House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Minister for Human Services Minister for Financial Services, Superannuation and Corporate Law the Hon Chris Bowen MP)

Chapter 9 - Regulation impact statement

Part 1: Introduction

9.1 The National Consumer Credit Protection Bill 2009 (Bill) is the centrepiece of a legislative package that implements the first phase of decisions by the Australian Government and the Council of Australian Governments (COAG) in 2008.

9.2 COAG reached an in-principle agreement on 26 March 2008 that the Australian Government would assume responsibility for regulating mortgage credit and mortgage advice, including non-deposit taking institutions and mortgage brokers, as well as margin loans. On 3 July 2008, COAG agreed that the Australian Government would also assume responsibility for regulating all other consumer credit products and requested the COAG Business Regulation and Competition Working Group report back at the 2 October meeting with a detailed implementation plan for other credit.

9.3 Against that backdrop, in September 2008 the Australian Government decided to:

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first, enact the Uniform Consumer Credit Code (UCCC) of the States and Territories and, where relevant, proposed amendments to the UCCC, as Commonwealth legislation;

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the new national framework would be administered by the Australian Securities and Investments Commission (ASIC), which would be given enhanced enforcement powers;

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secondly, to extend the scope of the current regulatory framework so that the new national consumer credit framework would:

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include consumer lending for investment properties;

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regulate the provision of margin loans;

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require all providers of consumer credit and credit-related brokering services and advice to be members of an external dispute resolution body;

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provide for a licensing regime requiring all providers of consumer credit and credit-related brokering services and advice to obtain a licence from ASIC;

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require licensees to observe a number of general conduct requirements, including responsible lending practices;

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regulate the provision of credit for small businesses; and

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introduce specific conduct obligations, where warranted, for particular credit activities or products.

9.4 On 2 October 2008, COAG agreed to an implementation plan for the regulation of of consumer credit. COAG agreed to a phased approach to reform, beginning with the transfer of responsibility key credit regulation, including the UCCC as phase one. COAG also agreed to an implementation plan for phase two, the regulation of remaining areas of consumer credit, including pay day lending (for example, pawnbrokers), credit cards, store credit, investment and small business lending, and personal loans, so that the reform package is completed in the first half of 2010.

9.5 A regulation impact statement (RIS) was prepared and considered in the context of consideration of the decisions by the Australian Government in September 2008. A copy of that RIS is in Chapter 10 of the explanatory memorandum. The September 2008 RIS includes background information, including the market and regulatory environment for consumer credit and margin lending, and consultation processes that had been carried out to that date. It also includes a diagram of the two-phased approach to implementation, that was endorsed by COAG.

9.6 This RIS should be read in conjunction with the September 2008 RIS. It focuses on analysis of key measures in the Bill that substantively change the regulatory framework. The following measures are discussed:

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ASIC's enforcement power;

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consumer lending for residential investment properties;

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licensing of participants; and

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responsible lending practices.

9.7 The issues of credit for small business, and specific conduct obligations, are part of the second phase and are not dealt with in the Bill or in this RIS.

Part 2: Consultation

Consumer credit

Green Paper on Financial Services and Credit Reform

9.8 On 3 June 2008, the Government released the Green Paper on Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation.

9.9 The Green Paper discussed the regulation of mortgages, mortgage brokers and margin loans, and proposed options for the Commonwealth taking over regulation in this area. With respect to other consumer credit products such as credit cards, personal loans and micro loans, the Green Paper asked for submissions on whether these products should also be regulated solely by the Commonwealth or whether there is a role for the States and Territories in this area.

9.10 Some 150 submissions were received in response to the Green Paper, and an overwhelming majority supported the Commonwealth assuming responsibility for the regulation of all consumer credit:

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From the industry's perspective, this support was driven by the reduction in compliance burden that would be achieved by reducing the number of different regulatory regimes under which they are required to operate.

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From the consumer advocates' perspective, this support was driven by the better protections and efficiencies a consistent national regime offers.

9.11 Most submissions supported the enactment of the UCCC, including the outstanding projects, as Commonwealth legislation and identified ASIC as the appropriate regulator:

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Licensing (with compulsory membership of External Dispute Resolution (EDR) Schemes) and disclosure requirements were seen as key features. In addition, several submissions highlighted the need for the concept of responsible lending, and consideration of capacity to repay requirements.

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A common view was that putting lenders and brokers into the Financial Services Reform Act 2001 (FSR) regime was inappropriate as selling and/or providing credit was fundamentally different to providing and/or advising on investments (Mortgage & Finance Association Australia; Gadens lawyers; ABA).

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Of the few submissions that suggested Chapter 7 of the Corporations Act 2001 (Corporations Act) would be appropriate, most commented that the existing requirements would require modification to apply appropriately to credit products and providers (AXA Asia Pacific).

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Several submissions supported, or understood need for, staged implementation (Financial Services Ombudsman, Financial Planning Association).

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It was suggested that the implementation costs would be minimised if the Commonwealth adopted the UCCC with minimal changes (Legal Aid NSW and QLD and Australian Finance Conference).

Other consultations, reviews and regulation impact statements

9.12 The NSW Government has undertaken extensive consultation on the draft NSW National Finance Brokers Package, and prepared a regulation impact statement. That package has been a reference point for many of the proposals in this package, particularly the responsible lending conduct provisions.

9.13 In late 2003, the Ministerial Council on Consumer Affairs (MCCA) took submissions on its Discussion Paper, Fringe Credit Providers. Thirty-eight responses were received. Following consideration of submissions, the proposals were substantially reworked and included in a Decision-Making Regulatory Impact Statement and Final Public Benefit Test, dated March 2006.

9.14 An inquiry in 2007 into home lending practices and procedures by the House of Representatives Standing Committee on Economics, Finance and Public Administration recognised the importance of consistently regulating non-bank lenders and mortgage brokers by recommending that the Commonwealth take over the regulation of credit including the regulation of mortgages. The Committee suggested that credit be included in the definition of a financial product for the purposes of the Corporations Act.

9.15 The Productivity Commission released its final report on Australia's Consumer Policy Framework (including regulation of consumer credit) on 8 May 2008. It recommended that the Commonwealth take over the regulation of credit and develop generic consumer law.

9.16 KPMG Consulting undertook consultation and released a report NCP Review of the Consumer Credit Code in December 2000, which has been the catalyst for the proposed amendments to the default notices and vendor terms provisions.

