ASIC to regulate credit?

On 12 December 2007 the Productivity Commission (Commission) released a draft report: Review of Australia’s Consumer Policy Framework (Report). In the Report, inter alia, the Commission has recommended (Draft Recommendation 5.2) that the responsibility for regulating finance brokers and other credit providers should be transferred to the Australian Government, with the regulatory requirements encompassed within the financial services regime administered by the Australian Securities and Investment Commission (ASIC).

As part of this transfer the Commission has recommended that:

• the Uniform Consumer Credit Code (UCC) and related credit regulation, appropriately modified, should be retained. The Australian and State and Territory Governments should give priority to determining the precise requirements, and how they would be best incorporated within the broader regime;
  
  
• a licensing system should be introduced for finance brokers that, amongst other things, requires them to participate in an ASIC-approved alternative dispute resolution (ADR) scheme; and
  
  
• a registration system should be introduced for other credit providers, not already covered by the broader licensing arrangements for financial service providers, with a condition of registration being participation in an ASIC approved ADR scheme.
  
  

The UCCC currently only applies to credit provided or intended to be provided wholly or predominantly for personal, domestic or household purposes. Chapter 7 of the Corporations Act 2001 expressly excludes credit from the financial services regime. Thus, business and investment loans are largely unregulated in Australia. However, there are some consumer protection provisions contained in the Australian Securities and Investments Commission Act that apply to the provision of credit.

ASIC has made a submission to the Commission in response to the draft Report. ASIC suggests that the UCCC can be amended to include loans to small business consumers and loans for investment purposes eg. margin lending or loan for purchasing investment properties, although ASIC prefers that the Chapter 7 licensing regime, with modifications, could be extended to these credit-related activities. In its submission ASIC suggests that margin lending could be regulated under Chapter 7 on the basis that margin loan facilities are closely tied to the underlying investments that they fund and are part of the investment decision-making process.

ASIC notes that there is a case to regulate margin lending to promote informed decision making by investors about specific risks relevant to margin lending, including:

• the heightened risks for investors because margin lending magnifies the extent of their losses if the value of an investment financed by margin loans falls in value; and
  
  
• the fact that consumers may not necessarily be aware of the extent to which margin lending contracts place the risk of changes to market condition on them, particularly the ability of lenders to unilaterally withdraw the facility forcing full repayment, often in adverse market conditions.
  

The Commission has also recommended that the UCCC be appropriately modified and incorporated into the broader financial services regime. ASIC has noted that the approach to disclosure under the UCCC is high prescriptive, yet narrowly focussed and that it might be beneficial to consider adopting a more flexible, principles-based approach to disclosure. ASIC takes the view that there are lessons to be learned from the more flexible, principles-based approach which currently applies in respect of financial product disclosure under Chapter 7, in assessing what modifications to the UCCC are appropriate. ASIC notes that the UCCC style of disclosure is at odds with disclosure to consumers under the financial services regime.

The Commission also recommends introducing a registration system for credit providers that do not hold an AFSL (i.e. credit providers who are not mortgage brokers), on the basis that registration is more cost effective way to achieve mandatory EDR scheme membership than a ‘full blown’ licensing system. ASIC notes the importance of avoiding unnecessary compliance costs. However, ASIC also notes that if the Commission’s recommendation on this aspect is implemented, it would result in the establishment of a dual licensing and registration system with different compliance burdens for different types of financial services providers competing in the same consumer lending market. For example, work done in advising a consumer or arranging a loan by an in-house employee of a credit provider would potentially be subject to a different regime from the same conduct done by a broker. ASIC notes that this issue would be at it most acute where an entity or corporate group combines credit provision and mortgage broking with individual staff engaged in both activities. The dual system may lead to regulatory arbitrage. ASIC has suggested a modified version of the financial services licensing and disclosure regimes could apply to all participants in the provision of credit, rather than introducing a separate registration system.

ASIC notes that appropriate modifications to the Chapter 7 regime would be required in respect of credit given the differences between credit and investment products. This would result in simpler and more streamlined regulation of credit providers than other financial services providers. In particular, ASIC notes that the consumer and compliance risks that arise in the context of credit are different to those arising from investment products. For example, a consumer who enters into a credit contract holds the lenders funds and makes the long term promises to repay in the future, with interest. In contrast when a consumer acquires an investment product, it is the product provider that holds an investor’s money and makes long term promises about its management and repayment. Additionally, with investment products, there is a very large range of different permutations of risk, cash flow, taxation, capital appreciation and potential financial loss for the investor to consider.

ASIC has suggested that credit providers could be required to comply with the following licensing requirements that currently apply (with potential modifications) to the financial services regime:

• be fit and proper (eg police and bankruptcy checks);
  
  
• provide their services efficiently, honestly and fairly;
  
  
• ensure representatives are adequately trained and comply with the law (using credit industry standards as a starting point);
  
  
• have adequate conflicts of interest arrangements in place;
  
  
• offer ASIC-approved external and internal dispute resolution mechanisms;
  
  
• have adequate compensation arrangements in place;
  
  
• notify ASIC of any breach of their obligations under the law;
  
  
• have a reasonable basis for any advice provided; and
  
  
• provide a financial service guide and statement of advice pursuant to Chapter 7 of the Corporation Act (with modifications) and disclosure in accordance with the UCC (with modifications).

The Commission has also recommended the consolidation of all existing financial services EDR schemes into a single umbrella scheme with independent arms. This would include the Banking and Financial Services Ombudsman, the Financial Industry Complaints Service and the Insurance Ombudsman Service. The Commission also recommends that the converged EDR scheme should adopt a common monetary limit. ASIC supports these recommendation and suggest that consumers or investors with a claim in excess of the monetary limit applied by any scheme should be able to waive the excess and have their claim met up to the monetary limit, rather than not receive any compensation at all. ASIC also notes that it will review its policy on dispute resolution and professional indemnity insurance this year.

The Report is timely and particularly important following the recent corporate collapses and the implication to investors who had taken margin loans to invest in those companies.  Would investors have been better informed of the risks if margin lending was covered by the financial services regime?  Further, the mortgage broking industry has long been unregulated and has necessarily been competitively advantaged over financial services businesses.  However, the final recommendation must weigh the benefits of any changes to the regime against the costs to ensure an efficient system.

The Productivity Commission proposes to release its final report in April 2008.

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