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 6 - Regulation impact statement - Margin loans - Attachment A

Executive summary

6.1 This is the regulation impact statement (RIS) referred to in paragraph 5.5 of Chapter 5. This RIS discusses:

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The development and implementation of a national regulatory framework for consumer credit (including margin loans) to be undertaken in two stages. The key components of the proposed framework seek to establish consumer protection across all consumer credit products and services. The framework is proposed to be developed by enacting relevant State and Territory based consumer credit regulations as Commonwealth statute; and consolidating and enhancing the framework as necessary to reduce the regulatory burden on business and strengthen protection in specific areas.

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Consultation on aspects of the proposed framework including the need for any enhancements (as outlined in the high level implementation plan and discussed herein) and its implementation.

Background

Consumer credit

6.2 Consumer credit is credit given by shops, banks and other financial institutions to consumers so that they can buy goods and services for personal, household or domestic purposes. Consumer credit encompasses for example, credit cards, payday loans and personal loans as well as mortgages.

6.3 The provision of consumer credit is a significant industry in Australia. As of June 2008, total consumer credit on issue, including securitisations, was $1,113.4 billion. Of this, housing credit on issue stood at $957.8 billion and other personal credit on issue was $155.6 billion. The largest sector of consumer credit is residential mortgages, which are estimated to account for over 86 per cent of all consumer loans. ^[1]

6.4 Industry participants include providers (also known as lenders and issuers) and brokers/advisers who act as intermediaries between providers and consumers. Providers are increasingly relying on brokers to originate loans - in 2003 25 per cent of home loans were originated by mortgage brokers, this rose to 37 per cent in 2007. ^[2]

6.5 The States and Territories currently regulate the provision of consumer credit by any provider through the Uniform Consumer Credit Code (UCCC).

6.6 While the provision of consumer credit is currently excluded from being a financial product under Chapter 7 of the Corporations Act 2001 (Corporations Act), Australian Securities and Investments Commission (ASIC) does regulate some consumer protection aspects of consumer credit. Specifically, the Australian Securities and Investments Commission Act 2001 (ASIC Act) prohibits conduct that is misleading or deceptive, or is likely to mislead or deceive, in relation to the provision of credit products and services.

6.7 The Council of Australian Governments (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. Subsequently, on 3 July 2008, COAG agreed that the Australian Government would also assume responsibility for regulating all other consumer credit products and requested the Business Regulation and Competition Working Group report back at the 2 October meeting with a detailed implementation plan for other credit.

Current regulation of consumer credit

6.8 The UCCC's scope is limited to the provision of consumer credit for personal, household or domestic purposes. As such consumer credit sought for investment purposes and credit-related advice is not regulated.

6.9 The main provisions contained in the UCCC include the following:

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provisions relating to the credit contract, including the form and content of the contract, how information about the contract is disclosed to the consumer, and how the contract may be changed;

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special provisions relating to circumstances where consumers are affected by hardship, including powers of a court to intervene in such circumstances;

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provisions relating to the enforcement of credit contracts, in particular what steps creditors must undertake before they can enforce a contract against a defaulting debtor;

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extensive provisions relating to civil penalties for breaches of the UCCC;

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special provisions regarding related sales and insurance contracts, as well as consumer leases; and

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provisions relating to the advertising of credit, including requirements for including a comparison rate.

History of the Uniform Consumer Credit Code

6.10 In 1993, the States and Territories agreed that consumer credit laws should be nationally uniform. They entered a Uniform Credit Laws Agreement (the Uniformity Agreement) under which the UCCC was developed. The UCCC is template legislation, substantially uniform in all Australian States and Territories. It was enacted in Queensland by the Consumer Credit (Queensland) Act 1994 pursuant to the Uniformity Agreement, and in the other States and Territories through various arrangements.

6.11 Under the Uniformity Agreement, amending the consumer credit legislation requires approval by two thirds of the members of the Ministerial Council for Uniform Credit Laws (the Council), which is a subcommittee of the Ministerial Council on Consumer Affairs (MCCA). Membership of the Council consists of the State and Territory Ministers responsible for consumer credit laws. Changes to the Uniformity Agreement itself require the unanimous approval by the Council.

6.12 The Australian Government is not a member to the Uniformity Agreement and does not have a formal vote in matters relating to the UCCC. It is however invited to comment on all matters relating to the UCCC considered by the Council.

Outstanding UCCC projects

6.13 To address gaps in the UCCC and changes in the credit environment, MCCA has already decided to implement some specific amendments to the UCCC. These amendments are expected to be introduced prior to the Commonwealth assuming responsibility and therefore reflected in the UCCC which will be transferred over at that time. These are:

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' Instalment' lending - amendments will ensure that vendor finance contracts for the purchase of land, 'conditional sale agreements' and 'tiny terms contracts' are brought within the scope of the Code.

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Default notices - to improve the enforcement process for both lenders and borrowers by giving consumers clearer and more relevant and understandable information when they default.

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Amendments to address ' fringe' lending practices - to address avoidance practices, increase the reviewability of credit fees and charges, improve regulator access to remedies, prohibit 'blackmail' securities and require lenders to supply basic direct debit information.