9.17 The Australian Government, through the Treasury, established an implementation taskforce consisting of officials from the Commonwealth Treasury, ASIC and the States and Territories in order to progress the COAG decisions in relation to consumer credit. That taskforce has met regularly to discuss policy approaches on various aspects and consider draft provisions. In addition, a consultative group of industry and consumer representatives has been involved in considering draft provisions as they have been prepared. The Industry and Consumer Consultative Group has involved representatives from the following bodies:

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Finance industry - Australian Finance Conference, Australian Bankers' Association, Abacus - Australian Mutuals (the Association of Building Societies and Credit Unions), National Financial Services Federation, Mortgage and Finance Association of Australia, Finance Brokers Association of Australia, Investment and Financial Services Association, Financial Planning Association, Insurance Council;

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Consumer advocate - Australian Consumers Association (CHOICE), Consumer Law Action Centre;

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Dispute resolution - Financial Ombudsman Service, Credit Ombudsman Service Ltd; and

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Legal - Consumer Credit Legal Centre (NSW), Law Council of Australia.

9.18 Consultations with the Industry and Consumer Consultative Group were not conducted in public. The consultations ranged from higher level discussions on broader policy matters through to consideration of draft provisions. Members gave feedback at a combination of face-to-face and telephone meetings, and by providing written comments. The consultations were conducted on a confidential basis. The first meeting was held on 31 October 2009 with meetings held on a monthly basis thereafter.

9.19 Key aspects of the feedback from the consultations with the Industry and Consumer Consultative Group has been factored into the final form of the proposals on consumer credit and is described in more detail under the relevant headings below.

Part 3: Regulation impact assessments

9.20 This part includes individual regulation impact assessments for the following measures in the Bill:

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ASIC's enforcement power;

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consumer lending for residential investment properties;

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the licensing requirements; and

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responsible lending conduct.

Impact assessment methodology

9.21 Impacts can be divided between three impact groups (consumers, business and government). Typical impacts of an option on consumers might be changes in access to a market, the level of information and disclosure provided, or prices of goods or services. Typical impacts of an option on business would be the changes in the costs of compliance with a regulatory requirement. Typical impacts on government might be the costs of administering a regulatory requirement. Some impacts, such as changes in overall confidence in a market, may impact on more than one impact group.

9.22 The assessment of impacts in this regulation statement is based on a seven-point scale (-3 to +3). The impacts of each option are compared with the equivalent impact of the 'do nothing' option. If an impact on the impact group would, relative to doing nothing, be beneficial, the impact is allocated a positive rating of +1 to +3, depending on the magnitude of the relative benefit. On the other hand, if the impact imposes an additional cost on the impact group relative to the status quo, the impact is allocated a negative rating of -1 to -3, depending on the magnitude of the relative cost. If the impact is the same as that imposed under the current situation, a zero score would be given, although usually the impact would not be listed in such a case.

9.23 The magnitude of the rating of a particular impact associated with an option has been assigned taking into account the overall potential impact on the impact group. The reference point is always the status quo (or 'do nothing' option). Whether the cost or benefit is one-off or recurring, and whether it would fall on a small or large proportion of the impact group (in the case of business and consumers), is factored into the rating. For example, a cost or benefit, even though large for the persons concerned, may not result in the maximum rating (+/-3) if it is a one-off event that only falls on a few individuals. Conversely, a small increase in costs or benefits might be given a moderate or high rating if it would be likely to recur or if it falls on a large proportion of the impact group. The rating scale for individual impacts is explained in the Table.

Rating an individual impact

Table 9.1

9.24 The ratings for the individual impacts compared to the status quo are then tallied to produce an overall outcome for the option. If it is positive, it indicates that the option is likely to produce a more favourable cost/benefit ratio than the status quo. If it is zero there would be no overall benefit from adopting the option, and if negative the option would provide overall a less favourable cost/benefit ratio than the 'do nothing' option. Ordinarily, options that have the highest positive score would be the favoured courses of action.

9.25 What is classed as a 'large', 'moderate' or 'small' cost or benefit depends on the nature of the problem and options being considered. Of course, the costs and benefits associated with options to address a problem costing billions of dollars per year are likely to be of a much greater absolute magnitude than the costs and benefits of options for dealing with a rather modest issue that affects only a handful of persons. However, as all the ratings are made relative to the status quo/ do nothing option for a particular problem, the absolute value of 'large' or 'moderate' or 'small' is not really important. All that matters is that within a problem assessment, the impacts of each option are given appropriate ratings relative to the status quo and each other. If that occurs, it will be sufficient for the methodology to yield an overall rating that assists in assessing the relative merits of options, from a cost/benefit perspective, to address the particular problem.

9.26 An example of the rating calculation for an option, using the seven-point scale ratings of impacts, is in the Table below. The example is based on a purely hypothetical scenario that a new type of long-wearing vehicle tyre is being sold and marketed, but it has become apparent that the new style of tyres have a higher risk of exploding while in motion than conventional tyres. The example is designed merely to illustrate how the rating scale might be used to compare a proposal's costs and benefits option to the 'do nothing' option - it is not intended to be a comprehensive or realistic assessment of options to address such a problem.

Illustrative rating for the problem of a long-wearing tyre that may fail

Option A: Do nothing

Table 9.2

Option B: Ban on sale of the new tyre

Table 9.3

Option C: Industry - developed quality control standards Table 9.4

9.27 In the above hypothetical example, Option C appears to have a better impact for consumers and a better overall cost/benefit rating than Option B.

3.1: ASIC enforcement powers (including penalties and sanctions)

9.28 As mentioned above, a decision has been made to enact the UCCC of the States and Territories and, where relevant, proposed amendments to the UCCC, as Commonwealth legislation. Further, a licensing framework for credit service providers will be introduced. It has also been decided that the new national framework will be administered by ASIC, which would be given enhanced enforcement powers.

9.29 This part of the assessment focuses on options for enhanced enforcement powers for ASIC.

Problem identification

9.30 The UCCC relies heavily on criminal sanctions to encourage compliance. The sanctions are fines expressed in penalty units, with a maximum of 30, 50 and 100 units. Section 179 of the UCCC defines each penalty unit as $100, so the maximum penalties are $3,000, $5,000 or $10,000.

