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Funds Management - Real Estate & Superannuation

Focus: Financial Services and Credit Reform – June 2008

Treasury's Green Paper recommendations on financial services and credit reform

In brief: Earlier this month, the Treasury Department of the Australian Government released a Green Paper on Financial Services and Credit Reform. Partner Susan Burns and team1 summarise and discuss the Paper.

How does it affect you?

  • The Green Paper, titled 'Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation', proposes that the Commonwealth takes on regulation of a number of areas currently regulated by both State and Federal legislation (to varying degrees). The likely areas are: mortgage credit and advice, margin lending and trustee corporations. The Paper also explores tighter regulation of debentures and 'property spruikers'.
  • The Paper is quite short and has little in the way of true evidence-based information.
  • While most of the objectives in the Green Paper are praiseworthy, it is very likely that the legislation to implement them will be complex, certainly more than first appears. Increased compliance costs and new uncertainties are the almost inevitable result.
  • Comments on the Paper are requested by 1 July 2008.

Mortgages, mortgage-broking and non-deposit taking institutions

Following on from the Productivity Commission report released in May 2008, which called for a national approach to consumer credit regulation, the Green Paper acknowledges that the regulation of credit is not uniform between the states and territories and has not kept pace with changes in lending practices.

The Paper notes that, as certain key financial services are organised to operate in an increasingly national or even international market, a uniform regime may be more appropriate. Shifting responsibility for mortgage credit providers, which provide the largest amount and most important form of consumer credit to the Commonwealth, was seen as more efficient and consistent than the current regime. The proposal includes a recommendation that the Commonwealth Government:

  • take over the regulation of mortgage credit and advice by establishing a single set of national rules based on including mortgages as a type of 'financial product' under Chapter 7 of the Corporations Act 2001 (Cth)2; and
  • entrust the licensing of mortgage providers, and the review and enforcement of relevant standards, to a single regulatory body, not at this stage determined but, given the range of responsibilities, likely to be the Australian Securities and Investments Commission (ASIC).

The Council of Australian Governments (COAG) has agreed in principle to the Commonwealth assuming responsibility for the regulation of mortgage credit and advice. However, before preparing any relevant legislation, the Commonwealth will examine whether it has the constitutional power to take on these responsibilities or whether it needs to seek referrals of power from states and territories.

Under this option, the regulation of most other types of consumer credit would remain with the states and territories and the Uniform Consumer Credit Code (UCCC). The two alternative options to this approach put forward in the Green Paper are:

  • leaving the regulation of mortgages, mortgage brokers and non-deposit taking institutions as it is, with its lack of Australia-wide uniformity and the more limited remedies available under the UCCC, the Australian Securities and Investments Commission Act 2001 (Cth) (the ASIC Act) and relevant state and territory legislation; or
  • the Commonwealth taking over responsibility for all forms of consumer credit, not only for mortgages but also for all other forms of consumer credit such as credit cards, car loans and other personal loans.

The Green Paper does not favour these alternative options.

Our comment: A single national regime for all forms of consumer credit was not seen as appropriate, given the fact that credit facilities or pay day loans may be affected by regional differences that cannot be incorporated into a national regime. In other words, the reasons for favouring a limited referral are practical and pragmatic3 . That said, lenders who provide both mortgages and other forms of consumer credit would obviously prefer a more comprehensive and consistent regime than that recommended.

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Trustee corporations

Although trustee corporations are currently governed by state and territory regulatory regimes, COAG agreed in March 2008 that the Commonwealth should become responsible for their regulation.

The proposed legislation would cover only the trustee corporations' personal trustee services and would not extend to:

  • 'non-traditional' activities such as acting as the trustee for superannuation funds, registered schemes and debenture noteholders that are already covered by Commonwealth legislation;
  • the current responsibilities of the states and territories for trust law and the statutory framework governing trustee's responsibilities; and
  • the activities of government-controlled public trustee corporations.

Subject to these limits, the intention of the new legislation is to:

  • create a national market for the trustee corporations industry;
  • devolve supervision of trustee corporations to a single regulator;
  • develop more cost effective and timely dispute resolution procedures; and
  • reduce business compliance costs, the direct cost of regulation and barriers to entry, especially for trustee corporations that operate in more than one jurisdiction.