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Reform of Mandatory Comparison Rates - to reform and streamline the operation of mandatory comparison rates (MCR) by responding to the independent review.

6.14 MCCA is also undertaking a number of projects in relation to the UCCC, which are in varying stages of development. These projects will be passed to the Commonwealth when it assumes responsibility and will be considered in the context of the national approach to the regulatory framework:

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Reverse mortgages and other equity release products - to improve consumer outcomes in relation to equity release products.

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Pre-contractual disclosure - to provide consumers with simple, accessible, relevant, concise and comprehensible pre-contract information.

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Universal membership of External Dispute Resolution (EDR) Schemes - to explore the feasibility of requiring all credit providers to belong to an approved EDR Scheme.

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Credit card responsible lending - to explore options to address credit card over-indebtedness.

Additional State and Territory specific regulation

6.15 By agreement among the States and Territories certain areas are exempted from the uniformity requirements applying to the UCCC. Additionally, some jurisdictions have moved unilaterally to address specific concerns. Accordingly, there are a number of differing requirements which are intended to augment the operation of the UCCC in the States or Territories in which they have application. For example:

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Victoria, New South Wales, Western Australia and the Australian Capital Territory have some limited broker specific regulation. The Western Australian legislation requires all finance brokers to be licensed and members of an EDR Scheme.

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New South Wales, Australian Capital Territory, Victoria and Queensland have legislation which limits the rate of interest and fees which can be charged on consumer credit products. South Australia expects to pass similar legislation by the end of 2008.

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Victoria has passed legislation which is to commence in March 2009 which will subject credit contracts to the unfair contact terms provisions in the Fair Trading Act. Victoria has also passed legislation due to take effect in March 2009 which requires all credit providers to be members of an EDR Scheme. In addition, Victoria is examining the requirement for enhanced registration of credit providers.

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South Australia is expected to pass legislation by the end of 2008 which will allow credit disputes to be heard in lower courts.

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Tasmania is expected to introduce a Bill into Parliament shortly that will restrict the advertising of high cost credit products.

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The Australian Capital Territory has legislation which imposes responsible lending requirements on credit cards providers.

Draft New South Wales National Finance Brokers Package

6.16 In addition to the UCCC and specific regulation mentioned above, the States and Territories have also agreed to national reforms aimed at regulating the finance broking industry, as recommended in the relevant decision-making RIS, subject to consultation on a draft Bill.

6.17 To this end, in November 2007, the New South Wales Government released the draft National Finance Brokers Package for public consultation on behalf of all jurisdictions.

6.18 The draft Finance Brokers Bill proposes to license all brokers to ensure that only reputable, skilled brokers transact with consumers and small businesses to obtain credit that suits their purposes and that they can afford. Applicants would be required to:

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pass probity checks;

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maintain mandatory membership of an approved EDR Scheme;

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attain prescribed educational qualifications or skills (not below a Certificate IV); and

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obtain mandatory professional indemnity insurance.

6.19 In addition, the draft Bill imposes a requirement that brokers confirm a person's capacity to repay before applying for credit; disclose certain information and have a reasonable basis for any recommendation. Further, brokers would not be able to charge a fee before credit was obtained.

6.20 Over 100 submissions were received and consultations conducted by New South Wales have revealed broad support for the draft Bill. However some concerns remain in relation to a few specific provisions, namely the capacity to repay, stay of enforcements and professional indemnity requirements.

6.21 In light of the COAG decisions it has been agreed that the Commonwealth will take over the project, and conduct further consultation on the remaining concerns. In accordance with the conditional approval given to the project by the Office of Best Practice Regulation, an updated assessment of the regulatory impact of the proposed regime will be undertaken once the details are established.

Margin loans

6.22 Margin lending describes an arrangement under which investors borrow money to buy financial products (such as listed shares, fixed interest securities and units in managed funds). The underlying financial products are then used to secure the loan for those products. The amount the investor can borrow depends in the loan-to-valuation ratio (LVR) offered by a lender of each stock.

6.23 As with most other loans, investors must pay interest on the amount borrowed under a margin loan, however regular repayments are not generally required. Instead, repayments are only required when the investment is subject to a 'margin call'. This occurs where the market value of the investment falls below the level agreed under the contract. A margin call requires the investor to take appropriate action to return the LVR to the agreed limits stated under the contract. This can be done by paying extra cash, selling some of the assets or giving the lender additional security. The lender is under no obligation to contact the investor when a margin call is made. The responsibility falls on the investor to take appropriate action in accordance with the timeframes, potentially less than 24 hours, as prescribed in the margin loan agreement.

6.24 There has been a rapid growth in the value of margin loans with the total value increasing from under $5 billion in June 1999 to over $37 billion in December 2007. More recently the total value of margin loans has dropped back to around $32 billion in response to the recent market turbulence. Consistent with the growth over the past nine years, the number of clients taking out margin loans has increased from 87,000 in 2000 to 202,000 in 2008.