9.31 In addition, a regime known in the UCCC context as 'civil penalties' apply to a range of breaches, particularly those that relate to a failure to undertake appropriate disclosure. These breaches may also permit the debtor or guarantor to make an application for an order relating to a breach by the lender. It is important to note that these types of orders under the UCCC are distinct from the 'civil penalty' regime under the Corporations Act. Under the UCCC, the penalty amount is applied for by, and the penalty can be payable to, a private person (such as an affected consumer), whereas a 'civil penalty' order under the Corporations Act involves a regulator applying for a pecuniary penalty payable to the government. For the purposes of the discussion in this RIS, the UCCC-type order will be described as 'consumer enforcement'. Civil penalty orders are intended to mean the type of civil penalty order found in the Corporations Act, which involves a regulator applying for a penalty amount to be paid to the government.

9.32 The UCCC does not include any infringement notice provisions.

9.33 In addition to reenacting the UCCC as Commonwealth law, it is also proposed to introduce a licensing framework, similar to that applying under Chapter 7 of the Corporations Act.

9.34 The limitations of some of the Corporations Act sanctions have been noted in the Final Report of the Regulation Taskforce, Rethinking Regulation (2006) and in the Review of Sanctions in Corporate Law (Treasury, 2007). In summary, disadvantages of criminal sanctions in the context of financial sector regulation is that they:

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can result in an overly cautious approach by businesses to compliance, which can stifle innovative approaches which would otherwise be desirable to encourage; and

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are time-consuming and costly to prosecute for the regulator and the defendant.

9.35 Accordingly, reliance solely or too heavily on criminal sanctions and pecuniary penalties can lead to:

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some behaviours that would otherwise contribute to overall economic efficiency and dynamism not occurring, because business is too cautious to risk criminal prosecution (especially for breach of rules against 'higher level' undesirable behaviours); and

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some 'lower level' undesirable behaviours persisting because it is too costly and/or time consuming for regulators to address it.

9.36 The costs of responding to actions for consumer enforcement under the UCCC were raised by industry groups as a problem in the context of the National Compensation Policy (NCP) review of the Consumer Credit Code (December 2000).

9.37 In the recent consultations, it was reported that the relevant authorities were not consistent in their approach to compliance/enforcement activity in relation to the UCCC. Some have prosecuted matters in court. Queensland authorities reported prosecuting one or two matters per year, at a cost of $50,000 to $60,000 per matter. Authorities in some other jurisdictions have reported relying on other methods, such as direct approaches to credit providers seeking variations on behalf of affected consumers. This issue was noted in the March 2006 RIS on Fringe Credit Providers (see 'Consultation' above). The different approaches among jurisdictions to compliance activities is likely to be due to a combination of factors. The resources associated with pursuing court action is likely to be one of those factors.

Objectives

9.38 The main objective of the enforcement power regime is to provide ASIC with enforcement options that help to minimise losses from:

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undesirable behaviour that the laws permit;

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desirable behaviour that the laws deter;

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the costs of enforcement.

Options

Status quo

9.39 ASIC does not currently have enforcement powers in relation to consumer credit (except for being able to take action in relation to any misleading, deceptive and/or unconscionable conduct on the part of financial product providers and intermediaries in their advertising and sale of consumer credit products). That position could not be maintained - there would have to be some enforcement powers in the national credit framework.

9.40 However, an equivalent to a status quo position would be to import the existing penalty regime of UCCC to cover breaches of that part of the new credit framework, and duplicate the enforcement regime of Chapter 7 of the Corporations Act for the new licensing framework. The enforcement provisions in the Australian Securities and Investments Commission Act 2001 would also apply. Accordingly, there would be a combination of criminal offences and civil penalties (derived from the Corporations Act equivalents), plus the criminal offences and consumer enforcement provisions currently in the UCCC.

Option A: A combination of criminal (including infringement notices), civil penalties and consumer enforcement

9.41 Under Option A, there would not simply be a duplication of the penalties in the UCCC and Chapter 7. Instead, the enforcement structure would include a tiered approach to sanctions, which would reflect considerations of the Review of Sanctions in Corporate Law (Treasury, 2007) and the Commonwealth Guide to Framing Commonwealth Offences, Civil Penalties and Enforcement Powers (AGD, 2007).

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Criminal penalties would continue to apple to offences which constitute serious or substantial wrongdoing, for example predatory lending or equity stripping. Such behaviour would have the effect or potential effect that warrants the strongest deterrent or punishment, or that market participants would expect an element of retribution for the wrongdoing. Criminal penalties would reflect those for similar offences in the Corporations Act.

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Civil penalties would be applied to offences which constitute conduct where it is considered that a criminal sanction is not warranted, because the wrongdoing is not 'serious' or 'substantial' in nature.

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The consumer enforcement regime in the UCCC would also be maintained for the breaches equivalent to those that they currently apply to in the UCCC.

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Infringement notices would be applied to offences for relatively minor offences, where a high volume of contraventions is expected, and where a penalty must be imposed immediately to be effective.

Impact analysis

Affected groups

9.42 The groups affected by the new regime of ASIC enforcement powers would be: consumers of credit; industry participants, including lenders and advisers; and the Government and ASIC.

9.43 In terms of industry participants, the licensing system existing in Western Australia provides some guidance as to the regulatory population. Western Australia has reported that there are approximately 190 credit providers registered in that jurisdiction, of whom approximately 100 operate nationally. These figures does not include approved-deposit taking institutions (ADIs) registered under the Banking Act 1959 (approximately 500 nationally) that may operate in Western Australia, as ADIs are not required to be licensed under the Western Australian legislation. However, many ADIs would be subject to the proposed consumer credit framework regulatory.

9.44 In addition to credit providers, the proposed regulatory framework also covers persons whose business involves suggesting consumers enter credit contracts, and assisting them enter contracts. Such participants would primarily (though not exclusively) be comprised of finance brokers. There are approximately 3,000 licensed finance brokers in Western Australia, and of those, around 200 have addresses outside Western Australia.

9.45 Persons other than brokers that are part of the credit supply chain and may be covered by aspects of the proposed regulatory framework include aggregators and mortgage managers. It is estimated that between one and two hundred persons would fall into those groups. Persons whose business is the collection of debts (either as assignee or as agent of a credit provider) will also be subject to aspects of the proposed regime, including licensing.

9.46 Based on the above, it is estimated that the affected population, in terms of industry participants, could be as high as 10,000 nationally.

