reform

Small business credit - what happened to the Phase 2 credit protection reforms agreed at COAG in 2008?

In 2008, the Council of Australian Governments (COAG) agreed to a two phase reform process for the regulation of credit and that in Phase Two the Commonwealth would consider the need to change the definition of regulated credit, and to address practices and forms of contracts that were not subject to the Credit Act.

After lengthy consultation, on 21 December 2012, the Minister for Financial Services and Superannuation, Bill Shorten, released for public consultation draft legislation to address perceived gaps in existing credit regulation and enforcement. 

"A review of the provision of credit to small business has shown that, while the majority of small business lenders and brokers provide a valuable service, some practices exist that result in high financial losses to small business borrowers. The draft legislation seeks to strengthen protections for small business borrowers, particular where the loan in secured against the family home, including by extending the Australian Securities and Investments Commission’s supervision and enforcement ability.

While difficult to quantify the costs and benefits, some lenders will incur additional one-off implementation costs. Most lenders will not incur these costs as they already comply (or can readily comply) with the proposed changes.  Borrowers, particularly those which have exhausted mainstream alternatives, may find it more difficult and costly to obtain credit but will have access to redress if misconduct occurs.

The Regulation Impact Statement was prepared by the Treasury and assessed as adequate by the Office of Best Practice Regulation."


Treasury Update, October 2014 (K&L Gates)

Due to the government moratorium on legislation awaiting the findings of the Financial System Inquiry, Treasury is not currently pursuing Phase 2 of the credit reforms concerning small business and investment lending.


Regulation Impact Statement: Small business credit, January 2013 

This Regulatory Impact Statement (RIS) considers whether credit provided to small business should be regulated, as part of the National Credit Reforms. 

Executive Summary 

The provision of credit to small businesses can assist them to meet their start up, expansion or ongoing business cost requirements. A review of the sector suggests that the majority of small business lenders and brokers operate in a way that provides a valuable service to their borrowers. However, some practices exist in the industry that can result in high levels of financial losses to individual small business borrowers.

These practices primarily occur in relation to ‘distressed’ small business borrowers, that is, borrowers who are in a position where they are seeking funds urgently to keep their business afloat (rather than, for example, wanting credit to expand their business). The most common scenario is where the business has defaulted in the repayments under an existing loan, and that lender has either commenced enforcement action or is threatening to do so.

The current legislative framework does not adequately address these practices. The possibility of enforcement activity by the Australian Securities and Investments Commission (ASIC) that would comprehensively address is subject to limitations including a combination of regulatory and enforcement gaps and the prohibitive cost and inefficiency of enforcement action. There are also substantial barriers to recovering compensable losses, both in actions taken by ASIC and by consumers in their own right.

It is recognised that small businesses cannot be absolved of all responsibility for their financial and business decisions, and a balance should be reached between protecting the most vulnerable and allowing the market to price risk. To achieve this balance, it is proposed to introduce targeted regulation which will minimise as far as possible the impact on lenders who are not engaging in these practices.

Targeted regulation would be introduced through a negative licensing scheme, improved disclosure requirements, universal access to external dispute resolution (EDR) and the introduction of a remedy for asset-stripping conduct. This approach is influenced by the extent to which lenders and brokers are largely already members of an EDR scheme and also hold an Australian credit licence (limiting the impact on these persons).

Were this not the case a different approach would need to be considered. These reforms will improve ASIC’s supervision and enforcement ability and give ASIC the ability to exclude entities from the market in the event of severe misconduct. They will also assist consumers by giving them access to more affordable dispute resolution, and result in improved understanding of the loan contract in some cases. 

The reforms are not expected to comprehensively address this type of misconduct in the small business lending market, but are expected to have a deterrent effect on some lenders. Borrowers will have improved access to compensation if misconduct occurs, and ASIC will have improved ability to identify and exclude lenders where, for example, they demonstrate a continued reluctance to comply with the law. 