Current regulation of margin loans

6.25 Margin loan facilities are based on complex contractual arrangements between the lender and the client. Primary disclosure of the terms and conditions governing the loan occurs through the lending agreement signed between the two parties.

6.26 Margin loans consist of a credit component and an investment component. Where the investment aspect involves a financial product such as shares, Australian Government regulation in the form of Chapter 7 of the Corporations Act applies.

6.27 In addition, where the investment aspect involves a listed share, Australian Securities Exchange (ASX) Listing Rules might apply. The Listing Rules set standards of behaviour for listed entities and include ASX's continuous disclosure requirements.

6.28 Misleading and deceptive conduct in relation to margin lending is regulated under the ASIC Act. Under this legislation ASIC can, for instance, take action against misleading advertising or misleading statements made by financial advisers in relation to the provision of margin loans.

6.29 The credit component of the margin loan transaction is currently largely unregulated. Margin loans are not regulated by the States and Territories under the UCCC, as credit provided for investment purposes is excluded.

6.30 The Corporations Act excludes all credit under the agreement with the States and Territories. However, where a margin loan is provided through a financial planner as part of an overall financial plan, ASIC considers that the Corporations Act applies to all the elements of the plan, including the margin loan facility as it is considered to be an investment vehicle.

6.31 As margin loans are supplied by a variety of providers, including banks, various industry standards, such as the Australian Bankers' Association Code of Banking Practice, may apply.

6.32 The Code of Banking Practice, which applies to personal and small business bank customers, sets out the banking industry's key commitments and obligations to customers on standards of practice, disclosure and principles of conduct for their banking services. This Code is not legislation; however, banks that adopt this Code are contractually bound by their obligations under this Code.

6.33 If the provider of a margin loan has adopted the Code of Banking Practise there is an obligation on the bank to exercise care and skill in determining a customer's ability to repay the loan. Under this Code members are required to provide both an internal and EDR Scheme for customer disputes.

6.34 However, margin loans are increasingly being provided by non-deposit taking institutions. Clients of these lenders do not benefit from the protection of the Code of Banking Practice.

Financial Services Reform - Chapter 7 of the Corporations Act

6.35 The Financial Services Reform Act 2001 (FSR) put in place a regulatory framework for the provision of a wide range of investment and risk management style financial products and advice related to those products, including securities, derivatives, general and life insurance, superannuation, deposit accounts and non-cash payments. This regime was incorporated as Chapter 7 of the Corporations Act.

6.36 The regulatory framework introduced under Chapter 7 sought to promote confident and informed decision making by consumers of financial products and services while facilitating efficiency, flexibility and innovation in the provision of those products and services; fairness, honesty and professionalism by those who provide financial services; fair, orderly and transparent markets for financial products; and the reduction of systemic risk and the provision of fair and effective services by clearing and settlement facilities.

6.37 The FSR regime provides for:

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All financial services providers are licensed and subject to uniform obligations and requirements by ASIC in the provision of the services for which they are licensed.

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All providers of financial services (including issuing, broking and advice) are uniformly regulated in the provision of the regulated financial products (noting tailoring of provisions for specific products and circumstances).

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Minimum standards such as training, disclosure, considerations in giving financial product advice, and general conduct are required of licensees in their dealings with retail clients:

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there are tiered training requirements, dependent on the level of advice and type of product being provided;

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membership of an EDR Scheme is compulsory;

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providers are required to conduct their services efficiently, honestly and fairly;

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there must be a reasonable basis on which providers base their advice; and

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disclosure of information to retail clients in relation to the provider's financial services business (in a Financial Services Guide), financial services advice (in a Statement of Advice) and financial services products (in a PDS) is required.

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All providers must have adequate compensation arrangements (generally professional indemnity insurance).

6.38 The Government has tasked the Financial Services Working Group to reform financial services disclosure documents in order to introduce simple, standard and readable documents which are more easily understood by consumers and allow for greater ease of product comparability. ^[3] Once implemented, these reforms may reduce compliance burden involved in complying with FSR and therefore produce cost savings.

Problem identification

Consumer credit

6.39 The inter-jurisdictional processes for changing the UCCC have led to prolonged delays in implementing necessary reforms leading in some cases to their effective abandonment. Amending the UCCC is a slow and arduous process requiring agreement among all jurisdictions. The protracted time frames for developing national finance broker regulation and for closing off some identified loopholes in the UCCC such as those related to the regulation of fringe lenders, are cases in point. Such delays have compromised the capacity of the regulatory regime to respond to market developments and the effectiveness of protections for those acquiring credit products and services, particularly in a market where products and practices are evolving rapidly.

6.40 The introduction of various State and Territory specific regulations has resulted in inconsistent consumer protection and has added red tape and unnecessary compliance costs on service providers. While the UCCC notionally provides for consistent administration and enforcement of a consumer protection code nationally, jurisdictions have unilaterally imposed additional requirements separate from the UCCC. Consequently, protections available to consumers acquiring credit are not uniform across jurisdictions and have resulted in providers who operate nationally or in multiple jurisdictions incurring additional compliance costs arising from the need to vary their business practices. Where this occurs, complexity and additional costs are imposed on consumers and businesses.