9.47 As to consumers, almost all the adult population are users or potential users of credit facilities. The Dun and Bradstreet consumer credit expectation survey for the March 2009 quarter (published in January 2009) reports that 18 per cent of Australians intended to seek new credit, or increase the limits of existing credit, in the March 2009 quarter.

Summary of expected impacts

9.48 In comparison with the status quo, the distinction between Option A and the status quo position is the use of infringement notices.

9.49 There are direct and indirect costs and benefits associated with those facilities. In terms of direct benefits, the costs for both the regulator and the regulated population would be far less than using the criminal and civil enforcement avenues already there. For example, the legal costs of defending a consumer enforcement case under the UCCC are reported to be in the range of $40,000 to $140,000 (see NCP Review of Consumer Credit Code, December 2000, at p134). It is reasonable to assume the costs of bringing the action are similar. If administrative actions were used as an alternative they would potentially save much of those costs, although defended matters may ultimately require a court process.

9.50 Lower-level (that is, less serious) transgressions are more likely to be pursued by the regulator under Option A. This outcome has benefits for consumers because it would improve overall standards of industry behaviour, but it carries some potential additional compliance costs for industry participants in comparison with the status quo.

9.51 In the 2008-09 Additional Estimates process, the proposed regulator, ASIC, was allocated $66.7 million in funding over four years to administer the new national consumer credit function. A proportion of that funding will be allocated to enforcement functions. Including the more flexible avenues under Option A would enable the enforcement budget to be used more effectively than under the status quo option.

Status Quo

Table 9.5

Option A

Table 9.6

Consultation

9.52 In the context of the NCP Review of the Consumer Credit Code (December 2000), the role of consumer enforcement under the UCCC was considered (see page 133ff). At that time, industry groups criticised inclusion of consumer enforcement because:

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the penalty was disproportionate to the gravity of the breach, and therefore was inefficient;

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there were significant costs associated with defending consumer enforcement proceedings that may discourage some entrants to the market;

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there were already a range of remedies available to officials and consumers - consumer enforcement does not produce any improved industry behaviour;

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the consumer enforcement regime has a number of functions other than encouraging compliance (for example, provision of compensation and licensing) and the multiple functions can create tensions;

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consumer enforcement encourages excessive disclosure and skews industry resources toward compliance with obligations that, in relative terms, may be deserving of less attention than other obligations that are not subject to those actions.

9.53 On the other hand, the report noted that consumer groups strongly supported the role of consumer enforcement as assisting produce competition in the credit market, arguing that consumer enforcement has been fundamental in ensuring a compliance culture among credit providers.

9.54 The report concluded (at page 137) that the consumer enforcement regime in the UCCC facilitates the objective of truth in lending, as well as providing a significant redress mechanism for borrowers. They facilitate fair trading outcomes including:

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provision of redress mechanisms for consumers; and

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minimal misleading, deceptive or unconscionable conduct by market participants.

9.55 The report did not recommend removal of the consumer enforcement regime in the UCCC.

9.56 In the development of the national credit framework, options for ASIC's enforcement powers and the inclusion of criminal, civil and infringement notices was discussed with ASIC, the Criminal Law Branch of Attorney-General's Department and the Financial Services and Credit Reform Implementation Taskforce (FSCRIT). FSCRIT is chaired by Australian Treasury and comprises officials from the States and Territories. The State and Territory officials were mainly from agencies responsible for administration of the UCCC, but also included some central agency representatives. Enforcements issues were also raised more generally with the Industry and Consumer Consultation Group (see discussion above under the 'Consultation' heading).

9.57 A theme of the discussions was a concern, particularly on the part of FSCRIT members, that the proposed new regulator ASIC would have sufficient regulatory tools to take action to address undesirable behaviours, and do so in a consistent manner across jurisdictions. ASIC favoured including infringement notices in the combination of enforcement tools and those views were taken into consideration.

9.58 In relation to these issues, the main matters raised by industry and consumer groups were that the sanctions are commensurate with the level of undesirable behaviour and that the regulator has appropriate enforcement,

9.59 These concerns have been considered in the development of ASIC enforcement powers and penalties and are reflected in the inclusion of infringement notices in the proposed enforcement regime.

Conclusion and recommended option

9.60 The main disadvantage of Option A compared to the status quo are transitional costs for the regulator and the regulated population in becoming familiar with a different compliance regime, including developing associated procedures. However, those costs are outweighed by the benefits to government, business and consumers associated with having a wider range of enforcement options available to the regulator, particularly in relation to the lower level breaches.

9.61 The recommended option is Option A.

3.2

Consumer lending for residential investment properties

Problem identification

9.62 Loans for the purchase of residential investment properties for investment purposes (that is, not for owner-occupied properties) are currently excluded from the scope of the UCCC.

9.63 There have been long-standing concerns in respect of the conduct of credit providers in connection with the provision of credit for residential investment properties. Examples of conduct that has adversely impacted on consumers include the provision of credit for properties that are sold as part of a 'scheme' operations that might include the following aspects:

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inflated prices for the residential investment property, including two-tiered property schemes where prospective borrowers are cold-called and flown interstate, and sold a property that is significantly above the market value;

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misrepresentations and misleading information provided to consumers about residential property investments, including future taxation and income streams;

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arrangements that involve consumers putting their homes at risk by using it as security in respect of the investment property loan, especially low or middle income borrowers who would otherwise not be eligible for a loan.

9.64 One or more of the above features have, in many cases, produced negative financial consequences for consumers - in particular, an inability to make the required repayments as required and facing forfeiture of the investment property and/or the consumer's home as a result.

9.65 To address those concerns, the Government has decided to extend the scope of the consumer credit framework to cover credit provided for the purpose of purchasing residential investment properties. The effect of that extension would be to subject credit providers for residential investment properties to registration and licensing requirements and responsible lending conduct obligations.

9.66 Having regard to that decision, the problem to be addressed in this RIS is the scope of the extension to residential investment property.

Objective

9.67 The objective in regulating credit for residential investment properties is to significantly reduce the frequency of negative financial outcomes for consumers in the residential investment credit market without imposition of unnecessary regulatory costs and impositions.

Options

Status quo

9.68 Retaining the status quo position (that is, no regulation of consumer credit for residential investment properties) is not a feasible option in light of the Government's decision. However, a description of the costs and benefits associated with the status quo are included as a benchmark against which the other options may be measured.

