29/03/2012

The Federal Government has released draft regulations which define a limited recourse borrowing arrangement (LRBA) by a SMSF as a ‘financial product’ under the Corporations Act.  The result could be:

• to require people who recommend such a strategy to hold an Australian Financial Services Licence, and
• to require participants in the arrangement to have such a licence and to comply with the disclosure provisions in the Act by issuing a Product Disclosure Statement.

Would either of these requirements be necessary for the trustees of a SMSF who decide for themselves to engage in an LRBA and to borrow the money from a related party? 

Draft Regulation 7.1.04H:

1. makes an LRBA a financial product,
2. states that the product is issued when a person enters into a legal relationship that sets up the arrangement; and
3. states that each party to the arrangement is an issuer of the product.

In an LRBA there are three parties – the SMSF Trustee/Borrower, the Holding Trustee/Purchaser and the Lender.  To establish the obligations of each as an issuer of the financial product it is necessary to consider the relevant provisions of the Corporations Act.

The draft Explanatory Memorandum refers to two possible obligations: 'hold an AFSL' and 'meet disclosure obligations'. We will deal with each of these separately.

Section 911A(1) of the Corporations Act 2001 (Cth) ('the Corps Act') states that a person who carries on a financial services business in the jurisdiction must hold an Australian Financial Services Licence ('AFSL') covering the provision of the financial services.

There are therefore two elements required – namely that the person provides a financial service and that they do so as part of a business.

Because the new regulation deems the parties to an LRBA to be issuing the product they are effectively deemed to be providing a financial service.  They therefore meet the first element.

The second element is that they are carrying on a financial services business.  Normally a SMSF, its related Holding Trustee and a related party lender would not, simply by engaging in an LRBA to the benefit of the SMSF and being a deemed issuer of the LRBA as a financial product, be carrying on a financial services business.

It would therefore not seem necessary for any of the three parties to have an AFSL under s.911A(1) of the Corps Act. Even if they were they may come within the exceptions in S.911A(2) including:

• the financial product is disposed of by the issuer to and at the direct request of the person to whom it is provided
• the person provides the service to a related body corporate (ie parent company, child company or sibling company), and
• the person provides the service in their capacity as trustee of a self-managed superannuation fund                              
  

Moving on to the need for disclosure,  particularly the issue of a product disclosure statement, Part 7.9 of the Corps Act deals with financial product disclosure and other provisions relating to the issue, sale and purchase of financial products.

Part 7.9 does not apply in relation to a financial product that is not issued in the course of a business of issuing financial products. A SMSF, its related Holding Trustee and its related party lender cannot be said to be carrying on the business of issuing financial products simply by engaging in an LRBA among the three of them.

It therefore seems that the parties would not need to comply with the product disclosure obligations in the Corporations Act.  The issue of a product disclosure statement will apply if a party to an LRBA is in the business of issuing financial products – such as a bank.

The main effect of the draft regulations will be in respect of the licensing and compliance requirements relating to those professional advisers who wish to provide advice on or deal in LRBAs.

It has been suggested that even real estate agents who sell property to a SMSF would need an AFSL.  We do not believe that a real estate agent who sells the property to a SMSF would need a licence if they did not recommend anything other than the purchase of the property by the fund.  They would not be able to comment on the borrowing arrangement as such but could continue in their role simply as salesman of the property.

If you have any questions in relation to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.