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 1 - Margin loans

Outline of chapter

1.1 Schedule 1 to the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 (Bill) amends the Corporations Act 2001 (Corporations Act) to set out a national regulatory regime for margin loans. Such loans are not directly regulated and are not subject to the state based consumer credit law.

1.2 The national regulatory regime for margin loans is established by including margin loans as a financial product in Chapter 7 of the Corporations Act. Chapter 7 regulates the provision of financial services supplied in relation to financial products (which are primarily of an investment nature). As margin loans are a form of credit widely used to finance acquisitions of investment-related financial products, Chapter 7 is considered to provide the appropriate regulatory setting for the regulation of margin loans.

1.3 Chapter 7 does not fully cover all aspects of margin loans as the regulatory regime was not originally designed for credit products. Accordingly, a number of adjustments are necessary to ensure the regime fits the characteristics of margin loans and that an appropriate level of investor protection is provided.

Context of amendments

1.4 A margin lending facility allows an investor to borrow money to invest in securities and other financial products against the security of any equity contribution, usually in the form of financial products.

1.5 Depending on the margin lending product and the provider, securities and other financial products may include listed shares, fixed interest securities and units in managed funds. In practice, margin loans are usually only available to fund purchases of 'approved' securities that the lender regards as acceptable from a risk and liquidity perspective. However, funds raised by way of a margin loan could potentially be used to purchase other financial products, goods or services.

1.6 Margin loan facilities are based on 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. As this disclosure is not currently regulated, it is not clear that investors are fully aware of the risks associated with a margin lending product.

1.7 The amount an investor can borrow generally depends on the loan-to-value ratio (LVR) offered by a lender for the securities or other financial products. The lender may reserve the power to change the assessed market value and LVR of a security at any time.

1.8 The money that the investor borrows in a margin loan is generally secured by these underlying investments. The investor retains legal rights over the investments.

1.9 However, an investor can also provide other assets, such as their home or investment properties, as security for the loan.

1.10 Repayment of a margin loan may be required in the event the investment is subject to a 'margin call'. A margin call occurs where the market value of the investments falls below the level agreed under the contract (margin). The borrower is then required to take action in order to return the margin loan LVR back to the agreed level. Lenders usually provide a 'buffer' above the LVR rate before initiating a margin call, which may or may not form part of the terms of the margin loan agreement.

1.11 When there is a margin call, the investor is required to adjust the level of assets securing the loan to return the portfolio to the agreed limits set under the contract. This can be done by paying extra cash, selling some of the assets, or giving the lender additional security.

1.12 A lender has recourse to the underlying security if there is a default on the terms or conditions of the loan and retains the right to take action against the borrower personally for such defaults.

1.13 Margin lending has grown strongly in recent years, with recent marketing of margin lending extending from high net worth individuals who generally are experienced investors, to a wider circle of retail investors. However, due to current market conditions, levels of lending have started to fall.

1.14 Margin loans are closely related to other financial products, such as shares or managed investments, which are already regulated under Chapter 7.

Current legislative framework

1.15 Currently, margin lending facilities are not regulated as a financial product, or subject to Australian Securities and Investments Commission (ASIC) regulation relating to financial services. This is because the term 'financial product' in the relevant legislation does not cover credit products (such as margin loans) as a result of the current referral agreement with the States and Territories. Further, State and Territory legislation governing consumer credit (the Uniform Consumer Credit Code) excludes investment loans such as margin lending.

1.16 However, there are regulatory measures which capture aspects of the margin lending product. This includes:

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The Australian Securities and Investments Commission Act 2001 (ASIC Act) gives ASIC the function of monitoring and promoting market integrity and consumer protection in relation to financial services. For the purpose of the ASIC Act, credit facilities (which include margin loans) are financial products and are subject to general consumer protection provisions of the Act, such as those relating to misleading and deceptive conduct.

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As margin loans are supplied by a variety of providers, including banks and stockbrokers, various industry regulations may apply, including, for example, the Code of Banking Practice and the ASX Market Rules.

Key risks

1.17 There have been serious concerns that not all margin borrowers are aware of the extent to which margin lending contracts place the risk of changes to market conditions on them. The possibility of such borrowers suffering unexpected consequences is particularly high in volatile market conditions such as those experienced since the impact of the global recession.

Opes Prime style arrangements

1.18 Following the collapse of Opes Prime and serious problems at Tricom, it was found that these entities were using arrangements that were promoted as 'margin loans' to the consumer, and functionally operated as such. However, they were based on different legal arrangements that did not necessarily involve a 'loan' and were more closely related to stock or 'securities' lending. Therefore, concerns have been raised that consumers were misled as to the implications of these facilities.

