Margin lending: No margin for error

Collapsing institutions and a loss of wealth have combined to give the margin lending industry a bad reputation. Angela Faherty explains why increased legislation and a more targeted approach could get the sector back on track.

Since the collapse of Storm Financial at the beginning of 2009, the margin lending market has come to something of a standstill.

Fraught with complexities and possessing a questionable reputation, margin lending as a practice has come under a great deal of scrutiny from regulators, advisers and investors alike.

The fallout from the Storm saga illustrated the perils of margin lending for those who are uneducated about the workings of the stock markets.

Clients who took out large margin loans in a bid to accelerate their returns found themselves with considerable debt when the markets plummeted and failed to bounce back to pre-global financial crisis (GFC) levels.

Stemming from this, a flurry of regulatory reforms were introduced with the aim of protecting investors from the risks associated with margin lending and the volatility associated with gearing as a practice.

While the introduction of the reforms was designed to protect consumers from the perils of such high-risk investments, it would seem the regulations were so stringent they stifled the market, resulting in a fairly stagnant market for the past two years.

Although the regulations were a reaction to the devastation caused by the collapse of Storm, many would argue they are also crucial to the future success of the sector. As with all financial services products, margin loans are not for everyone. Therefore, enforcing regulations that ensure clients are well advised about the benefits and the pitfalls seems to be common sense in the current economic climate.

Licence to margin lend

One debate that continues to rage in the financial services arena, however, is whether planners actually want to advise on margin loans given the problems that have arisen in the past. According to figures released by the Australian Securities and Investments Commission (ASIC) late last year, only 781 licensees applied for margin lending authorisation as of November 2010.

Opinion among the advisory community varies as to why licence applications are so low.

Some cite the inability to secure professional indemnity cover for margin lending as a reason to steer clear of the products, while others simply state it is due to the conservative nature of advisers or the simple fact that the product is not for everyone.

Whatever the reason, it appears that conservatism is continuing to reign among the advisory community — even for those with a credit licence, according to Innoinvest Consulting principal Su-King Hii.

He says that many planners applying for a credit licence include margin lending products on their application, yet shy away from actually selling the products.

“A lot of planners include margin lending products when applying for a licence and they do it for the purpose of having the option to advise on them in the future,” he says.

“However, a lot of them, even though they have advised on margin loans previously, are shying away because they are awaiting the outcomes of court cases and the fallout from the margin lending debacle that we experienced post and during the GFC.”

Indeed, there has been a great deal of change in the regulatory environment since the collapse of Storm Financial, so it is understandable that advisers are treading with caution.

Last year, those wishing to continue to lend or advise on margin loans were given a six month window from 1 February to 30 June to apply to ASIC for an Australian Financial Services Licence (AFSL).

Failure to do so meant that those not licensed had to cease to provide or advise on margin loans. In addition, new responsible lending requirements were also imposed on margin lenders.

The legislation also sought greater protection for consumers by providing direct access to external dispute resolution services, as well as providing clarity about responsibility for notifying clients in the case of a margin call. All these changes have created anxiety in the market both among advisers and consumers, says Hii.

“There are a lot of factors affecting the margin lending market at the moment, such as the Government’s [Future of Financial Advice] reform which talks about statutory fiduciary duty as well as the suitability assessments under the margin lending provisions,” he says.

Hii adds that the feedback he has been receiving from advisers is that they are simply taking a step back from margin lending and have either stopped offering the products to clients or are making referrals to specialists confident in the sector.

Investors are also reluctant to take out margin loans, according to recent figures from the Reserve Bank of Australia that show the total margin lending debt fell to $17.7 billion by September 30 2010, down from $18.8 billion on 30 June. This was the lowest debt level since March 2005.

Despite figures showing growth in the margin lending market has come to a halt, ANZ head of investment lending David Crundall says the firm has witnessed solid growth over the past 12 months. He attributes this to the conservative approach adopted by ANZ when it comes to lending.

“Since the recovery of the stock market post-GFC, we have captured greater market share and I think one of the main reasons for that is historically, our client base is relatively conservative.

"Our credit losses in investment loans during the GFC were insignificant and we have been very careful who we lend to. Our retail book means we lend smaller loans rather than the larger stock lends that are available,” he says.

Despite the growth seen at ANZ, Crundall admits the market is unlikely to be heading for a period of accelerated growth in current economic conditions, and says it is likely to be at least a year or so away from rising strongly.

However, he says during this time ANZ plans to focus on streamlining its investment lending products and processes and gearing itself up for continued growth.

Education

Discussions of growth in a sector plagued by negative press may seem odd, but the financial services industry is confident of the role margin lending can play during the wealth accumulation stage. It is getting this message across to consumers that appears to present the biggest challenge.

“People really need to understand the product,” says Hii. “If you use it correctly, you can accelerate your wealth creation. Ultimately, it is a case of educating the clients and educating the public about this particular product.”

Crundall agrees: “Margin loans are a good vehicle for wealth acceleration for those who know what they are doing and have a sound knowledge of equity markets. However, it is important to understand they are not for everyone.

“For example, a retiree seeking financial advice is looking to preserve wealth not accelerate it, so a margin loan would not be suitable. Once you start eliminating those clients for whom a margin loan is not really suitable, you actually end up with a much smaller and more appropriate client base,” he says.

The future

With tighter regulations and rules continuing to govern the margin lending sector, it is unlikely the sector will grow at any great speed in the near future.

However, this is not necessarily a bad thing.

Much of the furore surrounding the margin lending sector has been the result of bad advice and bad judgement — and the result has been stringent rules, tighter regulations and reluctance from advisers and investors to get involved.

Yet most industry players agree there was always a need for legislation and welcome the new proposals to tighten rules and offer greater protection to consumers, particularly in the shadow of the GFC.

“As a business we are fully supportive of the new regulations and have always been conservative in our approach. We plan to continue this,” says Crundall.

Hii also welcomes the legislation and says it should help to eliminate product pushing and ultimately benefit the adviser community as well as consumers.

He says: “The market is still in the early stages of the new regime and I think the balance is just right in that all advisers are required to be licensed or authorised and carry out suitability checks on their clients.

“That said, I don’t think now is the time to add more regulations. The industry is going through a waiting period. Everyone wants to see the dust settle before deciding whether the regime is working."