Option A: Broad scope

9.69 Under Option A (the broad approach), all scenarios involving the provision of credit to consumers (as that term is defined in the UCCC) for the purpose of residential investment properties would be covered by the new regulatory framework. In particular, the credit provision would be covered:

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regardless of the quantum of the loan;

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even if more than one investment residence is to be purchased;

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even when the residence to be purchased is under construction or bought 'off the plan';

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whether or not the consumer provides security over their existing property (particularly their own home) to provide additional collateral for the credit.

Option B: Narrow scope

9.70 Under Option B (the narrow approach), there could be one or more exclusions from the scope of the additional regulation, on the basis that participants in such transactions do not require the protections that would be provided under the consumer credit regulatory framework. For example, the exemptions that might be given would be including:

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for loans of amounts exceeding a specified (high) value, or to purchase more than one residential investment property;

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purchases for residences that have not been constructed or construction is not complete;

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loans for investment properties that do not involve the consumer providing additional security over existing assets, particularly their own residences.

Impact analysis

9.71 The groups affected by the new regime for would be consumers of credit; industry participants (principally lenders and, indirectly, advisers); and the Government and ASIC.

9.72 The businesses that would be potentially affected by the extension of the scope of the arrangements to residential investment properties would include a subset of the credit providers referred to under the 'ASIC enforcement powers' section. Not all credit providers would be affected because some providers do not deal in home loans. Also affected would be advisers in respect of investment home loans, such as mortgage brokers. Persons conducting business as 'property spruikers', whose business model includes encouraging or assisting clients to obtain credit from a particular source for an investment property purpose, would also be affected.

9.73 In its 2005 report Property Investment Advice - Safe as houses, the Parliamentary Joint Committee on Corporations and Securities noted that about 13 per cent of Australian households receive rental income (up from about 9 per cent in 1995), compared with about 6.5 per cent in both the United States of America and Canada, and 2 per cent in the United Kingdom. A large proportion of those investment properties would be financed with credit. The Committee noted that, in 2005, more than 30 per cent of home loans are for investment purposes. Figures from the Reserve Bank Bulletin from January 2009 (table D5) indicate that the proportion of home loans for investment purposes is still just above 30 per cent.

9.74 Both the providers of investment home loans, and persons assisting others to enter investment home loans (such as mortgage brokers) would be affected by a regulatory framework that includes investment home loans within its scope. If a broad scope were adopted, they would be required to comply with the same obligations as participants in providing other types of consumer credit under the new framework, including:

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obtaining a licence to carry on the business;

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as a consequence of licensing, being required to be members of external dispute resolution facilities and meet other obligations, such as conducting their business honestly and fairly;

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making assessments prior to entering into arrangements of whether clients are likely to be have the capacity to meet certain obligations, including obligations to repay.

9.75 Most of the participants in the investment home loan credit market would also offer their products and services in relation to loans for owner-occupied dwellings, which are clearly within the scope of the existing regulatory framework and the proposed new national credit framework. Accordingly, they would be required to meet obligations such as obtaining a licence in any event. However, the incorporation of investment home loans within the scope of the framework would mean that the transaction-based obligations, such as disclosure and assessment, would need to be met in relation to a wider class of transactions. The transaction-based disclosure and assessment obligations are described in detail in the regulation impact assessment under the 'Responsible lending conduct requirements' section below (Part 3.4).

9.76 The distinction between Options A and B would mean that the transaction-based obligations would only need to be met in a narrower range of transactions. However, few, if any, participants would be relieved of the 'one-off' obligations, such as obtaining a licence. That is because few, if any, participants have a business model that only involves dealing in the types of loan transactions that would fall within the possible exempt categories. Under Option B, almost all participants would deal with both exempt and non-exempt classes of transactions.

9.77 Accordingly, the difference in compliance costs between the status quo and Option A is likely to be very great for those participants that deal exclusively in investment home loans, as they would not fall outside the regulatory framework altogether under the status quo. Only a small proportion of participants would fall in that category. Most would fall within the scope of the framework for their other business activities (for example, owner/occupier home loans), and the additional compliance costs would result from the regime being applied to a wider range of transactions. The difference in compliance costs for industry participants between Options A and B is not likely to be significant as few participants would have businesses that operate solely or largely in the transaction classes proposed for exemption under Option B.

9.78 For consumers considering investment properties, the benefits of the regulatory framework for credit applying to investment properties will be:

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access to enhanced pre-contractual disclosure;

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remedies, including remedies for unjust conduct; and

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statutory rights to apply for a hardship variation.

9.79 Consumers will also be protected through the application of the national credit laws in that:

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unscrupulous operators may be excluded from the market due to the licensing requirements; and

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participants will be under obligations to ensure the credit contracts for borrowers are not unsuitable and that they can afford the repayments.

9.80 Consumers that suffer serious adverse financial outcomes, including loss of their homes, due to default on credit contracts regarding investment properties can occur in large groups in cases where a major investment property scheme fails. Among the affected groups are some who, as a result of their losses, are likely to utilise government assistance in the form of, for example, the age pension. Minimising such occurrences produce a small financial benefit for government.

9.81 The difference Options A and B is that, under Option B, some transactions would not be covered by the regulatory framework due to exemptions being applied. For consumers, in cases where they have no need for the protections of the regulatory framework, Option B would be slightly preferable because they would not have to deal with disclosure information or respond to assessment queries. This benefit is offset by the risk that the exemptions might extend to some cases where the consumer would be protected from suffering loss due to the protections offered by the regulatory framework.

Status quo

Table 9.7

Option A

Table 9.8

Option B

Table 9.9

9.82 The tables which compare be reference to the status quo appear to indicate that regulation of residential investment credit has the greatest overall benefit to consumers, in the form of a reduction of negative outcomes. For government and industry, both would indirectly benefit from a reduction in negative consumer outcomes but there are offsetting costs as a result of the regulation. Overall, a broad definition, while it has increased costs, has a higher overall benefit relative to the status quo than a narrow approach.

9.83 It is also noted that broader approach has some benefits relative to a narrow approach because:

•

it avoids costs associated with resolving disputes around the 'edges' of the exemptions about whether a particular transaction is covered or not; and

•

it avoids arbitrary rules (such as dollar thresholds) to govern which transactions by the regulatory framework and which fall outside, which might be exploited by unscrupulous providers.