Double gearing

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

1.20 Through an unfortunate combination of circumstances some of these borrowers have fallen into negative equity in relation to the value of their security vis-à-vis their margin loan and are now having to repay outstanding amounts on the margin loan as well as continuing to service the loan secured against their home. Where borrowers do not have additional sources of funds to do so, they are at risk of losing their homes.

1.21 Indications are that not all of these borrowers were familiar with the way in which a margin loan operates, including the potential consequences of margin calls. In addition, they may also not have been fully aware that they exposed themselves to the risk of losing their homes when they borrowed against their home to fund the margin loan.

Margin calls

1.22 Recent events have also raised concerns about whether the adviser or lender is responsible for notifying a client of a margin call.

1.23 Failure to notify a client of a margin call in a timely manner can result in significant losses, including resulting in a client going into negative equity.

Summary of new law

1.24 Margin loans are given a specific definition in the Corporations Act to ensure that all arrangements with the relevant characteristics of a margin loan are captured under the new national regime. Complications arise in this area because alternative legal structures not based on an explicit loan agreement have been used by providers such as Opes Prime and Tricom. The definition has been framed in a manner to include these alternative 'margin loan' type structures.

1.25 A 'margin lending facility' is explicitly included as a financial product for the purposes of Chapter 7 in the Corporations Act. This ensures that providers of financial services in relation to margin loans will be subject to the licensing, conduct and disclosure requirements in Chapter 7. It also subjects them to supervision and enforcement action by the national regulator, ASIC.

1.26 It is noted that the definition of margin loans as a financial product only extends to loans provided to individuals, as it is not intended at this stage to regulate business lending. Australian Government policy in relation to business lending will be developed in phase two of the Commonwealth's assumption of responsibility for the regulation of credit.

1.27 The investor protection regime under Chapter 7 of the Corporations Act requires that persons providing financial services and products must, among other things:

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have an Australian financial services licence (AFSL);

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comply with general conduct standards, including the requirement to deal with investors efficiently, honestly and fairly;

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have appropriate compensation arrangements in place for losses suffered by retail clients due to breaches of the law. This includes membership of an ASIC approved External Dispute Resolution Scheme (EDR Scheme);

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provide appropriate disclosure to their retail clients before and after a product is purchased, including providing a product disclosure statement, a statement of advice and periodic statements on an ongoing basis;

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have in place adequate arrangements for the management of conflicts;

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ensure that they have adequate resources and are competent to provide the services. They must also ensure that their representatives are adequately trained and competent to provide the services; and

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be subject to the enforcement provisions surrounding market manipulation, false or misleading statements, inducing investors to deal using misleading information, and engagement in dishonest, misleading or deceptive conduct.

1.28 The inclusion of margin loans within Chapter 7 will require margin lenders and advisers to obtain an AFSL and imposes this range of conduct and disclosure requirements on them.

1.29 With respect to licensing, the main financial services that are anticipated to be covered will be issuing (largely equivalent to lending) and the provision of advice in relation to margin loans. Appropriate transitional arrangements are provided to ensure that the licensing process occurs smoothly. This is particularly important for financial advisers, as the numbers involved are large and will require some time for ASIC to process.

1.30 A new responsible lending requirement that applies specifically to margin loan lenders is imposed seeking to ensure that clients are not given loans which they are unable to service. Lenders will be required to assess whether a proposed loan is unsuitable for the client, such that in the event of a margin call the client would not be able to service the loan or would only be able to do so with substantial hardship. If a loan is assessed as unsuitable, it must not be provided to the client.

1.31 A number of key factors that need to be considered by lenders in assessing unsuitability will be prescribed in regulations, including in particular situations where consumers have engaged in 'double gearing'. This term refers to situations where consumers borrow funds to finance their equity contribution for a margin loan. In some cases borrowers may use their residential home as security for the loan, which is considered to be a major risk factor as consumers may lose their homes if they are unable to service the loans.

1.32 A further provision regulates the notification of margin calls to clients, especially where the loan has been arranged through a financial planner. There have been situations where it has been unclear whether it was the lender or the planner who was responsible for notifying clients when a margin call occurred. Failure to notify a client in time can result in losses for the client. The amendments require that lenders must notify clients when a margin call is made, unless clients explicitly agree to notifications being provided through their planner.

Comparison of key features of new law and current law

Detailed explanation of new law

Definition of a margin lending facility

Capture as a financial product

1.33 An appropriate amendment is made to the table containing an outline of Chapter 7 to reflect the new amendments relating to margin loans . [Schedule 1, item 1]

1.34 A number of key terms used in the amendments are inserted into section 761A, which contains a number of key definitions for Chapter 7 of the Corporations Act . [Schedule 1, items 2 to 7]

1.35 A margin lending facility is included in the list of specific facilities that are financial products in paragraph 764A(1)(k) of the Corporations Act [Schedule 1, item 10]. This will trigger a range of obligations that apply to a financial product in Chapter 7 of the Corporations Act.