6.41 There is evidence that some consumers who access credit through brokers are not achieving appropriate outcomes. The concerns with the lack of regulation of brokers are well documented in the RIS prepared for the National Finance Broking Regulation. For example, the number and range of credit products currently offered by providers are too numerous and too complex to allow the majority of consumers to make fully informed decisions. As a result many consumers are turning to brokers. However, the use of a broker may not produce the best outcome, and could lead to considerable detriment, for the consumer. This is because consumers are often dependent on the broker's skill and expertise and therefore vulnerable to exploitation. Unfortunately, it appears some brokers may provide inappropriate advice and this occurs for a variety of reasons, including a lack of skill, remuneration based incentives and unscrupulousness.

6.42 There is evidence that some consumers are experiencing financial difficulties caused by over-indebtedness. There are a number of causes of this, for example, some consumers do not appreciate the implications of obtaining credit, and/or have an unrealistic appreciation of their capacity to repay. In addition, some providers' assessment practices maximise the amount of credit able to be granted but which cannot be repaid by the consumer without substantial hardship. The concern with the lack of a requirement on participants to establish a consumer's capacity to repay are well documented (albeit in a limited context) in the RIS on responsible lending practices in relation to consumer credit cards.

6.43 Consumers' access to dispute resolution mechanisms other than the Courts is limited under the UCCC as participants are not required to be members of an EDR Scheme. Therefore consumers who are unable to resolve a dispute directly with a provider who is not voluntarily a member does not have access to dispute resolution services outside of the court process. Court processes are often complex, time consuming and costly and therefore not a particularly viable solution.

6.44 Currently consumers have only limited protections when obtaining credit for investment or small business purposes. The UCCC does not regulate credit provided for investment purposes, nor credit provided to small businesses. That means, for example, the mortgage over a person's home is regulated under the UCCC but the same person's mortgage over another home, for investment purposes, is not. That person is not necessarily any more knowledgeable when entering into that contact, and may have used their primary residence as security, but does not have access to the protections offered by the UCCC. Furthermore, a loan to small business may also be used indirectly to fund personal consumption or be secured by personal assets, particularly in the case of an unincorporated operator, but is not afforded protections under the UCCC. The FSR regime only regulates investment in financial products (for example, shares but not real property) and related advice - not the credit used to obtain it.

6.45 There is evidence that some consumers are poorly informed about the key features and risks of certain credit products. The UCCC contains a number of provisions regulating disclosure, mainly pre-contractual which focuses on the contractual obligations rather than the features and risks of the actual product. As such, it appears that the existing disclosure requirements may not be sufficient to prevent confusion and financial loss.

6.46 The penalty provisions in the UCCC are largely limited to civil remedies for breaches of the legislation. There is no provision for a regulator to intervene through administrative action. In addition, the regulator does not have standing in court. This means the regulator cannot deal with minor breaches of the legislation in a manner commensurate with their impacts or take action on behalf of consumers as a general population.

Margin loans

6.47 With the strong performance of the ASX over the recent years, the instance of margin calls has been very low. However, with the stock market moving into a time of more uncertain growth, there has been some concern surrounding retail clients' understanding of how their margin loan product operates. Recent market volatility has been alarming for small investors, particularly those who have only experienced positive markets previously. This has highlighted the current absence of consumer protection regulation concerning margin loans, particularly in relation to retail investors.

6.48 There are serious concerns that consumers are not necessarily aware of the extent to which margin lending contracts place the risk of changes to market conditions on them. In particular, some contracts allow the lender to unilaterally withdraw the facility or withdraw a particular company's stock from their acceptable list of equities over which margin lending is accepted, thereby forcing full repayment.

6.49 Furthermore, it is not clear that investors fully understand how the LVR ratio works and that the loan provider is able to change this in a very short period of time.

6.50 There are also serious concerns that marketing material, separate from the contract itself, highlighting 'bull market' gains make margin loans seem much simpler than they in fact are and do not fully disclose the downside risks.

Policy objectives

6.51 To give effect to the COAG decisions of 26 March and 3 July 2008, in that the Australian Government will assume responsibility for the regulation of consumer credit and margin loans.

6.52 To provide a comprehensive, nationally consistent consumer credit regime, by addressing conflicts or gaps in the existing consumer credit regime where there is evidence that consumers are suffering loss and other detriment or an unnecessary compliance burden is being placed on business.

6.53 To determine the most appropriate way to handle margin loans to ensure people who invest through them are aware of the associated risks.

6.54 To reduce the regulatory burden on business, better protect the interests of consumers and ensure the regulatory regime contributes to ensuring the Australian economy is modern and strong.

Implementation options

Implementation scope

6.55 The terms of the COAG agreement are quite broad and allow the Commonwealth to determine the precise scope and mechanism for implementing the national regulation of consumer credit and margin loans. Although the Commonwealth has not previously regulated consumer credit the States and Territories, as well as industry participants and consumer groups, have substantial knowledge of the issues involved and will be used to inform the development of the national regime.