The Green Paper proposes that these goals be achieved in one of two ways:

1. Based on consumer protection supervision and regulated by ASIC

Under this option, trustee corporations would be licensed and supervised by ASIC. The Green Paper envisages that licensing requirements could be adapted from those currently applying under the Corporations Act to custodial and depository services (encompassing minimum standards of organisational capacity, financial resources and funds management expertise), while specific consumer-protection and disclosure requirements would be developed separately.

2. Based on prudential regulation by APRA

The Green Paper notes that this approach would require separate legislation, as well as new standards by the Australian Prudential Regulation Authority covering 'fit and proper' requirements for directors and senior management, risk management systems, outsourcing, resources and capital requirements.

The emphasis of this alternative would be on the 'health of the entity itself, as distinct from directly focusing on the entity's capacity and resources to effectively manage trust assets for beneficiaries'4 and is likely to be more intrusive than the first option.

Our comment: Option 1 fits more neatly into the current regulatory regime, both practically and philosophically, and is likely to be favoured for that reason. It is also probable that the level of supervision provided by that approach would be suitable, given the nature of trustee corporations' operations.

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Margin lending

The Green Paper provides evidence to demonstrate that the use and availability of margin lending has increased markedly over the past decade. Margin loans are provided by a variety of lenders and currently the contractual arrangements between lenders and their clients are regulated in a piecemeal manner, depending on:

  • what industry the lender is part of – for example, the Code of Banking Practice applies to members of the Australian Bankers' Association; and
  • which component of the contract is under consideration – the underlying investment is generally governed by Chapter 7 of the Corporations Act while the credit component is not specifically regulated, although the consumer protection provisions of the ASIC Act provide some protection. The UCCC, for example, does not apply because credit provided for investment purposes is not covered.

The Green Paper sets out two options for the reform of margin lending regulation. It also explores maintaining the status quo and rejects that option, on the basis that less-regulated margin lenders are increasingly marketing to less sophisticated investors.

1. Include margin loans as a financial product under the Corporations Act and apply the Chapter 7 regime

Under this option, the licensing, disclosure and enforcement provisions of Part 7 of the Corporations Act would apply to margin loans and the providers of these products.

Our comment: Despite inevitable complexities, including margin loans as a financial product under the Corporations Act is a reasonably natural extension of Chapter 7. An example of the possible complexities is whether (and how) a distinction will be drawn between margin lending and securities lending (and similar activities). Recent events have shown that, while different in structure, these arrangements can be effectively the same in economic terms.

2. Develop a separate Commonwealth regulatory regime for margin loans

This option would involve creating a separate system to reflect the Chapter 7 licensing, disclosure, market misconduct and enforcement provisions.

Our comment: Although this option allows for specifically tailored margin lending legislation, the inevitable overlap between such legislation and the Corporations Act would create inefficiencies for businesses required to operate under different regimes.

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Debentures

The level of regulation applying to debenture products currently depends on:

  • the price; and/or
  • the structure

of the product, because a number of different regulatory regimes currently apply. Some operators have sought to take advantage of these differences to minimise or avoid regulation.

Our comment: The Green Paper proposes a number of different reforms which, together, should significantly improve the regulation of debenture products, and which are based on the policy objectives underlying the Financial Services Reform legislation.

1. Harmonisation of regulation of promissory notes

Promissory notes are a form of debenture used to raise funds and are regulated under the Corporations Act either as debentures, as financial products or, in some cases, as interests in managed investment schemes.

The Green Paper proposes that the Corporations Act definition of 'debenture' be extended to include all promissory notes issued to retail investors. We take this to mean that the exclusion from the 'debentures' definition of promissory notes with a face value of at least $50,000 will be removed.

2. Licensing of debenture issuers

Because of peculiarities under the current licensing regime, certain issuers of debentures are not currently required to hold an Australian financial services licence.

The Green Paper proposes that:

  • issuers carrying on an investment business that regularly offers securities to retail investors; and
  • for whom such issues constitute their main source of funding,

be licensed by ASIC to do so.