1.36 A margin lending facility is specifically excluded from subparagraph 765A(1)(h)(i) of the Corporations Act, which exempts credit facilities from the meaning of financial product [Schedule 1, item 11]. This is to make clear that a margin loan facility does not fall in the general exclusion of credit matters in the Corporations Act.

Meaning of issue of margin lending facility

1.37 The issue of a margin loan is a key concept in determining whether a person needs to obtain an AFSL. An amendment to subsection 761E(3) (at the end of the table) clarifies when a margin loan has been issued to a client. A margin lending facility is issued to a person when they enter into the legal relationship that constitutes the margin lending facility, as the client under the facility . [Schedule 1, item 8]

General definition - margin lending facility

1.38 A specific definition of a margin lending facility is considered appropriate to ensure that other lending practices are not inadvertently captured in the definition.

1.39 Section 761EA gives meaning to a range of definitions associated with a margin lending facility . [Schedule 1, item 9]

1.40 A margin lending facility is [Schedule 1, item 9, subsection 761EA(1)]:

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a standard margin lending facility;

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a non-standard margin lending facility; or

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a facility declared by ASIC to be a margin lending facility (unless the facility has been declared by ASIC not to be a margin lending facility).

1.41 The definition is intended to capture, among other things:

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the basic or 'vanilla' margin loan;

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Opes Prime and Tricom style arrangements, where appropriate. This is to ensure that products that are functionally similar to a margin loan (and advertised as a margin loan) are also captured;

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hybrid products that utilise the key features of a margin loan;

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a limited or non-recourse margin loan (where the amount the lender can recover is restricted to the mortgaged financial product); or

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a margin loan where the assets securing the loan are more than just the financial products purchased through the loan, such as residential property.

1.42 Other forms of investment lending more generally will be addressed separately in the Commonwealth's broader reforms to consumer credit.

Standard margin lending facilities

1.43 A definition of a 'standard margin lending facility' is provided [Schedule 1, item 9, subsection 761EA(2)]. The key elements of the definition include:

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who is the 'provider' and who is the 'client'. It is noted that the client must be a natural person, which excludes all lending to corporate entities from the definition [Schedule 1, item 9, paragraph 761EA(2)(a)];

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a requirement that the borrower must use the loan (wholly or partly) to acquire shares or other financial products [Schedule 1, item 9, subparagraph 761EA(2)(b)(i)] or to refinance a margin lending facility [Schedule 1, item 9, subparagraph 761EA(2)(b)(ii)];

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that the loan must be wholly or partly secured over shares or other defined securities ('marketable securities'). 'Marketable securities' is defined by existing section 9 of the Corporations Act [Schedule 1, item 9, paragraphs 761EA(2)(c) and (d)]; and

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that the client is subject to a 'margin call' in circumstances where the 'current LVR' of the facility exceeds the agreed threshold [Schedule 1, item 9, paragraph 761EA(2)(e)].

1.44 The current LVR is defined as the ratio of the outstanding debt to the security provided for the loan . [Schedule 1, item 9, subsection 761EA(3)]

1.45 This means that a 'margin call' can occur where the value of the securities underlying the loan falls below a certain critical level due to adverse market movements or where the customer draws down too far on the loan. The critical level may include a buffer granted by the provider, provided it forms part of the terms of the facility . [Schedule 1, item 9, subsection 761EA(4)]

Example 1.1 : Example of a margin loan

An example is provided to assist in understanding the definition and how a margin call operates:

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Loan amount - $85,000.

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Original value of the secured property - $125,000 (the value of property provided by the client as security, which must include some marketable securities, and which may (but need not) include some or all of any financial products purchased by the client with the loan).

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Margin call occurs if the current LVR is above 80%.

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Original current LVR = 85,000/125,000 = 68%.

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Value of the secured property falls to $100,000.

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Current LVR = 85,000/100,000 = 85%.

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Facility is in margin call on the date the current LVR exceeds 80%.

1.46 Due to the way the definition is framed, certain types of investment and other loans are excluded from its scope.

Use of the loan

1.47 In order for a loan to be a margin lending facility for the purposes of Chapter 7 of the Corporations Act (and the Corporations Agreement), the purpose and use of the loan must be investment related in a particular manner as defined in the Bill.

