Margin lending health check overdue

Margin loans are to the investment industry what power tools are to the tradesperson - useful for getting the job done faster but dangerous in unskilled hands.

The use of gearing or debt is something almost every investor will employ at some stage. Whether it is the mortgage for the home, a loan for a rental property or a margin loan on a share portfolio gearing is a strategy that is worthy of consideration and discussion with a qualified adviser - be it a financial planner or accountant.

Borrowing to invest brings with it the prospect of accelerated wealth creation and tax deductions - a seductive combination to most investors.

But like a high-powered tool borrowing can wreak havoc on a portfolio if the right controls are not in place. Which makes the proposals to regulate margin lending under the Corporations Act announced this week by the Minister for Superannuation and Corporation Law, Senator Nick Sherry, a welcome if overdue development.

Our Federal-State system of government has its strengths but a clear weakness has been the confusion around regulation of mortgages, margin lending and certain types of financial debt instruments like debentures and promissory notes which were at the centre of the collapse of the Westpoint property finance group.

The recent collapse of the broking group Opes Prime exposed a serious flaw in the margin lending business model that had developed during the strong growth years of a bull sharemarket. The stock lending practice that groups like Opes Prime and Tricom had used successfully dramatically unwound when market falls triggered margin calls.

Clients discovered they did not have clear title over the shares they had borrowed to buy. Given that the margin loan market is now valued at $32 billion most of the major margin lenders were unaffected and passed this latest market test - although no doubt a few nervous clients got out the loan contracts and read the fine print for the first time.

Margin lending is a mainstream financial product in 2008 - and it should be regulated as such and the organisations proferring these services should be licensed under the Corporations Law.

With the benefit of hindsight it seems ridiculous that you cannot buy a simple managed fund without being given a Product Disclosure Statement and a statement of advice if you invest via a financial planner yet there is no such regulatory disclosure requirement for taking out a much higher risk margin loan. So bringing margin lending under the Corporations Law umbrella and giving ASIC regulatory control is entirely sensible.

It would be interesting to survey margin lending clients - it would not be surprising if most investors believed margin lending was already regulated by ASIC.

The proposals put forward by Senator Sherry will not stop people losing money by borrowing and making poor investment decisions. But at least it will provide a level of transparency and uniformity around the rights and obligations of investors who decide to add a margin loan into their financial planning toolkit.