask whether the proposed changes to the margin-lending landscape are being rushed through. The legislation was introduced in the Federal Parliament only seven weeks after the exposure draft was released for comment. Seven weeks sounds like it might be enough time, but once you allocate time to receive and then review submissions, consider the issues and then rewrite sections of the draft legislation, check the amendments and prepare the bill for Parliament, there isn’t a lot of time left for genuine consultation. And this is one of the most significant legislative overhauls since the financial services reforms.

Given the financial services regime is riddled with patch-ups and regulatory Band Aids, this smacks of process being sold short (no pun intended).

The Australian Securities and Investments Commission’s (ASIC) recent submission to the Parliamentary Joint Committee on Corporations and Financial Services contained a number of controversial proposals, some of which provide insight into ASIC’s views on a range of issues. One in particular stands out. ASIC seems determined to protect retail clients from complex high-risk products, but by effectively cutting off the chance to invest!

A number of ASIC’s proposals appear designed to support this. For example, ASIC is seeking the power to make product issuers include specific content in their advertising and marketing material. But it has also suggested licensing investors for certain types of products.

It seems clear where ASIC would like to see this end up. Margin loans will still exist in ASIC’s world, but don’t be surprised if their use becomes largely restricted to sophisticated or experienced investors.

While margin lending is not a particularly complex concept, it has caused the most grief for ASIC in recent times. By making margin loans a financial product, financial advisers will be prevented from giving advice on them, unless their AFS licence is amended to authorise margin lending advice. In addition, financial advisers are going to be required to be trained (ie, RG 146 compliant) in order to provide advice to retail clients on margin loans.

There will be a transition period into the new regime, but these requirements put ASIC back in the box seat. It will have the ability to determine who will be authorised to provide advice on margin loans and deny certain licensees the right to provide financial services on margin loans - if they cannot convince the regulator they have appropriate qualifications, experience and expertise.

This is not the first time regulatory and legislative changes have savagely impacted financial service providers. In August 2008, ASIC’s enhanced disclosure regime for unlisted debenture issuers saw the majority of smaller issuers withdraw or cease to offer their

products at all. We are now left with debentures that only the big end of town can effectively offer.

Margins loans are now clearly in ASIC’s cross-hairs and the next duck lined up for the chopping block is likely to be derivative-based products, such as contracts for difference.

No one would argue against the need for real and effective protection of retail investors; nor that product issuers and advisers must be accountable for their actions.

But in most cases it is not the underlying product that is at fault. There is nothing wrong with margin loans as a product. The problem is a lot of the investors who utilised them didn’t know enough about them or were not adequately advised of the implications if the market moved against them.

I am sure there were more than a few investors who just saw the dollar signs and thought they could make a small fortune out of what was perceived (and in some cases sold) as a continually rising market.

The real challenge for ASIC is establishing a regime where it can effectively monitor licensees to ensure clients are provided with quality advice and that the products they acquire are appropriate for their circumstances. Not an easy task by any stretch.

In the end, what a number of ASIC’s proposed changes are really doing is telling retail clients that they may not be sophisticated enough to utilise complex or high-risk products. Keeping in mind that ASIC’s primary focus is to educate consumers and to help them make better financial decisions, do these suggested reforms then represent an admission that this is looking less likely to be achieved?

David MacLeod is a partner at McMahon Clarke Legal.