1.48 Subparagraph 761EA(2)(b)(i) requires that the loan must be partly or wholly used for the purchase of, or beneficial interest in, financial products. This means that this use of the loan must form part of the terms of the margin loan facility . [Schedule 1, item 9, subparagraph 761EA(2)(b)(i)]

Investment lending

1.49 General investment lending is intended to be excluded from the definition of a margin loan facility. Other forms of investment lending more generally will be addressed in phase two of the Commonwealth's assumption of responsibility for the regulation of consumer credit.

Example 1.2 : Examples of excluded investment lending

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A loan secured against a residential or investment property and used to purchase securities is an investment loan.

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Where general consumer lending (such as a personal loan or credit card) is wholly used to purchase an investment product (financial product). If it is partly used to purchase an investment product, the loan is a consumer loan and will be regulated under the consumer credit legislation.

1.50 Alternatively, the definition is not intended to capture margin loans used solely for personal, domestic or household use, or (non-investment) business purposes.

Example 1.3 : Examples of excluded lending

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Where the only use of a margin loan is for the purchase of a product or service for personal, domestic or household use, such as the purchase of travel or a car. In this circumstance, it is expected that either the lender does not provide the loan, or that they provide the loan under an Australian credit licence.

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Where the only use of a margin loan is to purchase assets for a farming business (business purpose).

Non-standard margin lending facilities

1.51 The type of margin loan targeted by the definition of a 'non-standard margin lending facility' is not based on a loan agreement, but uses a type of securities lending agreement (with variations) to achieve a similar economic outcome as would a standard margin loan.

1.52 General 'stock' or securities lending, particularly in the wholesale market, is not intended to be included in this definition.

1.53 This type of structure was used by lenders such as Opes Prime and Tricom and provided as a 'margin loan', 'equity finance' or 'securities finance'. The key difference, from the client's point of view, is that in a non-standard margin loan, title to the security provided for the loan passes out of the client's hands. This key aspect of a non-standard margin loan is captured in the definition.

1.54 Subsection 761EA(5) sets out the definition of a non-standard margin loan [Schedule 1, item 9, subsection 761EA(5)]. The key elements of the definition include:

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determining who the provider is and who the client is in the context of transferred securities. It is noted that the client must be a natural person, which excludes all lending to corporate entities from the definition [Schedule 1, item 9, paragraph 761EA(5)(a)];

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the client receives 'transferred property'. Transferred property is the equivalent arrangement to the provision of credit or cash in a standard margin lending facility. It may sometimes be referred to as collateral for the 'transferred securities' [Schedule 1, item 9, paragraph 761EA(5)(b];

•

the funds provided to the client must, as in the case of a standard margin lending facility, be at least partly used to acquire financial products. This is intended to ensure that only facilities are captured which have a similar outcome to a standard margin loan [Schedule 1, item 9, paragraph 761EA(5)(c)]; and

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the client is subject to a margin call in circumstances where the current LVR of the facility exceeds the agreed threshold [Schedule 1, item 9, paragraph 761EA(5)(e)].

1.55 Non-standard margin loans also operate on the basis of margin calls, which occur when the LVR exceeds an agreed threshold. The definitions of 'margin call' [Schedule 1, item 9, subsection 761EA(7)] and 'current LVR' [Schedule 1, item 9, subsection 761EA(6)] for a non-standard margin lending facility are similar to those for a standard margin lending facility, with some amendments to suit the special characteristics of non-standard margin loans.

Example 1.4 : Example of a non-standard margin loan

An example is provided to assist in understanding the scope and intent of the definition:

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Value of the transferred property given by the provider to the client = $85,000 (equivalent to the loan amount in a standard loan).

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Value of the transferred securities transferred by the client to the provider = $125,000 (value of the marketable securities transferred by the client to the provider, which may (but need not) include some or all of any marketable securities purchased with the loan).

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Margin call occurs if the current LVR is above 80%.

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Original current LVR = 85,000/125,000 = 68%.

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Value of the transferred securities falls to $100,000.

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Current LVR = 85,000/100,000 = 85%.

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Facility is in margin call on the date the current LVR exceeds 80%.

1.56 The operation of the definition of a non-standard margin lending facility in the manner outlined in the example above is quite different from a general 'stock' or securities lending transaction.

1.57 In the case of a general 'stock' or securities lending transaction, the cash collateral (or the value of any non-cash collateral) usually must always exceed the value of the transferred securities (that is, the ratio must normally be in excess of 100 per cent, say 102 per cent), and margining will be required if the ratio falls below the agreed minimum of say 102 per cent.

Example 1.5 : Example of normal stock lending arrangements

An example of a general stock or securities lending transaction is provided to assist in understanding the difference from the transactions captured by the definition:

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Value of cash or non-cash collateral provided by securities borrower to securities lender = $105,000.

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Value of borrowed securities = $100,000.