6.56 A primary weakness of the existing UCCC is its inability to respond to market developments in a timely manner because of the co-operative amendment process. This will be overcome when enacted as Commonwealth law, in part because, where possible, it will be drafted on a principles basis so that it does not necessarily need to be amended to regulate new products and behaviours. In addition, a national regime will provide consumers and participants with consistency by reducing duplication and inconsistent obligations.

6.57 Despite those inherent improvements, given the concerns identified above it would seem that simply enacting the UCCC as Commonwealth law will not be sufficient to comprehensively regulate consumer credit in a way which achieves the Government's objectives. Some potential enhancements which could be made have been identified below. Their necessity, and the impacts their introduction would have, will be evaluated on the basis of views solicited through further consultations.

Potential enhancements to the regulation of consumer credit under the national regime

6.58 The scope of the regime may need to be framed so as to capture additional transactions and services.

6.59 The UCCC only regulates the provision of consumer credit. That is, the UCCC does not regulate the provision of credit-related advice, and excludes credit provided to consumers for investment purposes and loans made to small businesses. This means that some transactions undertaken by consumers are outside of the protections offered by the UCCC.

6.60 However, the draft Finance Brokers Bill has been specifically crafted to regulate the provision of advice by brokers/advisors in all jurisdictions in relation to all consumer and small business credit.

6.61 The absence of a comprehensive approach for regulating credit advice is widely acknowledged as a key deficiency of the current regime. Changes in the credit environment and the increased availability of a range of products being offered by a range of lenders have seen consumers rely more heavily on finance brokers/advisors when considering their lending options, yet there is no regulation of these transactions. That is, the UCCC only regulates the actual lending portion of the transaction and not the advice. There is no regulatory requirement that advice is appropriate for the consumer and there is evidence that in its absence consumers have suffered detriment.

6.62 Consumer borrowing for investment purposes is not regulated by the UCCC. Individual investors are often not sophisticated and consider investing in real property to be a lower risk activity than other investments. Such investment is often long term and involves large sums of debt. Past increases in property prices and average household incomes have promoted consumer confidence which has led to increased borrowing to fund investment. However recent downturns in property and financial markets have left some investors with reduced levels of equity and liquidity. These investment credit contracts are not subject to regulatory oversight and protection. By comparison, the FSR regime regulates investment in financial products, and advice in relation to it.

6.63 Similarly, small business operators are not necessarily sophisticated investors. Small businesses may not have sufficient resources to obtain detailed advice, negotiate favourable contract terms or engage in costly and complex legal arrangements to resolve disputes. The extension of protections under the national credit regime to small businesses is similar to the scope of the FSR regime for financial products.

6.64 In contrast to the UCCC, Chapter 7 of the Corporations Act regulates the provision of financial services products (such as shares but not real property) and advice related to those products provided to all retail clients.

6.65 The need to extend the scope of the legislation to other transactions and services has not yet been determined and will be the subject of consultation.

All industry participants may need to be licensed

6.66 The UCCC does not contain a licensing regime. However, in recognition of the need for, and benefits of, licensing the States and Territories have agreed to license the brokers/advisers of all consumer and small business credit in all jurisdictions, as proposed in the draft Finance Brokers Bill.

6.67 A licensing regime generally restricts entry to those people who are appropriately skilled and of good character. Licensing is a mechanism by which obligations can be imposed on participants. In addition, it provides for more effective and efficient enforcement. It allows the population to be known to the regulator, who can then ensure that required standards are met and impose penalties for non-compliance. Experience suggests that, in the absence of a licensing regime, unscrupulous or unskilled people can operate in the market for some time before being identified. Once identified there is often no mechanism to resolve disputes outside of the courts.

6.68 There is wide ranging community and industry support for the introduction of a comprehensive licensing regime (for example , Finance Sector Union, Credit Ombudsman Service, Finance Brokers Association Australia, Mortgage & Finance Association Australia).

6.69 In addition, the Productivity Commission recommended a licensing system for finance brokers, and a licensing or registration system for credit providers (with both requiring participation in an approved EDR Scheme). Chapter 7 requires all financial service providers be licensed.

6.70 Should a licensing requirement be included in the national regime, it may be inappropriate to only license brokers/advisors (as proposed in the draft Finance Brokers Bill) and not providers as well, given they can also interact directly with consumers. However the obligations imposed may vary depending on the role of the participant.

Industry participants may need to provide additional disclosure to consumers.

6.71 The UCCC already requires certain disclosure, mainly pre-contractual. However this has not been adequate to properly inform consumers of all the risks associated with specific credit products, such as reverse mortgages.

6.72 Without all relevant information, consumers are not able to make well reasoned decisions. Making inappropriate decisions can lead to financial stress.

6.73 In recognition that some people may not understand the risks involved with reverse mortgages the States and Territories are currently considering the need for specific disclosure. A consultation RIS is being prepared by the States on this matter.

6.74 In addition, the States and Territories have commissioned research into pre-contractual disclosure to ensure it is simple, accessible, relevant, concise and comprehensible.

