daytrade diaries... sept 11/12 weekend, page-3

http://www.smh.com.au/business/armed-and-dangerous-with-a-licence-to-sell-20100910-15538.html

Armed and dangerous with a licence to sell
MARCUS PADLEY
September 11, 2010


I'm not sure whether you know but late last year the Australian government became responsible for the regulation of margin lending. About time too.

Before that credit products like margin loans were not caught by the Corporations Act and even more worrying consumer credit legislation at state level actively excluded investment loans (which is margin lending).

In which case product providers and sellers could pretty much make it up as they went along and obviously, in some cases, did, much to the disadvantage of their unsuspecting, or should that be ''trusting'', clients.

Margin lending has now become a ''financial product''. The beauty of that is that in order to sell said financial product or advise on margin lending you now need an Australian Financial Services licence. Net effect, the whole financial advisory world including individual brokers are currently in the process of doing exams to get a margin lending accreditation.

It involves educating ourselves about the new legislation much of which has appeared as a consequence of recent disasters like OPES Prime and Storm Financial. The new legislation basically endorses prudent plain vanilla margin lenders.

For instance. Did you know, there are ''standard'' and ''non standard'' margin lending facilities. The key difference is that with a standard margin lending facility you keep the title to the security you used to get the loan. In other words you own the cash, shares or property you put up.

In a non-standard margin lending facility the ownership most likely passes to the loan provider. This was the OPES Prime structure. So when the loan provider goes bust, their creditors own your ''stuff''. Clearly there are proper margin lenders and ''others''.

There are also some new ''responsible lending conduct'' requirements imposed on margin lenders. As of now margin lenders have a legal responsibility to assess that a loan is ''not unsuitable'' for a client.

Note, it's not whether it's suitable that matters, but that it's not unsuitable, and if they make an assessment of unsuitability then they can't open or increase a margin loan facility for you. It's a response, presumably, to the Storm Financial debacle.

Most of us have sat the online exam already at the end of which you press a button and get a pass or fail. At this stage it doesn't give you a mark unless you actually get 100 per cent in which case it tells you. My colleague Sam and I sat it together. He got 100 per cent.

I didn't. Very annoying, but I think I know where I went wrong. On the most basic calculation.

Let me ask you. If you have $30,000 and you borrow $70,000 to invest in a $100,000 share portfolio, how geared are you? It had me confused for a moment. In my book surely you've borrowed over twice as much as you own so you're at least 200 per cent geared (233 per cent actually). But you're not, the course notes tell me. The answer is 70 per cent geared (70 per cent of the $100,000 is borrowed). Go figure.

On that calculation a home buyer who buys a $1,000,000 house with a $250,000 deposit is only 75 per cent geared instead of 300 per cent geared. And a CFD trader who buys a $100,000 exposure to Rio Tinto with a $5000 account balance is only 95 per cent geared instead of 2000 per cent geared. Got to admit, the official way sounds better; my way is far too scary.

Then there is the concept of double gearing. That's when you use a loan (most obviously your home loan) to finance the cash you put up for a margin loan.

The notes didn't tell me how to calculate the gearing ratio of a loan geared on a loan, but I'm pretty sure that if I did that and cocked it up my ensuing ''death by spouse'' would make the detailed gearing calculation pretty much academic.

But let's not fear gearing. Indeed the richest man in England once generalised to me that nobody ever got rich using their own money.

Gearing isn't complicated, it isn't a mystery, it's just an accelerant, a tool that will exaggerate the impact of your investment decisions, and provided by sensible mainstream margin lenders to knowledgeable borrowers with rational expectations to buy things that go up in price, it is clever. Until things go down of course. And there's the rub.

Marcus Padley is a stockbroker with Patersons Securities and the author of stockmarket newsletter Marcus Today. His views do not necessarily reflect the views of Patersons.