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Margining by the securities borrower is required if the value of the collateral becomes less than the agreed ratio of the value of the collateral to the value of the borrowed securities, which say is agreed at 102%.

Scenario A

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Value of the borrowed securities rises to $125,000.

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New ratio = 105,000/125,000 = 84%.

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The securities borrower must provide extra collateral of (or worth) at least $22,500, so that the value of the collateral is at least $127,500, and the ratio increases to at least a minimum of 102%.

Scenario B

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Contrast the situation if the value of the borrowed securities falls to say $85,000.

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The new ratio = 105,000/85,000 = 123.5%.

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That would not trigger any margining requirement on the part of the securities borrower. (On the contrary, the securities borrower may be entitled to call for the return of some or all of the excess collateral that it has provided, until the new ratio falls to not less than 102%.)

ASIC may declare facilities to be margin lending facilities

1.58 ASIC has the power to declare that a particular kind of facility is, or is not, a margin loan. In declaring a kind of facility as a margin loan, ASIC must also define key features such as a 'margin call' in the context of the facility. These powers are necessary to deal with product innovation and the likelihood that over time new margin loan structures will evolve that may not be captured by the current definition, such that the relevant investor protection provisions continue to apply . [Schedule 1, item 9, subsections 761EA(8) to (10)]

1.59 A declaration that a particular kind of facility is, or is not, a margin loan under subsection 761EA(8) or (9) must be in writing and is a legislative instrument for the purposes of the Legislative Instruments Act 2003 (Legislative Instruments Act).

Meaning of limit of a margin lending facility

1.60 The meaning of the key term 'limit' is given a specific definition in the case of standard and non-standard margin loans. For standard margin loans, the limit means the maximum amount of credit under the loan agreement, while for a non-standard loan it means the maximum amount of property that may be transferred by the provider to the client under the terms of the agreement. It is also stipulated that ASIC must define the term if it declares that something is a margin lending facility . [Schedule 1, item 9, subsection 761EA(11)]

Responsible lending for margin lending facilities

1.61 Subdivision A, Division 4A of Schedule 1 sets in place responsible lending requirements. The responsible lending provisions are intended to be broadly consistent with the provisions outlined in the National Consumer Credit Protection Bill 2009. However, there are some differences to take into account the specific nature of a margin loan.

Requirement to make assessment of unsuitability

1.62 Margin lenders are required, before issuing a loan or increasing the limit of an existing loan, to make an assessment to determine whether the loan facility is unsuitable for a 'retail client' [Schedule 1, item 12, section 985E]. 'Retail client' is defined in existing section 761GA of the Corporations Act. It is noted that this requirement only applies to lenders, and not to advisers.

1.63 Before issuing a new margin loan or increasing the limit of an existing loan, the lender must make an unsuitability assessment as set out in detail in section 985F. The assessment must be made within 90 days before the loan is issued or the limit increased, or any other period as prescribed in regulations. The assessment must cover the period during which the issue or limit increase occurs. At the time the assessment is made, the person doing the assessment should ask the consumer when it is expected that they intend to obtain the loan or limit increase - usually by reference to a future period rather than a precise date (for example, in the next two weeks, or in July or August). Assessments are to be made on that basis. The purpose of this section is to ensure that assessments are not used if they were prepared with a view to the loan being advanced in a different period to that in which the loan is actually issued or limit is increased. The lender must also have made the inquiries and verification as set out in detail in section 985G. Failure to make an assessment as required incurs a civil penalty . [Schedule 1, item 12, subsection 985E(1)]

1.64 Provisions are included that clarify that an increase in a credit limit that occurs because of changes in the market value of the underlying security does not require an unsuitability assessment to be made . [Schedule 1, item 12, subsection 985E(2)]

1.65 A regulation-making power is included allowing other situations to be defined in which a limit increase is considered to have occurred or not to have occurred. Concerns have been raised during consultation about the possibility of circumstances occurring where a borrower breaches the agreed credit limit through actions that are beyond the control of the loan provider. It is intended to use this regulation-making power to address such situations before the commencement of the new regime. The regulation-making power could also be used to address other situations where the strict application of the requirement to make an unsuitability assessment may not be justified, or where it is considered necessary to apply the requirement to circumstances that do not fall within the current scope of the provision . [Schedule 1, item 12, subsection 985E(3)]

Unsuitability assessment

1.66 The unsuitability assessment must be made if the margin loan facility is issued or the loan limit increased, and must specify the period it covers. If no loan facility is issued, or no limit increased, no assessment is required to be made. This is considered to be appropriate as the misconduct that is intended to be addressed by this provision relates to clients that are placed into margin loans that may be unsuitable for them. If the loan is not provided there is evidently no risk of such harm affecting the client . [Schedule 1, item 12, section 985F]

Reasonable inquiries etc. about the retail client

1.67 In making an assessment, margin lenders are required to make reasonable inquiries about the client's financial situation and take reasonable steps to verify it [Schedule 1, item 12, paragraphs 985G(1)(a) and (b)]. This includes any inquiries or verification steps prescribed by regulations [Schedule 1, item 12, paragraphs 985G(1(c) and (d)], and must be made in a manner prescribed (if prescribed by regulations) [Schedule 1, item 12, subsection 985G(2)].

