This article was written by Hannah Glass and Scott Farrell.
Focus on crypto-asset regulation is both deepening and broadening. Recent papers published by Australian and international regulators show how this goes beyond the nature of the crypto-asset itself to now include the impact that these assets, and decentralised systems, may have on the broader financial ecosystem. This expansion is an important development for anyone interested in the crypto-asset industry.
Four papers - ASIC’s revised INFO 225, a consultation by IOSCO, the International Organization of Securities Commissions, and two reports by the FSB, the Financial Stability Board, to the G20 – provide further clarity around the status of individual crypto-assets, consider crypto-asset exchanges (crypto-asset trading platforms or CTPs), and touch on the broader risks and responsibilities of the crypto-asset industry in the global financial ecosystem, including the effect of decentralisation on traditional financial stability. Importantly, crypto-assets, decentralised finance and distributed financial systems are being examined internationally from all angles.
ASIC has updated its INFO 225. This expands on the previous guidance and provides further information regarding when a crypto-asset will be a financial product. To this end, it encourages issuers and others interacting with these assets to consider the rights attaching to and features of the crypto-asset itself. INFO 225 reiterates that persons other than issuers should consider their responsibilities and that laws other than the Corporations Act, including consumer laws, may apply, for example, where a product is not a financial product. ASIC also advises that the status of a crypto-asset overseas will not determine its treatment under Australian law and cautions that those seeking to rely on an exemption from being licenced, or seeking to prove that a crypto-asset is not a financial product, must be prepared to justify such a conclusion.
IOSCO is consulting on key risks, issues and regulatory considerations of CTPs. It is seeking feedback in relation to participant access to markets, safeguarding of assets, identification and management of conflicts of interest, technological and prudential operational mechanisms, market integrity and governance rules, price discovery mechanisms, and clearing and settlement of transactions. It is seeking views on how these considerations are managed and how they might be managed in the future. Like ASIC’s INFO 225, IOSCO provides that where a crypto-asset available or stored through a CTP is regulated in a particular jurisdiction, it would expect the existing regulatory framework to apply to that crypto-asset and the CTP’s operations.
FSB has released two reports. The first FSB Report provides an update to the G20 regarding the work of other international regulatory bodies, including IOSCO. The second FSB Report is a far more involved examination of the effect of decentralisation on financial stability. It focusses on three types of decentralisation– decentralising risk, decentralising record keeping and decentralising decision-making – and examines the effect that this may have on the application of the principles of financial market infrastructure (PFMI). It also sets out some of the benefits and risks posed by decentralisation and examines these against four real world examples of decentralisation (peer to peer lending, payments and settlement, trade finance and capital markets and tokenisation). Finally, and most importantly, the FSB, though this report, recommends that regulation should be activity focussed and look at the objectives it is aiming to achieve, rather than the entity it is looking to regulate.
ASIC’s updated INFO 225
In Australia, following the federal government’s consultation in February regarding whether further guidance or changes to the law were required to assist those in the crypto-asset industry (see our alert for further details), ASIC released an updated version of their initial coin offerings and crypto-assets information sheet (INFO 225).
INFO 225 does not indicate any change in ASIC’s views regarding when a crypto-asset is a financial product. Indeed, some of the updated INFO 225 is identical to ASIC’s original INFO 225 published in September 2017 and updated in May 2018 (see our alert Decrypting Crypto? for further details).
As before, this guidance identifies a broad range of people other than issuers (such as promoters, miners (entities processing or validating transactions), wallet providers and exchanges) who may be required to comply with the financial services licensing regime under the Australian Corporations Act. It also notes that some may even need to consider whether they are operating a financial market or a clearing and settlement facility, both of which have substantially more onerous regulatory requirements to match the potential for systemic risk.
It again emphasises the importance of complying with all relevant Australian laws on an ongoing basis including the Anti-Money Laundering and Counter-Terrorism Financing Act, taxation obligations and the Australian Consumer Law. In relation to the Australian Consumer Law, INFO 225 includes practical guidance regarding promotional or other communications.
Most relevantly however, the revised INFO 225 expands on the previous guidance by providing more information regarding when an asset will be an interest in a managed investment scheme and includes links to relevant regulatory guides and diagrams to help those interacting with crypto-assets.
ASIC provides the following key additional messages:
- consider the rights attached to and features of each crypto-asset to determine whether it is a financial product; and
- be prepared to justify a conclusion regarding the application of the Corporations Act to activities involving crypto-assets.
Consider the rights attached to and features of each crypto-asset.
ASIC counsels those in the crypto-asset industry to consider all the rights attached to and features of a crypto-asset to determine whether it is a financial product. These may be determined from the initial coin offering (ICO) white paper (offering document), or from other circumstances, such as how the ICO or crypto-asset is marketed to investors. Even rights which are not legally enforceable should be taken into account.