Consultation

9.84 In the course of the consultations with the Industry and Consumer Consultation Group, referred to in the 'Consultation' heading above.

9.85 Options A and B were discussed in detail. Stakeholders generally favoured inclusion of investment property credit without any significant modifications or variations, so that participants may apply the same procedures to these investment loans for other home loans. Stakeholders agreed that:

•

there was no particular exemption or circumstance associated with consumer credit for residential investment purposes for which the protection offered by regulation was not required; and

•

the definition of the type of investment credit to be regulated should be broad.

Conclusion and recommended option

9.86 Within the parameters of the decision to extend the application of the UCCC to credit for residential investment properties, the preferred position is to adopt a broad definition of the activity to be regulated (Option A).

3.3

Licensing of participants

Problem identification

9.87 In general, licensing a regulated population is intended to ensure that a particular product or service is provided to the public with a certain assurance of competence and quality. Licensing systems are common in financial services, where there are considerable information asymmetries that justify regulatory intervention.

9.88 These issues are particularly evident in respect of finance brokers and intermediaries. They were documented in detail in the RIS developed in the preparation of the Finance Brokers Bill drafted by New South Wales. That Bill was superseded by the proposal for the Commonwealth to take over the regulation of credit. The RIS noted that undesirable market practices included:

•

recommending products that give higher commissions to brokers but which are inappropriate, higher cost and/or unaffordable for clients;

•

misrepresenting applicants' financial details to ensure they qualify for loans in order that brokers obtain commissions, and when, if the lender was aware of the borrower's actual financial position, they would reject the application;

•

'upselling' loans to higher amounts to increase commissions;

•

engaging in 'equity stripping' with lenders, that is, arranging emergency loans for borrowers in financial difficulty (particularly those facing foreclosure of the family home) with high-cost credit providers, in the expectation that the borrower will ultimately default permitting subsequent transfer of equity in a consumer's home to the broker and the lender.

9.89 Concerns such as those were considered in the context of the decisions of the Australian Government and COAG in 2008 that providers of credit and of advice relating to credit are to become subject to a national licensing system administered by ASIC.

9.90 The issue discussed in this RIS is the preferred form of the licensing framework.

Objectives

9.91 The main objectives in establishing a licensing system for lenders and brokers of credit is to have a market environment for credit in which:

•

lenders and brokers/intermediaries act honestly and have adequate resources and competency to carry on their businesses;

•

borrowers who suffer losses because of a breach of their obligations by lenders or brokers/intermediaries are able to obtain compensation; and

•

dishonest or incompetent lenders and brokers/intermediaries are prevented from continuing to operate.

Options

Status quo

9.92 Under the current State-based regulatory framework there is no consistent requirement for providers of credit and services related to credit to be licensed. Some, but not all, states have established requirements in this area. Western Australia has a comprehensive licensing system for mortgage lenders and brokers. Victoria and the Australian Capital Territory have registration systems covering credit providers and brokers.

9.93 In light of the terms of the decisions by the Australian Government and COAG to introduce a national licensing system for credit administered by COAG the status quo is not a feasible option, but it has been included as a reference point against which the costs and benefits of other options can be compared.

Option A: Establish a new licensing system modelled on Chapter 7 of the Corporations Act

9.94 The issues raised above in relation to credit and credit-related advice are of a similar nature to those that prompted the establishment of the licensing system in Chapter 7 of the Corporations Act for investment products and related advice. Accordingly, a licensing model along those lines, adapted to suit credit, would clearly be an option for consideration in this context.

9.95 Key elements of this option would include:

•

The licensing framework would be included in the new consumer-credit legislation.

•

Any individual or entity proposing to provide credit (lenders) or credit-related services (brokers/intermediaries) would be required to obtain a licence from ASIC.

•

Licensees would be subject to a range of general conduct obligations modelled on the obligations in the Corporations Act, including that the business is run honestly, efficiently and fairly.

•

Competency/training requirements would be included, particularly for providers of credit-related advice.

•

Licensees would be required to implement appropriate compensation arrangements such as professional indemnity insurance.

•

ASIC would be provided with appropriate enforcement powers, including powers to suspend or cancel licences and to issue bans.

Option B: Expand the existing Chapter 7 of the Corporations Act licensing framework to include providers and brokers/intermediaries of credit

9.96 Rather than establish a new framework, another option would be to simply expand the existing Chapter 7 licensing system to include credit and credit-related services. Key elements of this option would include:

•

The main elements of the existing Chapter 7 licensing framework (Australian Financial Services Licence - AFSL) would be expanded to incorporate participants providing credit and credit-related services.

•

Participants would be licensed by obtaining an AFSL, but there would be new categories of AFSLs to encompass credit-related services.

•

The requirements regarding AFSLs (training, compensation, ASIC enforcement) would apply.

Impact analysis

9.97 The groups affected by the new regime for licensing would be consumers of credit; industry participants including lenders and advisers; and the Government and ASIC. Reference should also be made to the discussion in Part 3.1 under the heading of Impact Analysis, in respect of the likely regulated population.

9.98 The main group affected is industry participants who will need to become holders of an Australian credit licence (ACL) in order to continue engaging in credit activities. Currently there is a licensing scheme in Western Australia and a registration scheme in the Australian Capital Territory and Victoria for lenders and brokers. For persons operating across jurisdictions, or nationally, the position will be simplified in that they will now only need to hold a single licence.

9.99 The most significant impact will be on those who only conduct business in States or Territories where there is currently no licensing or registration scheme. It can be anticipated that these businesses will face significant transitional costs. However, within this group the impact will be less on those persons (predominantly brokers but also some lenders) who are members of an industry body, the Mortgage and Finance Association of Australia, as these persons, in order to qualify for membership, must already meet some of the proposed obligations (for example, they must be a member of an EDR Scheme and hold professional indemnity insurance).

9.100 From the participant perspective, licensing will involve one-off costs in applying for a licence, together with ongoing licence fees. There will be also be one-off costs of preparing the application and the costs of complying with the ongoing obligations associated with the licence, including, in particular:

•

training and supervision costs; and

•

maintaining adequate compensation arrangements (for example, professional indemnity insurance).

9.101 In respect of training and supervision, it is proposed that the Bill will include clauses requiring licensees to ensure that representatives understand and adhere to compliance arrangements. It is expected that ASIC will provide guidance on what it considers are the relevant competency standards.

