New Corporations Regulation – Instalment Warrants are financial products

Legislation

The Minister for Financial Services, Superannuation and Corporate Law has released draft regulations that will amend the Corporations Regulations to provide that:

• Limited recourse borrowing arrangements are financial products under Chapter 7 of the Corporations Act when acquired by superannuation funds which attract licensing and disclosure requirements.
• These arrangements are not credit facilities under the Corporations Act and are therefore not excluded from being financial products under Chapter 7 of the Corporations Act.
• An Australian Financial Services Licence (AFSL) covering derivatives is taken to also cover limited recourse borrowing arrangements to superannuation funds.

Timing

The new Corporations Regulations will be effective from 29 September 2010. They are not expressed as applying only to loans issued after that date. Advice in relation to existing loans could be caught as financial product advice.

Comments

The new Corporations Regulations deal with the confusion as to whether instalment warrants are regulated or unregulated under Chapter 7 of the Corporations Act. Instalment warrants must be treated as financial products, and the licensing and disclosure obligations that follow will apply to them. It is worth noting that under the draft regulations:

• All limited recourse borrowing arrangements involving super funds (not just SMSFs) are caught. There is no definition of  ‘instalment warrant’ or ‘limited recourse borrowing arrangement’ in the regulations; the changes are drafted to capture any loan made pursuant to section 67(4A) of the Superannuation Industry (Supervision) Act 1993(SIS Act).
• ‘[A]n arrangement relating to the acquisition of an asset’ under 67(4A) of the SIS Act will be a financial product, so it is not just the loan but the entire arrangement (eg establishing a security trust to hold property). This raises issues about how many parties would be required to satisfy Corporations Act requirements. In our view, the lender will be the only ‘issuer’ of the financial product, but other participants may be giving advice.
• It is curious that the regulations provide that a derivatives authorisation will be taken to cover the relevant arrangements. Does this mean that the 67(4A) arrangements are not really considered to be derivatives under Chapter 7 of the Corporations Act? There are practical implications eg there are deemed issuer provisions that apply only to derivatives. Do these extend to instalment warrants?
• An issuer of a limited recourse loan will need to have an AFSL with a derivatives authorisation (if they are in the business of providing financial services, ie they issue loans as part of a business where there is system and repetition), or enter into an intermediary authorisation arrangement under section 911A(2)(b) (where the issuer only issues the loans through a licensed intermediary which has an AFSL with a derivatives authorisation. This may be an option for lenders within a corporate group that do not have an AFSL with a derivatives uthorisation, but there is an entity within the group that does).
• Banks and other lenders like credit unions will not be able to rely on the credit facility exemption in relation to limited recourse loans to SMSFs (as they can with other types of loans) to avoid the need to comply with the licensing, disclosure and conduct obligations in Chapter 7 of the Corporations Act. This is likely to mean having to give a PDS to a fund trustee that is thinking about applying for a loan. Banks will need to be careful about what their staff members say to potential borrowers about loans (so they are not giving advice about financial products, and can rely on the ‘general advice in a PDS’ exemption).
• Advisers who are recommending limited recourse loans to clients will need to do so under an AFSL that has an authorisation to advise on derivatives, and will also need to consider whether they are dealing in derivatives (either by arranging for the issue of a derivative or applying for a derivative on behalf of a client), if they are assisting with the paperwork to establish a loan.
• The continuing debate about whether an SMSF is a retail or wholesale client will become particularly important, given the issuer will have to give a PDS to the fund trustee, and advisers will have to give a Financial Services Guide and Statement of Advice to clients if they are recommending they take out a loan, if the fund trustee is deemed to be a retail client.
• Most organisations and advisers that offer SMSF loan packages or structure up limited recourse borrowing arrangements for SMSFs will need to be licensed. We would expect that lawyers will generally be able to rely on the exemption under Corporations Regulations where acting on instructions to prepare the loan paperwork. However, the accountants exemption for SMSFs (regulation 7.1.29A of the Corporations Regulations Act 2001) will not apply to these loans (the exemption only permits accountants to provide advice on the establishment of SMSFs, not the fund’s investments, and the Government has announced plans to repeal it anyway), so accountants will need to consider whether they need to be licensed, or acting under an AFSL, in order to advise on them.