1.68 The purpose for undertaking reasonable inquiries about the client's financial situation is to obtain an understanding of the client's ability to meet all the repayments, fees, charges and transaction costs of complying with a possible margin call. The general position is that clients should be able to meet their contractual obligations from income and available liquid assets, rather than from long-term savings or from equity in a fixed asset such as a residential home. The returns that are potentially available from the portfolio financed by the loan may be taken into account in a reasonable manner, but should not constitute the sole or main source of funds available to meet a margin call and service the margin loan.

1.69 As a general rule, reasonable inquiries about the consumer's financial situation should be expected to include determining the amount and source of the consumer's gross and disposable incomes, the reliability of the income and the availability of assets, in particular liquid assets, to meet demands for additional payments such as a margin call. The detailed nature of these inquiries may differ depending on the borrower and their circumstances.

1.70 Regulations will be made to prescribe specific matters that lenders must take into account, which are intended to include important considerations such as whether clients have taken out a second loan to finance their equity contribution for the margin loan, and whether they have used their homes to secure this second loan. This creates a scenario known as 'double gearing' which may in some situations lead to the risk of clients losing their homes, if they are unable to service their loans following a margin call.

1.71 It is therefore important for lenders to have assessed the potential impact of such factors on a client's position before deciding to provide a margin loan. Particular attention should be paid to the risk of a client losing their residential home as a consequence of being unable to service or repay the margin loan.

1.72 In undertaking the assessment lenders are required to take into account information about the client's financial situation and other matters required by the regulations that they either already possess, or which would be known to them if they made reasonable inquiries and took reasonable steps to verify it. Where lenders are unable to access information, for example because of rules quarantining information within business units, this would clearly fall outside the scope of the reasonable inquiries expected to be made.

1.73 This provision also requires lenders to take reasonable steps to verify the information they have obtained. This is intended to mean that lenders must make such efforts to verify the information provided by the client as they would undertake in the normal course of their business. Conducting a credit check is, for instance, considered to be an action undertaken by lenders in the normal course of their business.

1.74 As the responsible lending provisions impose new requirements on margin lenders, current business practice for margin lending may not in all circumstances be sufficient to satisfy the need to take reasonable steps to verify information. In such situations, reference may have to be made to practices applied in other credit areas.

1.75 It is noted that there will be matters that will not be able to be known to the credit provider. This may arise where the consumer simply does not disclose the matter, despite the credit provider's inquiry, and where there was no reasonable way of verifying the information provided.

1.76 ASIC will also provide guidance where appropriate to set out further detail about reasonable inquiries and the verification process in particular circumstances.

Reliance on information provided in a statement of advice

1.77 In making reasonable inquiries, lenders may rely on information provided in a statement of advice for the client, where the statement of advice recommends the margin lending facility, and it was prepared no more than 90 days before the day on which the margin lending facility is proposed to be entered into. In these circumstances, the provider is not required to verify such information . [Schedule 1, item 12, subsection 985G(3)]

1.78 This reliance provision is intended to minimise the regulatory burden on lenders and the impost on consumers, where the same information has already been provided to an adviser.

1.79 It is, however, noted that lenders cannot solely rely on the information provided in a Statement of Advice (SoA) where that information does not satisfy the benchmark of having to make reasonable inquiries about the client's financial situation. In those circumstances lenders would have to make inquiries to obtain additional information in order to comply with the benchmark.

1.80 It is envisaged that margin lenders could make arrangements for information relevant to a margin loan to be excerpted from an SoA and presented to them in a particular format. Lenders will have to obtain appropriate confirmation that any information excerpted in this way forms part of an SoA, including the date of the SoA.

When margin lending facility must be assessed as unsuitable

1.81 Guidance is provided as to when a margin loan must be assessed as unsuitable [Schedule 1, item 12, section 985H]. Clarification is provided that lenders may reject loan applications for reasons other than those mentioned in the legislation [Schedule 1, item 12, subsection 985H(1)].

