On 16 October 2023 the Australian Federal Treasury released its public consultation paper regarding the proposed regulatory regime for digital asset platforms. The proposed framework highlights the Australian Government’s intention to ensure consistent oversight and safeguards for consumers by regulating digital asset platforms and other intermediaries within the existing Australian Financial Services Licence (AFSL) regime and introducing a new type of financial product called a ‘digital asset facility’. The announcement can be found here.
Whilst the proposal is in draft, we set out below the potential ramifications on Australian intermediaries in the digital asset ecosystem:
- The litmus test for regulation of digital asset platforms will be asset holding. Specifically, platform providers will be required to hold an AFSL if the total value of platform entitlements held by any one client exceeds $1500 or the aggregate assets held by the platform provider exceeds $5 million.
- A mix of standard and tailored licensing obligations will apply to service providers in relation to digital asset facilities.
- All arrangements involving digital asset facilities will need to be structured as non-discretionary arrangements and operate in accordance with pre-agreed and transparent rules and procedures.
- Platform operators with ‘financialised functions’ such as staking or trading will be subject to additional rules.
- A key objective will be appropriately aligning Australia’s digital asset regulatory framework with international jurisdictions.
Read on for more detail.
The main purpose of the announced proposals is to address and prevent consumer harms while implementing appropriate guardrails to safely foster innovation in the crypto ecosystem. Intermediaries in the digital asset ecosystem are almost universally structured as digital asset platforms. The recent failures of digital asset platforms last year represent cases where too much power and too little regulation resided in centralised leaders / intermediaries and Ponzi-like schemes. The financial scandals and resultant public mistrust has drawn much needed attention to the ecosystem, and accentuated the need for reform in Australia.
Asset holding as the regulatory anchor point:
The proposed regulatory framework places digital asset platforms in a position akin to financial service providers. Under the proposals, the business of holding significant values of digital assets, or assets backing digital assets, will become a regulated activity and subject to minimum standards. Under the proposals, a digital asset facility will be an asset holding arrangement. Think: digital asset issuers, intermediaries, crypto exchanges and trading platforms, crypto asset payment and merchant service providers, and wallet providers and custody service providers. The proposed framework would leverage broad concepts around ‘control’ to identify the holding arrangements to bring within the regulatory perimeter. For example, businesses with the ability to exercise, coordinate, or direct ‘factual control’ over the assets in a real and immediate sense.
Financial services licensing:
The proposed framework would recognise certain asset holding arrangements as a financial product, requiring platform providers and other intermediaries performing financial services in relation to digital asset facilities (e.g. brokers, arrangers, agents, market makers, and advisers) to hold an AFSL. A person who carries on a ‘financial services business’ in Australia must hold an AFSL covering the provision of the financial services (unless an exemption applies) and meet the disclosure and conduct requirements as prescribed in the Corporations Act. Generally, a person provides a ‘financial service’ if they provide financial product advice, deal in a financial product, make a market for a financial product, operate a registered scheme, provide a custodial or depository service or provide a crowd-funding service.
The government intends to introduce a ‘financialised functions’ regime which covers specific activities that do not involve financial products. Leaving an intentional gap for ‘non-financialised activities that involve digital assets that are not financial products’ but still need to meet additional minimum standards. Such functions would include:
- Token trading – intermediating the exchange of platform entitlements between account holders.
- Token staking – intermediating an account holder’s participation in validating transactions on a public network
- Asset tokenisation – intermediating the creation and exchange of platform entitlements backed by tangible and intangible non-financial product assets.
- Funding tokenisation – intermediating the sale of entitlements to fund the development of ‘non-financial’ products and services.
Non-financial tokens expected to fall into the financialised functions regime include:
- tokens that attest to membership of a group or support of a cause
- tokens redeemable for a non-financial service or tangible goods
- tokens representative of a right to access a physical location or event
- tokens used to balance the supply and demand of a finite resource
- tokens that provide no entitlements but for ‘factual control’ or that have no counterparties
Note the existing securities and financial fundraising regime will continue to apply to issuers of financial products. The proposed framework will not change or reduce the liability of a person for how tokens are sold or distributed.
The consultation period runs until 1 December 2023. Further consultation on exposure draft legislation in 2024. It is proposed that a 12-month transitionary period will come into effect after commencement of the legislation to allow appropriate amount of time for industry participants to plan and make changes to ensure compliance, including the need to possibly obtain an AFSL.
Aiming for Australia’s international alignment:
Today’s consultation paper also indicates the Government’s intention to align Australia’s regulation of digital asset platforms with the jurisdictions like the EU, UK, Canada, Hong Kong and Singapore. In the APAC region, Hong Kong’s VASP regime came into effect in June 2023. In addition to defining virtual assets for the first time, the regime introduces a licensing requirement for centralised virtual asset exchanges, whilst leaving other VASP activities unregulated, at least for now. In Singapore, certain crypto related activities are licensable under the payment services legislation, including dealing activities and operating a digital payment token exchange, or potentially as e-money. Both jurisdictions are putting out proposals in relation to the regulation of stablecoins.
It is interesting that Australia’s Treasury proposes to introduce licensing requirements using the existing AFSL requirement as just over a year ago it had proposed the development of separate licensing regime for ‘Crypto Asset Secondary Service Providers’. The current proposal will remove the complexity associated with two separate licensing regimes operating in tandem but there are also risks associated with a ‘one size fits all’ approach. As an initial observation, the proposal only goes so far as to regulate a ‘digital asset facility’ without providing regulatory clarity on the nature of the rights attached to such ‘assets’ or the distinction between a traditional financial product and a digital asset on a ‘digital asset facility’.
Smart regulation provides consumer protection benefits but at the same time it must balance the freedom of innovation. As they say in this space: ‘don’t trust, verify’. The government’s proposal provides a good foundation for further discussion with industry. We will be reviewing the proposal further and look forward to sharing further thoughts with our readers and through the consultation process.