9.102 It is proposed that the Bill will provide for an obligation to maintain such compensation arrangements as are specified, either in the regulations or formally by ASIC. It is likely that professional indemnity insurance is one type of compensation arrangement likely to be specified.

9.103 The costs of the above will vary greatly with the size of the licensee's business and the extent to which external advisors are engaged to assist with the process. However, guide, the one-off costs under the existing licensing regime for financial services would be a minimum of several hundred dollars in up-front and annual expenditure for a small firm with no employees or external advisors, through to many thousands of dollars for a large firm.

9.104 It is not considered that there would be any significant difference in the compliance cost impact for industry between Option A and Option B. As noted above, the submissions in response to the Government's Green Paper on Financial Services and Credit Reform indicated a reasonable level of industry support for Option A.

9.105 Consumers will benefit from licensing in that:

•

unscrupulous operators will be excluded from the market where they fail to meet the licensing requirements (whereas at present they can move to a jurisdiction with no or minimal entry requirements if they are banned in another State or Territory); and

•

the standards of conduct in the industry should improve over time due to the obligations attached to licensing.

9.106 Establishing a licensing regime, or extending the existing regime to cover credit advice, would involve significant resources on the part of the regulator. In the 2008-09 Additional Estimates process, the proposed regulator, ASIC, was allocated $66.7 million in funding over four years to administer the new national consumer credit function. A proportion of that funding will be used in connection with the establishing the licensing framework for consumer credit, including processing applications.

Status quo

Table 9.10

Option A: Establish a new licensing system modelled on Chapter 7 of the Corporations Act

Table 9.11

Option B: Expand the existing Chapter 7 of the Corporations Act licensing framework to include providers and brokers/intermediaries of credit

Table 9.12

Consultation

9.107 Licensing was a key focus of the Industry and Consumer Consultation Group, referred to in the 'Consultation' heading above. Stakeholders discussed:

•

the desirability of a separate licensing scheme for credit providers, rather than including credit in the definition of 'financial products' in the existing AFSL regime in the Corporations Act:

-

stakeholders generally opposed the incorporation of consumer credit into the AFSL regime as credit was fundamentally different to other financial products (note that margin loans were an exception because of their close connection with investment products regulated under the Corporations Act), so the favoured option was the creation of a tailored framework for consumer credit including a standalone licensing scheme;

•

ways to minimise costs to industry where the same entity holds an AFSL and an ACL (including, for example, the desirability of having the same licence number where possible);

•

transitional arrangements, including the desirability of the legislation being supplemented by regulatory guidance from ASIC; and

•

a range of technical issues, such as:

-

the circumstances in which a person who is assigned a loan by a licensed credit provider should be required to become licensed; and

-

a number drafting options for draft legislative clauses.

9.108 Feedback received from the group has been factored in to the design of Option A. In particular, it is proposed that a streamlined mechanism for licensing will be incorporated for persons that already hold an AFSL, or certain licences under State-based regulatory frameworks.

9.109 It should be noted that some stakeholders were also members of the consultation group in relation to margin loans (which is addressed in a separate Bill), where the unique aspects of this product, and its intermingling with shares or other financial products, led to a different approach to regulation.

Conclusion and recommended option

9.110 Options A and B would both offer significant benefits to consumers and overall benefits in comparison with the status quo. The cost-benefit profiles for both yield identical outcomes using this methodology, so the choice between them is finely balanced.

9.111 The advantages of Option A are that incorporating a licensing framework into the existing AFSL system in Chapter 7 of the Corporations Act would offer potential efficiencies for government in establishing and maintaining the framework and, for those businesses that already hold an AFSL for other products, they would already be familiar with the system.

9.112 The disadvantage, in comparison with Option B, is that the existing framework was not designed with credit products in mind. It would require significant tailoring to ensure it applied appropriately, though both exemptions and variations. Those would result in introduce additional complexities and costs for participants, as well as introduce perceived anomalies.

9.113 An independent system can be tailored to its purpose at the outset, and reduce the risk of elements that are unnecessary in the credit context to be applied unnecessarily. For example, the arguably requirements in the AFSL licensing framework for licensees to have compensation arrangements in place may not need to be of the same nature or size when the consumer has received credit as when they have invested funds. Similarly, remedies for consumers associated with unlicensed conduct are likely to need to be different, as remedies such as rescission are most appropriate in the investment rather than the credit environment.

9.114 On balance, Option A is preferred.

3.4

Responsible lending conduct requirements

Problem identification

9.115 According to the May 2008 final Productivity Commission's report on the Review of Australia's Consumer Policy Framework (the PC Report) there has been an increased use of credit in Australia over the last 20 years.

9.116 This growth has contributed to historically high levels in the stock of debt held by households as well as increased commitments required to service debt. Evidence suggests that these increases have come about mostly as a result of the growth in the size of home loans.

9.117 The distribution channels for the provision of credit to consumers (such as the use of various intermediaries) and the development of products such as no and low documentation loans have often resulted in a separation from the borrower from the lender and limited or filtered the documentation and enquiries made regarding a consumer's financial position when seeking to apply for credit.

9.118 Concerns have been expressed that this 'separation' factor, when combined with incentives for persons in the distribution chain to issue loans, have resulted in many consumers entering into credit transactions that are unsuitable for their credit requirements and/or are unsuitable, in the sense that they are, or become, unable to meet the relevant obligations without suffering hardship.

9.119 Consumer defaults, particularly on home loans, can cause intense personal hardship to individuals and families and, due to the flow-on effects on such issues as housing prices, can have broader economic implications if they occur on a large scale.

9.120 In response to those concerns, in September 2008 the Australian Government decided that the phase one of the implementation plan on national consumer credit regulation framework should include the regulation of responsible lending conduct. This decision was endorsed by COAG on 2 October 2008.

9.121 The problem addressed in this RIS is, what the key elements of the new regulatory framework for responsible lending conduct should be.

Objectives

9.122 The key objective is to establish a regulatory framework for responsible lending conduct (in accordance with the decisions of the Australian Government and COAG) in a manner that strikes a reasonable balance between the goals of minimising the incidence of consumers entering unsuitable credit contracts, and the goal of maximising access to credit for consumers who have the desire and ability to service it.

Options

Status quo

9.123 Retaining the status quo position (that is, no formal regulatory framework for responsible lending conduct) is not an option in light of the 2008 decisions of the Australian Government and COAG. However, a description of the costs and benefits associated with the status quo are included as a benchmark against which the other options may be measured.

