Margin lenders will need an AFS licence

Lenders providing margin loans will have to assess a borrower's capacity to service the loan, will have to comply with strict margin call notification rules and will need an Australian Financial Services Licence, under changes proposed by the Australian government.

The Minister for Superannuation and Corporate Law, Nick Sherry, yesterday released an exposure draft of the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009.  It incorporates margin lending facilities as financial products for the purposes of the Corporations Act.

In addition to the responsible lending requirement and regulation of the notification of margin calls, new measures include rules for disclosure of terms and conditions and a requirement to give borrowers a copy of the lender's assessment of  their  capacity to service the loan.

A commentary published with the draft bill says: "Disclosure of the terms and conditions governing the loan is not currently regulated. It is not clear that investors are fully aware of the risks associated with a margin loan product.

"There have been serious concerns that not all margin borrowers are aware of the extent to which margin lending contracts place the risk of changes to market conditions on them."

For example, the lender may reserve the power to change the LVR of a security at any time.

ASIC's consumer protection powers do not extend to credit products, although the regulator's power to police misleading and deceptive conduct in the financial services market does cover the sale of credit facilities.

The new law will give margin loans a specific definition in the Corporations Act. Complications have arisen because providers such as Opes Prime and Tricom used alternative legal structures not based on an explicit loan agreement.

"The definition has been framed to include these alternative structures."

Providers will be subject to the licensing, conduct and disclosure requirements of Chapter 7 of the Corporations Act. Lenders will have to have an AFS licence and be subject to ASIC supervision.

Under the new responsible lending rules lenders will be required to assess whether a proposed loan is suitable for a client. No responsible lending requirements apply under present law.

A loan would be unsuitable if, in the event of a margin, call the client would not be able to service the loan or would only be able to do so with substantial hardship.

Borrowers' ability to service their loans must not be dependent on the expected returns available from the investments financed by the loan.

Lenders must inquire whether a second loan has been taken out to finance their equity contribution for the margin loan.

The commentary says: "There have been recent cases where clients who had entered into margin lending arrangements are at risk of losing their homes due to double gearing strategies. Double gearing arises where clients borrow funds against the equity in their homes and use the funds as an equity contribution to a margin loan."

Borrowers will be able to ask for a copy of the lender's assessment of their suitability for a margin loan.

The notification of margin calls will be regulated. "There have been situations where it has been unclear whether it was the lender or the borrower's financial planner who was responsible for notifying clients when a margin call occurred."

The new provision requires that lenders must notify clients unless clients explicitly agree to notifications being made by their planner.

The new law does not cover general investment lending, such as a loan secured against residential property and used to purchase securities, or margin loans used for personal or business purposes.

Lenders will have to ask their clients what the loan is for. The government has asked for feedback on how to address the issue of client intention.

The government has also asked for feedback on whether there should be a credit limit for a margin lending facility.