6.75 Further, the proposed amendments to address 'fringe' lending practices include requiring additional disclosure in relation to direct debit authorities and clarifying disclosure requirements for annual percentage rates.

6.76 The need to impose any additional disclosure requirements, such as ongoing or product specific disclosure requirements, will be considered in the second phase.

The expected conduct and behaviour of industry participants in relation to their dealings with consumers may need to be regulated.

6.77 The UCCC contains some conduct requirements. However, numerous submissions to various consultations papers have suggested these provisions are not sufficient. There is evidence that practices such as 'equity stripping', 'churning', the provision of inappropriate advice, the provision of credit to consumers who can not afford to repay it and the charging of excessive fees have occurred, to the detriment of consumers.

6.78 The consumer is in a position where they are dependent on the broker's skill and expertise and therefore vulnerable to exploitation. It is in the industry's interest that consumers value the services which are available. One way to achieve consumer confidence is to ensure market participants behave in an appropriate manner.

6.79 The application of general conduct requirements is a principled (as opposed to prescriptive) method of addressing concerns which may otherwise be manifested as specific obligations and products features.

6.80 The concept of requiring responsible lending practices was consistently raised by consumer advocacy groups (such as Care Inc Financial Counselling & Consumer Law Centre ACT, Consumer Credit Legal Centre NSW, ACTU and the Financial Sector Union) in responses to the Green Paper.

6.81 The draft Finance Brokers Bill proposes to address this issue in part by imposing a requirement that the consumer's capacity to repay be considered before any credit product is recommended (a RIS was prepared). The draft Finance Brokers Bill also requires that the advisor/broker has a reasonable basis for recommending a particular credit product.

6.82 In addition, the States and Territories are considering imposing additional conduct requirements, in the form of responsible lending provisions, on credit card providers to address concerns with over-indebtedness. A consultation RIS was prepared.

6.83 Chapter 7 of the Corporation Act requires providers conduct their services efficiently, honestly and fairly.

6.84 If additional conduct requirements were to be introduced it is envisaged that they would oblige participants to observe a number of general conduct requirements such as those imposed by Chapter 7. In addition, credit-specific requirements, such as establishing a person's capacity to repay and banning specific predatory lending practices, could be imposed. The need for any additional conduct requirements, and the specifics of the obligations they would impose if adopted, have not yet been determined and will be the subject of consultation.

Industry participants may need to provide access to appropriate dispute resolution services.

6.85 Under the UCCC membership to EDR Schemes is voluntary. Tribunals have been established to deal with complaints related to consumer credit. Western Australia, and more recently Victoria, are the only jurisdictions to have introduces legislation which requires brokers/advisors to be members of an external dispute resolution scheme.

6.86 The importance of mandating access to an EDR Scheme is that they provide consumers who are unable to resolve a dispute directly with their provider with a free, fair and independent dispute resolution mechanism. The alternative is often the complex, time consuming and costly court process which is not particularly viable.

6.87 In the absence of a legislative requirement several industry associations, such as the Mortgage & Finance Association of Australia and the Australian Bankers' Association Code of Banking Practice, require their members be members of EDR Schemes.

6.88 The draft Finance Brokers Bill proposes to mandate membership of approved EDR Schemes for all brokers. Chapter 7 mandates membership of an ASIC approved EDR Scheme.

6.89 In recognition of the value of access to EDR Schemes, the States and Territories had commenced examining the feasibility of requiring all credit providers to belong to an approved EDR Scheme. However, this work was postponed following the COAG decisions.

6.90 The need to impose a requirement to provide access to dispute resolution services has not yet been determined and will be the subject of consultation. If such a requirement were to be introduced it is envisaged that access to EDR Schemes would be free to consumers and similar to the schemes which operate for the purposes of Chapter 7 of the Corporations Act.

The regime will need to be enforced by a national regulator, namely ASIC, in a way which minimises avoidance of the requirements.

6.91 The UCCC is enforced by each State and Territories' Fair Trading Office. The UCCC contains a range of civil penalties. The regulators lack the ability to intervene quickly and to act unilaterally in instigating court proceedings against persons acting inappropriately or failing to meet required standards.

6.92 The amendments to address 'fringe' lending practices proposed by the States and Territories recommend giving government consumer agencies standing in court proceedings.

6.93 Moving to a single national regulator is consistent with having a national scheme. ASIC is the logical choice, given its experience in enforcing the Corporations Act and its existing infrastructure and relationships with financial services providers. This conclusion is supported by the fact that ASIC was repeatedly identified as the appropriate regulator in submissions to the Green Paper and by the Productivity Commission in its report of May 2008.

6.94 The alternative national regulator, the Australian Competition and Consumer Commission, has little experience in the regulation and licensing of financial services or credit, nor the established relationships with those providers. Further, it would be expected that the incremental cost of extending ASIC's oversight to credit would be less than that required to extend the Australian Competition and Consumer Commission functions to credit regulation.

6.95 The States and Territories have indicated they do not want a continuing enforcement role once the Commonwealth assumes responsibility for credit. However they reserve the right to enforce generic consumer protection laws where applicable.

