Ralph reforms set to shake margin lending

The booming margin lending market may be attracting heat from regulators around the world, but Ralph inspired tax changes are set to keep the flame burning. Jason Spits examines the rise and rise of margin lending.

The booming margin lending market may be attracting heat from regulators around the world, but Ralph inspired tax changes are set to keep the flame burning. Jason Spits examines the rise and rise of margin lending.

Margin lending is a relatively new product within the Australian market having spent less than a decade on the shelves but until recently it has failed to really grab the attention of investors.

Reasons for this include the element of risk attached to borrowing to invest in shares or managed funds, added to the fact that the first margin loans were intro-duced in a time when interest rates were high.

The prospect of receiving a margin call and the need to come up with necessary funds to top up the borrowed amount also hasn’t done margin lending any favours.

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However, the recommendations handed down in the Ralph review of business taxation have given margin lending a shot in the arm.

While the halving of capital gains tax (CGT) to a maximum of 24.25 per cent was-n't aimed at margin lending, the result is nonetheless very beneficial.

Commonwealth Securities director Paul Rickard says the change is leading the changing fortunes of margin lending.

"This is a product which hasn't been made particularly accessible due to various factors but now has the opportunity for more people to become involved," Rickard says.

"The upside for clients is the reduction in CGT which will make growth assets more attractive. The downside is that a cloud hangs over deductibility of interest for companies using margin lending."

This aspect of margin lending however should be carefully examined says BT Funds Management senior vice president Brian Bissaker.

"The full deduction of interest is a technical issue and investors should seek tax advice. Yet it is also worth remembering this is a preliminary set of changes and there could be further alterations including the relief remaining active for compa-nies," Bissaker says.

Yet under the reforms outlined, Bissaker says the strategies involved in margin lending will remain unaltered but the investment vehicles will change.

"This probably won't change the normal strategies but vehicles will shift to indi-viduals and small businesses under the revenue turnover limit of $1 million per an-num," Bissaker says.

"Both of these can still claim interest deductions while individuals get the best CGT reductions, so these are the entities to use if investors are looking for the best returns."

This swing to individual investors and the growth of share purchasing in Australia has also changed the focus for those taking out margin loans, according to Lever-aged Equities marketing manager John Meagher.

"We find some investors are putting off buying property and buying shares because returns are better using margin lending as a line of credit approach to offset other areas such as businesses or property," Meagher says.

"As long as investors manage the risk and use a conservative approach, it is a valid wealth accumulation vehicle. There are tax issues but the main focus is for asset growth to be built over time."

There is still a downside to margin lending inherent within the product, says Bis-saker, despite the positives on offer.

"Gearing is still high risk in the short term and borrowers need to have enough cash to fund margin calls and be aware of rapid changes in the share market and interest rates," Bissaker says.

"Borrowers need to be comfortable with the risk elements and always need to have that in mind."

Yet Rickard says that while the structure of the product is important, investors in the short term can be more optimistic than in the past.

"The impact on margin loans from interest rates is important, but the share market this year will have a greater relevance. Confidence is high and spending is up so it will take a number of rate increases to have a noticeable impact on margin lend-ing," Rickard says.

The emphasis on the share market is also indicative of the changing face of margin lending. Meagher says the market is attracting younger investors who are shying away from the traditional home purchase.

"The market has changed through demutualisations and floats with more general interest in the share market. People are also more at home with borrowing to invest in shares instead of property which is part of the demographic moving down into the late 20s and the early 30s," Meagher says.

"The banks coming in with lower minimum loan deposits has also lead to continual expansion and a lower margin call. With expanding markets, investors need a large fall before the borrower is on the phone with a margin call."

Rickard says the actions of the banks and social change has also lead to growth in the popularity of the product.

"The lowering of the upfront loan deposit is attracting a different class of lender who tends to be more mainstream and also younger. With the starting amount of $20,000, which can be drawn down, the new borrowers also tend to have a lower net wealth," Rickard says.

"Changing marriage patterns have seen the first investment no longer in housing but in growth assets and as such I don't think margin lending has reached a zenith yet. By the standards in the US there is still a large potential ahead for it."