It is difficult to quantify the cost to industry and the benefits to borrowers (and there is difficulty in observing and quantifying any flow on consequences), and it is not possible to state definitively whether or not this reform would have a net benefit in monetary terms. Costs to all small business lenders will include one off implementation costs to change disclosure procedures and modify other practices to address regulatory risk. Most lenders would not need to make substantial changes as they are already complying with, or are in a position to readily comply with the reforms. Nevertheless, the reforms propose addressing this conduct in a way that may have impacts on all borrowers, primarily through the risk of higher costs or some lenders exiting the market. 

Overall, it is considered the reforms balance the need to protect borrowers while minimising as far as possible the costs to industry, and have the potential to reduce significant losses to individual businesses. 
 

Our approach to the lack of regulation in SME finance

InvoiceX has been built by experienced founders who are passionate about providing a better deal for ambitious businesses and investors.

As is the case overseas, invoice finance in Australia falls under asset based financing, which is not currently an activity regulated by ASIC (Class Order [CO 04/239]). We would welcome regulation but you cannot choose to be regulated, as our regulatory advisers have pointed out.

More broadly, business finance is Australia is hardly regulated with very high level ASIC protections. A January 2013 government review confirmed this and recommended the following course:

"Targeted regulation would be introduced through a negative licensing scheme, improved disclosure requirements, universal access to external dispute resolution (EDR) and the introduction of a remedy for asset-stripping conduct."

InvoiceX does not invest any capital into invoices itself or on behalf of any third parties. Unusually, our founders' investment vehicles invest in every trade alongside our other investors on the same terms. InvoiceX does not take client deposits or give any investment advice. InvoiceX only accepts Sophisticated Investors on its platform.

InvoiceX is the first and only SME finance provider of any type in Australia to reveal its loan book in full. We will continue to do this as we develop. We aim to provide the best terms in Australia for invoice finance.

Finance has been offered to SMEs on unfair terms for too long. Banks over-collateralise loans based on real estate, reduce or remove overdraft limits with little or no notice. Some non-bank lenders lock SMEs into onerous contracts, especially in invoice finance but also quite a number of emerging online lenders that promise quick decisions at very high, unstated interest rates with penal early repayment terms.

This needs to change. We do not lock our customers into contracts. Businesses can quickly raise finance on just one invoice with no set-up fees on fair and transparent terms and are under no obligation to continue using InvoiceX afterwards. And it is a confidential service which does not involve the SME's customer.

Voluntarily at the outset, we set up a not-for-profit Special Purpose Vehicle to handle all transactions between Buyers (investors) and Sellers (SMEs) on our platform. The day-to-day management of this SPV in terms of settling trades and real-time accounting and reconciliations is outsourced to BDO, a Top 5 international accounting firm. Furthermore, we require regular internal auditing of the SPV as an additional layer of protection. All of this means that if InvoiceX ran into any difficulties, there is a robust system in place to handle the winding down of the platform or effect a transfer of ownership.

We voluntarily pay to be a member of the Credit and Investments Ombudsman, a free, independent and impartial external dispute resolution (EDR) service for our customers. It is approved by ASIC with over 20,000 financial services members in Australia.

We voluntarily maintain professional indemnity insurance although we do not provide financial advice.

We are supporters of significant efforts being made to create the Australian equivalent of the UK Peer-to-Peer Finance Association. This body would require members to operate by a strict set of rules in order to promote high standards of conduct and consumer protection.

We are members of Fintech Australia, a national not-for-profit organisation with a vision to make Australia the number one market for FinTech in Asia. Its key objectives are to support the Australian FinTech community, build awareness and trust in FinTech startups and to advocate for better policy on behalf of our members.

Finally, our two founders have worked in regulated industries throughout their 25-30 year careers, holding significant influence functions. We firmly believe in transparency, fairness and high standards of conduct.

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Invoice trading is booming in Australia, according to a report by KMPG, University of Sydney, Cambridge University and Tsinghua Graduate School

As reported in The Australian today, in the first Asia-Pacific report surveying Alternative Finance published this week, it is notable that, relative to consumer lending, alternative business finance and, in particular invoice trading, has developed much more strongly in Australia than in the US and the UK.