6.96 The need for any enhancement to ASIC's enforcement powers (such as the ability to impose administrative and criminal penalties, have standing in court cases and the ability to ban industry participants), have not yet been determined and will be the subject of consultation.

Proposed regulation of margin loans under Chapter 7 of the Corporations Act

6.97 The proposed regulation of margin loans under Chapter 7 is included in phase one of the proposed implementation plan.

6.98 The Simplifying and Standardising Financial Services and Credit Regulation Green Paper proposed three options for margin loans: 1) maintain the status quo; 2) include margin loans as a financial product under the Corporations Act and apply the Chapter 7 regime; and 3) develop a separate regulatory regime for margin loans.

6.99 A number of submissions were received however, whether margin loans need to be regulated, and if so the appropriateness of Chapter 7 to do so, has not yet been determined and will be subject to further consultation.

Implementation mechanisms

6.100 Due to constitutional limitations, the preferred approach to any regulation of credit would be to amend the Corporations Act. There are two options for the implementation of Commonwealth regulation of consumer credit.

Option A

6.101 Extend Chapter 7 of the Corporations Act to regulate the provision of all consumer credit products and related advice including consumer mortgages for investment purposes, and loans to small businesses, as a financial product.

Option B

6.102 Enact the UCCC (including outstanding projects) to the extent possible and the relevant provisions of the draft National Finance Brokers Bill, supplemented with additional licensing, conduct and disclosure provisions as required to comprehensively regulate the provision of consumer credit and related advice, including consumer mortgages for investment purposes, and loans to small businesses as a new chapter of the Corporations Act.

Assessment of impacts

Impact group identification

6.103 The groups affected by the amendments are consumers of credit; industry participants including providers and brokers/advisers; and the Government and ASIC.

Assessment of costs and benefits

Option A: Extend Chapter 7 of the Corporations Act to include all consumer credit products.

Table 6.1

Option B: Enact relevant provisions of the UCCC and the draft Finance Brokers Bill, supplemented as required, as Commonwealth law

Table 6.2

Preferred approach - Option B

6.104 Despite its gaps, the UCCC provides a well developed foundation for the regulation of consumer credit, which is well known by industry and consumers. Moving the UCCC under Commonwealth control resolves many of its weaknesses. Further the UCCC framework can be enhanced with additional licensing, conduct and disclosure provisions, drawn from the draft Finance Brokers Bill and supplemented as required, to provide for the comprehensive regulation of consumer credit.

6.105 Chapter 7 of the Corporations Act does not contain the necessary credit specific provisions, such as dealing with defaults, repossession and hardship requirements. In addition, its licensing, conduct and disclosure frameworks are specifically designed for the regulation of financial services that are not necessarily appropriate or applicable to credit products given the different risks involved. This is consistent with the views expressed by the financial sector in response to the Green Paper. However, Chapter 7 may provide a basis from which to produce the additional regulation necessary to supplement the UCCC and draft Finance Brokers Bill.

Business cost calculator

Consumer credit

6.106 Until the details of the proposed national regime (including the licensing, conduct and disclosure requirements) are decided it is difficult to estimate the cost of compliance to business. It is expected that there will be an initial cost to businesses in transitioning to the new system, such as obtaining their licence. In addition, it is expected that there will be on-going costs involved in disclosure, compliance, training and membership of an EDR Scheme.

6.107 Consultations to date have suggested that implementation costs would be minimised if the Commonwealth adopted the UCCC with minimal changes (for example , Legal Aid NSW & QLD and Australian Finance Conference). The proposed regime will be subject to further consultation in order to achieve a design which minimises compliance costs while delivering enhanced protections to consumers.

6.108 It should be noted that these costs are offset in part by savings from no longer having to comply with multiple State and Territory based regulation, which is often duplicated or inconsistent. In addition, a national regime of consumer credit regulation will allow, over time, for streamlining and consolidation.

Margin loans

6.109 Until the details of the regulation, if any, for margin loans are decided it is difficult to estimate the cost of compliance to business. Consultations noted that introducing a new regime, as opposed to extending Chapter 7, would be more costly for both businesses and government.

6.110 Traditionally, margin loans have been sold through AFS licensees. Although the provision of margin loans, or advice in relation to them, are not currently subject to the obligations imposed by Chapter 7 the extension of those requirements would not be expected have a large impact for existing AFS licensees.

6.111 If margin loans were to be regulated under Chapter 7, it is expected that the majority of the cost will be borne by those industry participants who are not already AFS licensees, and that some of those costs would be passed on to consumers.

6.112 If margin loans were to be regulated, Option 3 would appear to result in the creation of a separate regime for margin loans that would unnecessarily mirror Chapter 7, creating regulatory overlap for businesses offering margin loans and other financial products. This would create inefficiencies for businesses that would be required to obtain separate licences for different products and develop disclosure documents for those products under different regimes.

Staging

6.113 The national regime could be implemented as either a single step or a staged process.

6.114 Under a single step process a national regulatory regime could be introduced only after all of the work had been done to refine the existing regime, undertake the necessary consultation and approval processes, and draft the entire package of legislation. This would delay the implementation of any reform for several years, during which time the current problems with the regulatory regime would remain unaddressed.