1.82 A loan is unsuitable where a client who receives a margin call would not be able to comply with their financial obligations around a margin call, or would only be able to do so while suffering substantial hardship [Schedule 1, item 12, paragraph 985H(2)(a)]. A power is provided to prescribe specific situations where a loan must be assessed as unsuitable. It is intended to prescribe a number of such situations, subject to further consultation and consideration, before the regime commences [Schedule 1, item 12, paragraph 985H(2)(b)].

1.83 The assessment is to be based on the facts as they have been obtained by the provider or are otherwise available to the provider at the time of making the assessment. There is no requirement for providers to make assumptions about potential future developments.

1.84 In making the assessment, lenders must take into account information concerning the client's financial situation, as well as other matters prescribed by regulations. It must also be information which the lender has reason to believe was true, or would have had reason to believe that the information was true, if it had made the inquiries or verification required. Information that does not satisfy these requirements must not be taken into account . [Schedule 1, item 12, subsection 985H(3)]

1.85 The assessment conducted by the lender must specifically address the ability of the client to cope with the potential consequences of a margin call, in particular the possibility of having to deal with negative equity situations. An important factor in the assessment is the time allowed to the client to meet the margin call. Where clients are allowed only a short period within which the margin call must be met, the importance of the client having sufficient liquid assets to cope with such situations is enhanced. It is not intended that the potential sell-down of part or all of the portfolio to adjust the LVR to the required level should imply substantial hardship.

Giving the retail client the assessment

1.86 Clients may request the lender to provide them with a written copy of the assessment, but only if the request is made within seven years after the loan is issued or the loan limit increased . [Schedule 1, item 12, section 985J]

1.87 Failure to give the client a copy of the assessment is an offence (50 penalty units) and incurs a civil penalty . [Schedule 1, item 12, subsection 985J(1)]

1.88 Lenders do not have to give the client the written assessment if the loan is not issued or the credit limit not increased . [Schedule 1, item 12, subsection 985J(1), note 3]

1.89 Appropriate time limits for providing the assessment are imposed. If the request is made before the loan is issued or the limit increased, then the copy must be provided before the agreement is finalised. If the request is made after the arrangements are finalised, the copy must be provided within seven business days if the request is made within two years after the loan is issued or the limit increased. Requests made later than that must be addressed within 21 business days. Failure to comply with these requirements is an offence (50 penalty units) and also incurs a civil penalty . [Schedule 1, item 12, subsection 985H(2)]

1.90 The provider must give a copy of the assessment in a manner (if any) prescribed by regulations . [Schedule 1, item 12, subsection 985J(3)]

1.91 This assessment must be given to the client without charge. It is an offence (50 penalty units) and incurs a civil penalty to make a client pay for the assessment . [Schedule 1, item 12, subsection 985J(4)]

1.92 Subsections 985J(1), (2) and (4) are offences of strict liability, because it is considered that these offences should attract criminal sanctions where there is no 'fault' but for the failure to provide the assessment as required by the law. This is based on the relatively low penalty amount and the need to include a deterrent for breaches of these provisions . [Schedule 1, item 12, subsection 985J(5)]

Unsuitable margin lending facilities

1.93 Lenders must not provide a new loan or increase in the limit of an existing loan where the loan or increase is unsuitable for the client [Schedule 1, item 12, section 985K]. Failure to comply with this requirement attracts a civil penalty and is also a criminal offence carrying a maximum penalty of 100 penalty units, two years imprisonment or both [Schedule 1, item 12, subsection 985K(1)]. Providing a client with an unsuitable margin loan is the main 'harm' these provisions are intended to address.

1.94 The same unsuitability definitions and other requirements apply as described above in relation to sections 985E and 985H. These amendments specify when a facility is unsuitable, what information the provider must base the assessment on, and exempt a particular situation from the definition of an increase in the limit of a facility . [Schedule 1, item 12, subsections 985K(2) to (6)]

1.95 A regulation-making power is provided allowing particular situations to be prescribed in which a margin lending facility is not taken to be unsuitable . [Schedule 1, item 12, subsection 985K(4)]

Notification of margin calls

Issuer must notify client of margin call

1.96 Subdivision B, Division 4A sets in place a requirement that the lender must make reasonable efforts to notify the client when a margin call occurs . [Schedule 1, item 12, subsection 985M(1)]

1.97 Lenders are allowed to make use of a buffer before issuing margin calls to borrowers, as this is a useful practice for accommodating short-term fluctuations in market values. As mentioned above, this requires the buffer to be part of the terms of the facility.

When issuer must notify client's agent, and agent must notify client, of margin call

1.98 A lender may notify a financial adviser, instead of the client, based on contractual arrangements agreed to by the relevant parties.