Our comment: As is noted in the Green Paper, entities that carry on a business of investing in securities, land or other investments, and who raise the funds for these investments through an offer or invitation to the public, are already required to hold an AFS licence. It is not completely clear from the Green Paper which additional entities would be covered by the new licensing requirements, unless the requirement that the funds used by the investment business be raised by 'an offer to the public' is removed from the existing licensing trigger – the Green Paper suggests that such a requirement is now anachronistic and needs to be reviewed.

3. Licensing of debenture trustees

The Green Paper proposes that debenture trustees for retail issues be licensed by ASIC (see also our section on trustee corporations, above). The list of approved types of debenture trustees in Chapter 2L of the Corporations Act would be removed.

4. Review of debenture trustee duties

The Green paper proposes aligning the existing trustee duties in Chapter 2L of the Corporations Act with those currently contained in ASIC Regulatory Guide 69, Debentures – improving disclosure for retail investors.

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Property spruikers

There is no direct regulation of property investment advice, although the general consumer protection provisions of the Trade Practices Act 1974 (Cth) or the ASIC Act apply, as do the state and territory consumer protection laws. The Green Paper asserts that property spruikers or those providing real property investment advice can 'take advantage of regulatory gaps and inconsistencies between fair trading laws, the financial services regime and the real estate licensing regime'.

The Green Paper acknowledges the widespread calls for the regulation of property investment advice and seeks submissions on possible options for reform, including submissions in line with the recommendations made by the Parliamentary Joint Committee Report on the regulation of property investment advice of June 2005 (the Parliamentary Report).5

The Green Paper does not make specific recommendations for regulatory reform, but adds that 'it is difficult to specifically define and quarantine the property spruiking sector for specific regulation from other areas of the real estate industry'.

The Paper does, however, refer to the recommendations of the Parliamentary Report. This report recommended that the regulation of property investment advice, but not of real property or real estate transactions generally, should be a Commonwealth responsibility.6 The Parliamentary Report further recommended that real property be included as a financial product in Chapter 7 of the Corporations Act, that property investment advice be categorised as a financial service under Chapter 7 and that those giving real property investment advice should, with some exceptions, be required to hold an AFS licence.7

The Victorian Law Reform Committee delivered its report into property investment advisers and marketeers in April 2008 and its recommendations also draw a distinction between advice about property investment (which it recommends should be regulated under Chapter 7 of the Corporations Act) and real property transactions (which it recommends should continue to be regulated by the states and territories).8

Our comment: The regulation of the provision of real property investment advice and the specific inclusion of real property as a financial product in Chapter 7 of the Corporations Act would see both the disclosure and licensing regime under that Act expand. While such regulation may provide greater protection to consumers investing in real property, it would also result in a significant increase in the compliance costs for businesses that provide advice about direct real estate investment (including costs involved in developing systems to identify conduct to which Chapter 7 applies). We expect that is one reason why the Green Paper makes no recommendation on this issue.

Footnotes
  1. *Partner Peter Jones, Senior Associate Penelope Barclay and Lawyers Georgina Perry, Svetlana German and Nadine Bairle.
  2. 'Credit facilities' including mortgages are currently specifically excluded from the definition of 'financial product'.
  3. It is what COAG has agreed.
  4. Green Paper – Financial Services and Credit Reform: Improving, Simplifying and Standardising Financial Services and Credit Regulation: June 2008, page 24.
  5. The Paper refers to previous inquiries in relation to property investment advice, including the joint working party established at the Ministerial Council on Consumer Affairs established in 2003 to investigate property investment advice, the Parliamentary Joint Committee on Corporations and Financial Services' report on the regulation of property investment advice issued in June 2005 and the March 2007 inquiry of the Law Reform Committee of Victoria on property investment and property marketeers.
  6. Parliamentary Joint Committee on Corporations and Financial Services, 'Property Investment Advice – Safe as Houses?', June 2005 at 2.45, 2.97.
  7. Parliamentary Joint Committee on Corporations and Financial Services, 'Property Investment Advice – Safe as Houses?', June 2005 at 3.54, 3.56.
  8. Victorian Law Reform Committee, 'Inquiry into Property Investment Advisers and Marketeers', April 2008, Recommendations 5, 8.

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