6.115 Alternatively, a national regulatory regime could be introduced in stages. This would involve the early introduction of Commonwealth law addressing the most urgent problems (such as mortgage credit and advice, margin loans and other matters), followed by the later introduction of additional features, after further consideration.

6.116 The first phase would include the enactment of the UCCC, relatively unchanged, as Commonwealth law which ensures continuity and certainty for both business and consumers. As industry currently complies with the UCCC there would be minimal operational difference in transferring existing legislation to the Commonwealth. It is expected that several of the currently outstanding projects will have already been enacted as amendments to the UCCC by this time.

6.117 Depending on the outcomes of consultation, the key changes from the existing regime introduced in phase one would be:

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the extension of the regime to consumer mortgages for real property;

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the licensing of all industry participants, which could be based on the provisions in the draft Finance Brokers Bill;

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compulsory membership in an EDR Scheme; and

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the introduction of general conduct provisions, including the requirement that a person's capacity to repay be considered when determining eligibility for credit.

6.118 ASIC would also assume responsibility from the State and Territory Fair Trading Offices for regulating consumer credit in phase one. This would enable ASIC to commence producing educational material and licensing industry participants, giving industry time to transition into the new scheme. In addition, it would immediately reduce duplication or inconsistency in regulatory burden inherent in complying with multiple State and Territory jurisdictions.

6.119 The second phase would focus on determining the need for specific conduct, disclosure and product requirements and the extension of the scope of the law to cover remaining investment loans and loans to small businesses.

6.120 Managing the single stage implementation of such a large reform is considered to be more difficult than a staged process. These difficulties were demonstrated during the introduction of the FSR regime in 2001. Industry participants and the regulator were overwhelmed by the quantum of changes and the compressed timeline in which they were required to comply with the new regime.

6.121 The inbuilt delay in implementing the reform as a single package is undesirable, given the pressing concerns with certain aspects of consumer credit. Further, should any aspect of a single package be delayed the entire project would be delayed. In contrast, a staged process ensures that important and non-controversial aspects can proceed urgently.

6.122 In response to the Green Paper several submissions noted that, should the Commonwealth take over the regulation of all consumer credit, a staged implementation would be advisable (for example , Financial Services Ombudsman, Financial Planning Association).

Consultation

Consumer credit

Green Paper on Financial Services and Credit Reform

6.123 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.

6.124 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.

6.125 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 they are required to operate under.

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

6.126 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 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 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 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 the 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

6.127 The Government has 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.

6.128 The New South Wales Government has undertaken extensive consultation on the draft NSW National Finance Brokers Package. These consultations have identified consensus on a majority of provisions. The Commonwealth Treasury will undertake further consultation on the disputed provisions. (A decision-making RIS was given conditional clearance by the Office of Best Practice Regulation in 2006.)

6.129 The New South Wales Government released a consultation RIS on responsible lending practices in relation to consumer credit cards on 22 August 2008. Submissions are due by 3 October.

6.130 A decision making RIS for fringe credit providers was approved by the Office of Best Practice Regulation in 2006.

6.131 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.

6.132 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.

6.133 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.

Margin loans

6.134 Some 20 submissions in relation to margin loans were received in response to the Green Paper.

6.135 There was general support for the inclusion of margin loans as a financial product in Chapter 7 of the Corporations Act (Grant Thornton, Australasian Compliance Institute, Financial Planning Association, Australian Financial Counselling & Credit Reform Association Incorporated, Australian Institute of Credit Management).

6.136 It was noted that introducing a new specific regime (as opposed to extending Chapter 7) would be costly for both government and participants, would add further regulation to a system that already suffers from inefficient regulatory overlap and increase the risk of future inconsistency (Macquarie Bank, National Australia Bank, Australasian Compliance Institute, ANZ).

6.137 Some submissions called for further research and analysis before any action was taken and cautioned against a 'knee jerk' reaction to recent failures such as Opes Prime and Lift Capital, which involved products not sold by the majority of the industry (Australian Bankers Association, Securities and Derivatives Industry Association, Investment and Financial Services Association Ltd).

Recommended option and conclusion

6.138 Cabinet is asked to agree to the two-staged implementation plan as described below, subject to the outcomes of a detailed consultation process.

6.139 The recommended approach achieves synergies with existing regimes (UCCC and FSR) thus reducing the regulatory burden as much as possible while at the same time achieving the Government's objectives.

Implementation and review

6.140 The phased approach proposed for development and implementation of the consumer credit regulatory framework (as described in the diagram above) will be subject to detailed consultation with relevant stakeholders. Consultation will be undertaken on the planned implementation process and throughout the development of draft legislation and could include:

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officials from State and Territory Governments and ASIC;

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a special group of key industry experts and consumer advocates; and

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wider community consultation on draft legislation and specific areas such as the draft Finance Brokers Bill.

6.141 In addition, this RIS will be updated to assess the impacts and analyse the costs and benefits of the proposed preferred design of the various features.