We are quoted in the article as noting that this underlines the exceptionally under-served nature of the Australian small business lending market, which at the recent Altfi Summit in Sydney was estimated to be seeking an additional $95bn of finance.

This trend is also reflected in RBA lending statistics which show property loans since the GFC have grown by $538.7bn (+54%) while business lending has increased by just $72.5bn (+9%).

(RBA Statistics: Business Credit Seasonally Adjusted: $765.5bn in December 2008 to $838.0bn; Housing Credit (Owner Occupied and Investor) $992.9bn to $1,531.6bn)

KPMG’s endorsement of invoice trading will go a long way, but regulation is what really builds trust in a sector. The truth is, unlike consumer lending, a sandbox won’t accelerate the development of innovative new business finance products – but increased involvement from and endorsement by the gamekeeper will accelerate business adoption.

The government’s most pressing need now is to accelerate the adoption of alternative finance by SMEs, which would provide a kick-start to our economic growth. Introducing disclosure standards as to the cost of finance and terms and conditions of finance – similar to comparison rates for mortgages – is a simple step to take, but would dramatically change the reputation of the sector.

It’s clear that the regulatory environment needs a 21st century approach, and the government seems to be aware of this, but we are all waiting to see words turn into action. We’re in a similar position to when the SMSF market first emerged – the regulators had to rapidly come up with a new approach then, and the need is even more pressing now with the increased speed of the development of new business finance products.

As Paul Keating said: “When we laid the foundations for the current superannuation system in the 1991 Budget, I never expected Self Managed Super Funds (SMSFs) to become the largest segment of super. They were almost an afterthought added to the legislation as a replacement for defined benefit schemes.” 

Time to get wriggle on!

  

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2 actions that Government can take to accelerate business growth

Yesterday, Australia saw the establishment of a government advisory panel on Fintech and the launch of a reform manifesto by Fintech Australia which we support.

We strongly believe that Government needs to become bolder in addressing market failure in providing our small-mid sized businesses with access to growth capital.

Here are two steps that could be taken this year:

  1. Build awareness of alternative financing options for SMEs to address market failure
    eg a mandatory referral obligation for banks declining credit applications
     
  2. Set up a Business Bank to: 
    • consolidate existing government funding mechanisms for SMEs in one place; and
    • provide modest co-investment support and endorsement for Alternative Finance providers

Working capital is the main impediment to growth, not equity.

Service businesses need working capital to grow and the current Basel III banking system cannot help in a meaningful way.

This is particularly true in the case of our critically important mid-sized companies:

Grant Thornton, December 2015:

According to the firm, mid-size business injects a combined annual turnover of $1.1 trillion into the Australia economy; contributing a further $241 billion through wages and salaries, employing more than 3.7 million Australians in the process.

Background

There are interesting overseas examples, particularly in the UK.

ACCESS TO FINANCE - FREE UP ALTERNATIVE FINANCE

The UK's major lenders will soon be required to share the financial information that they keep on small business to give these companies the best chance of securing loans.

The Government plans to force the banks to share their SME credit information with other lenders and to offer to share the details of SMEs rejected for a loan with online platforms that can match them to alternative finance providers.

The British Business Bank has also been tasked with "increasing and diversifying" the supply of finance available to SMEs. The Bank will facilitate up to £10bn of finance by 2019, according to new forecasts.

 

 

CONTEXT - MARCH 2014

At present the largest four banks in the UK account for over 80% of UK SMEs’ main banking relationships. Many SMEs only approach the largest banks when seeking finance. Although a large number of these applications are rejected - in the case of first time SME borrowers the rejection rate is around 50% - a proportion of these are viable and are rejected simply because they don’t meet the risk profiles of the largest banks. There are often challenger banks and alternative finance providers with different business models that may be willing to lend to these SMEs.

Although the largest banks will sometimes refer these SMEs on (e.g. to brokers), in many cases challenger banks and other providers of finance are unable to offer finance as they are not aware of their existence and the SMEs are not aware of the existence of these alternative sources of finance. This is a market failure, of imperfect information, resulting in SMEs that are viable loan propositions not receiving the finance they need.