Option A: Regulation of the provision of credit advice

9.124 Under Option A, advice to consumers about credit would be regulated in the same way to the regulation of advice about financial products under the Corporations Act. This option would include regulatory elements such as:

•

requiring the adviser to undertake sufficient inquiries into the consumer's personal circumstances (not only financial circumstances) and conducting sufficient investigation;

•

requiring the adviser to have a reasonable basis for any financial product advice;

•

requiring the advice to be of a standard that is appropriate for the client;

•

requiring the adviser to document all advice and the basis for that advice in a Statement of Advice to a level of detail that allows the consumer to decide whether to act on the advice and requiring a number of prescribed mandatory inclusions in the statement;

•

requiring disclosure of any commissions that are payable or receivable by the adviser or the adviser's employers, and any other interests that might be capable of influencing the advice given for every financial product recommended;

•

requiring mandatory provision of a Statement of Advice to the consumer within five working days; and

•

imposing higher level obligations on advice that recommends the replacement of one product with another.

Option B: Responsible lending conduct obligations

9.125 Under Option B, there would be regulation of certain conduct in relation to credit contracts, which would be known as 'responsible conduct' obligations. Those rules would provide for persons involved in the credit supply chain to observe a number of obligations, chiefly that:

•

persons providing credit (credit providers), persons suggesting credit or assisting persons to obtain credit (credit assisters); representatives of such persons and debt collectors would all be required to issue to consumers a credit guide, which includes basic information about the identity of the participant, dispute resolution, and compensation arrangements;

•

credit assisters suggesting persons enter credit contracts would be required to make preliminary assessments about the suitability of the contract, in terms of whether it meets the consumers' requirements and also whether the consumer can meet the financial obligations under the proposed contract; and

•

credit providers would, before entering into a credit contract with the consumer, be required to conduct a suitability assessment.

Impact analysis

9.126 The groups affected by the amendments are consumers of credit; industry participants including credit providers and credit service providers; the Government and ASIC.

9.127 In terms of benefits to consumers, regulation of credit advice and applying responsible conduct obligations both offer the prospect of preventing consumers entering unsuitable contracts. However, as the responsible conduct obligations would apply to advisers and lenders, it is likely to be somewhat more effective at achieving that goal. Option A, however, offers consumers the prospect of higher quality advice more generally (rather than merely preventing unsuitable contracts). Overall, the benefits for Options A and B are of a similar magnitude.

9.128 The costs of complying with the obligations for the type of regulation under Chapter 7 (Option A) are familiar to businesses that provide financial product advice. The RIS for the Corporations Legislation Amendment (Simpler Regulatory System) Bill (2007) noted that the industry has indicated that the cost of preparing an statement of advice is approximately $260 on average. That estimate was based on cost estimates provided by industry for producing a Statement of Advice, which primarily consists of the time that an adviser would spend on documenting the client's information and the advice provided. It does not include the costs of making appropriate inquiries of the client and doing the analysis.

9.129 The costs associated with complying with Option B would primarily relate to the obligations to prepare and provide a credit guide and undertake the suitability assessments.

9.130 The provision of a credit guide is expected to be of a similar compliance cost to the Chapter 7 requirement to provide a Financial Services Guide. The major costs associated with the guide for most licensees would be in compiling and checking that the information is accurate and meets the requirements of the legislation. Many licensees may choose to use external advisors in that process. If in printed form, it would cost the same to produce as a small pamphlet or brochure - the unit cost being dependent on volume.

9.131 The requirement to undertake a suitability assessment will involve making reasonable inquiries about how the proposed credit would impact on the consumer's financial situation. Such inquiries might include obtaining information regarding:

•

the consumer's current income and expenditure, and the maximum amount the consumer is likely to have to pay under the proposed contract;

•

any expected significant changes in the consumer's financial circumstances.

9.132 The extent of the required inquiries will be dependent on the circumstances of the individual case, in particular the significance of the proposed credit in the context of the consumer's overall finances. Prudent lenders and credit brokers/advisers would ordinarily make inquiries along similar lines as of their normal business operations, in order to assess the customers' capacity to repay. It is proposed that provision will be made to minimise duplication of inquiries where a consumer deals with intermediaries rather than with the lender directly.

9.133 Industry groups expressed significant concern about the compliance costs associated with applying an advice regime for credit similar to the advice framework in Chapter 7. As between Option A and B, the least costly option in terms of compliance costs is likely to be Option B.

Status quo

Table 9.13

Option A: Regulation of the provision of credit advice

Table 9.14

Option B: Responsible lending conduct obligations

Table 9.15

Consultation

9.134 The Industry and Consumer Consultative Group (referred to in the Consultation section above) was consulted in relation to this issue.

9.135 Industry participants were very strongly opposed to a proposal that would apply a regulatory framework similar to Chapter 7 of the Corporations Act to advice relating to credit. Participants cited high compliance costs and complexity of the advice framework under Chapter 7 and submitted that it would be in appropriate to apply a framework designed primarily to an investment context to advice in relation to credit.

9.136 Consumer advocates expressed the view that responsibility for making responsible lending decisions should rest with the credit providers - not only those providing advice.

9.137 The views of stakeholders on this issue were a key consideration in development of the alternative Option B, which is based on responsible lending conduct and unsuitability assessments.

Conclusion and recommended option

9.138 Option B is preferred. As it requires persons suggesting consumers enter contracts, and persons actually entering contracts, to consider suitability, it is likely to be more effective than Option A at reducing the incidence of consumers entering unsuitable credit contracts and suffering hardship. Further, the overall compliance costs of associated with the option are likely to be lesser than the costs associated with regulating advice in a similar manner to advice regarding financial products similar to the current framework in the Corporations Act.

Part 4: Implementation and review

9.139 The recommended options would be implemented primarily through the introduction of the National Consumer Credit Protection Bill 2009 and consequential amendments to legislation including the Corporations Act and the Australian Securities and Investments Commission Act 2001. Associated regulations would also be required.

9.140 There will be an opportunity to refine the framework established in phase one of the project in the course of developing phase two, which is proposed to include investment credit.

9.141 The new credit laws would, like the regulatory framework for regulation of corporate regulation and financial services, be the subject of ongoing monitoring and review by the Australian Government.