1.99 If there is an agreement between the lender, the client, and a financial adviser ('the agent') that 'the agent' will act on behalf of the client, then [Schedule 1, item 12, subsection 985M(2)]:

•

the lender must make reasonable efforts to notify the agent; and

•

the agent must make reasonable efforts to notify the client.

1.100 Failure to comply with the notification requirements, under both subsections 985M(1) and (2), incurs a civil penalty.

When and how notification must be given

1.101 The notification of a margin call must be given at a time determined by ASIC. If ASIC has not prescribed a time, then the notification must be provided as soon as practicable . [Schedule 1, item 12, subsection 985M(3)]

1.102 The notification must be given in a manner agreed between the parties, or, if there is no such agreement, in a manner determined by ASIC. If ASIC has not prescribed a manner, then the notification should be provided in any reasonable manner that would satisfy the objective of ensuring that the client receives the notification in a timely fashion . [Schedule 1, item 12, subsection 985M(4)]

1.103 'Reasonable manner' is considered to include electronic means such as the telephone, facsimile, SMS and email. Notification through a client's individual account which is accessed by means of the client logging on through the lender's website alone is generally not considered to be a 'reasonable manner', unless the client is simultaneously alerted through other means that an important notice has been placed in their account.

1.104 ASIC can determine the time and manner in which notification is to occur. This determination by ASIC must be in writing and is a legislative instrument for the purposes of the Legislative Instruments Act . [Schedule 1, item 12, subsections 985M(5) and (6)]

Margin lending facility not to be conditional on notification arrangements

1.105 Making arrangements to notify the agent in the event of a margin call should not be a condition of entering into a margin lending facility. Such a contravention attracts a civil penalty . [Schedule 1, item 12, section 985L]

General amendments

1.106 Amendments are made ensuring that the provisions in section 1016A of the Corporations Act relating to the use of application forms and in section 1017D in relation to the provision of periodic statements apply to margin loans . [Schedule 1, items 13 and 14]

1.107 Amendments are made applying the civil penalty provisions in section 1317E of the Corporations Act as described in various parts of this explanatory memorandum to the Bill . [Schedule 1, item 15]

1.108 The penalties for breaching the responsible lending requirements are inserted in the list of penalties for offences in Schedule 3 to the Corporations Act . [Schedule 1, item 16]

Application and transitional provisions

1.109 Division 1 of Part 10.12 of the Corporations Act contains the transitional arrangements for the amendments in the Bill relating to margin loans.

1.110 A number of key definitions are specified in relation to the transitional arrangements for the national margin lending regime . [Schedule 5, Division 1, section 1487]

1.111 The Corporations Act will apply to issuing and advising by margin lenders and financial advisers in relation to margin loans twelve months after the legislation comes into force. This period will give potential licensees time to prepare for the new regime by adapting their systems and processes, training staff and in other necessary ways. It is noted that issuance and advice are only captured insofar as they relate to margin loans issued after commencement of the Bill . [Schedule 5, Division 1, section 1488]

1.112 Applications to ASIC for obtaining a licence are not to be made until one month after the legislation comes into force. This period is designed to provide ASIC with time to prepare for receiving and processing applications . [Schedule 5, Division 1, subsection 1489(1)]

1.113 The transitional arrangements enable persons to apply for AFSLs and ASIC to issue or vary licences thereafter until the Chapter 7 regime including the new amendments comes into force 12 months after commencement of the legislation. Any AFSL, or variation of an AFSL, granted by ASIC does not take effect until 12 months after commencement . [Schedule 5, Division 1, subsections 1489(1) to (3)]

1.114 During the period from 6 to 12 months after commencement, lending and advising in relation to margin loans may only be done by persons who have applied to ASIC for a licence or a variation to an existing licence allowing them to provide these services. ASIC is also given the power to reject a licence application during this period if it considers the application to be unsuitable. This power is required as such applicants could otherwise provide the services until the new regime comes into force 12 months after commencement . [Schedule 5, Division 1, section 1490]

1.115 It is not anticipated that the Bill (or instruments made under it) effects any acquisition of property other than on just terms contrary to paragraph 51(xxxi) of the Constitution. A relevant clause is included out of an abundance of caution to ensure that an acquisition contrary to paragraph 51(xxxi) cannot take place. In any circumstance where an acquisition contrary to paragraph 51(xxxi) is effected, the relevant law or instrument does not apply. This clause overrides section 1350 of the Corporations Act which contains provisions relating to the payment of compensation due to the acquisition of property otherwise than on just terms . [Schedule 5, Division 1, section 1491]

1.116 Regulations may be made prescribing matters of a transitional, application or saving nature relating to the legislation. This power is considered necessary to deal with unexpected or minor transitional matters arising after the legislation is passed . [Schedule 5, Division 1, section 1492]