Even where a crypto-asset has been recognised as a regulated product in an overseas jurisdiction, it does not automatically translate that the crypto-asset would be considered to be an equivalent product in Australia. Instead, the particular rights should be assessed against the Australian regulatory regime itself. This applies regardless of where an ICO or crypto-asset is issued, traded or sold.
As the rights attaching to a crypto-asset may change over the asset’s lifetime, ASIC recommends seeking advice on an ongoing basis.
Be prepared to justify any conclusion regarding crypto-assets.
ASIC puts the crypto-asset industry on notice that they should be prepared to justify a conclusion that an ICO does not involve a regulated financial product. Similarly, if a crypto-asset business is seeking to rely on an exemption from holding an Australian financial services licence (AFSL) by reason of only providing services to ‘wholesale’ clients, this must also be able to be justified.
ASIC also reminds issuers that a financial product cannot be issued by a person acting as an authorised representative of an AFSL holder. A product can only be issued by someone on its own behalf.
This means that all persons in the crypto-asset industry should consider the nature of the assets they hold, their actions regarding those assets and what this means for them specifically in the Australian regulatory context.
The IOSCO Consultation
The IOSCO Consultation, entitled Issues, Risks and Regulatory Considerations Relating to Crypto-asset Trading Platforms (IOSCO Consultation) focuses on the risks associated with trading crypto-assets on CTPs and responsibilities of those CTPs. This is not a statement of a particular regulator. Instead it has been informed by information provided by all IOSCO members, including ASIC.
Unlike its previous consultations which have focussed on the assets themselves, this centres on CTP being all facilities or systems that bring together multiple buyers and sellers of crypto-assets for the purpose of completing transactions or trades. This includes trading venues, as well as other functions performed by intermediaries, custodians, transfer agents and clearing houses.
Like INFO 225, the IOSCO Consultation identifies that, in the event that a crypto-asset falls within an IOSCO member’s regulatory remit, it would expect that the existing regulatory frameworks apply to that asset and, accordingly to the CTP. Interestingly, even where a crypto-asset is not a regulated product, the issues and risks posed by trading on the CTP are similar to those associated with trading traditional financial products. Consequently, it would expect IOSCO’s three core objectives – investor (consumer) protection, ensuring markets are fair, efficient and transparent, and reduction of systemic risk - apply.
Indeed in compiling the IOSCO Consultation, it conducted a survey of IOSCO member organisations’, including ASIC, in which many member organisations indicated that existing regulatory frameworks adequately captured CTPs. However, the IOSCO Consultation also provides that some of its members are considering new or tailored requirements to account for the novel and unique characteristics of CTPs.
Following the publication of the IOSCO Consultation, it is now seeking submissions regarding its key considerations including measures that may be used by regulatory authorities to address these as well as the associated risks and issues.
Responses to the IOSCO Consultation are due on 29 July 2019.
The IOSCO Consultation has been followed by two reports by the FSB itself. One, Crypto-assets – Work underway, regulatory approaches and potential gaps (FSB G20 Report) updates the G20 Finance Ministers and Central Bank Governors in relation to work underway on regulatory and supervisory approaches to crypto-assets. The other, Decentralised financial technologies - Report on financial stability, regulatory and governance implications (FSB Decentralisation Report) sets out the FSB’s views on the effect of decentralisation in financial markets. Together these are referred to as the FSB Reports.
FSB G20 Report
The FSB G20 Report provides a useful summary of the work undertaken by the following international regulatory bodies, including IOSCO.
- The Basel Committee on Banking Supervision (BCBS) is considering whether to formally clarify the prudential treatment of crypto-assets across the set of risk categories.
- The Committee for Payments and Market Infrastructures (CPMI) has been focussing on central bank issued digital currencies (CBDC), calling for continued monitoring of CBDC and private tokens used for payments.
- The FSB is exploring the financial stability, regulatory and governance implications of distributed ledger, peer to peer and other decentralised technologies. It has also prepared a directory of regulators monitoring risks related to crypto-assets.
- As noted above, IOSCO has released its paper.
- In October 2018 the Financial Action Task Force (FATF) recommended that activities involving “virtual assets” should be covered under AML/CTF regulation. Virtual assets refer to digital representations of value that can be digitally traded or transferred and can be used for payment or investment purposes, encompassing both convertible and non-convertible, and centralised and decentralised forms, as well as ICOs.
- The Organisation for Economic Co-operation and Development (OECD) has published a report on ICOs, calling for clarity and proportionality in the regulatory and supervisory framework. It is now considering the implications of “tokenising” assets and “stablecoins”.
Most importantly, the FSB G20 Report notes that its members agreed that any risk assessment needed to be forward looking. It also reminds the G20 that any coordinated response should balance the need for coherent multilateral action, with an acknowledgement of differences among jurisdictions and the fast-moving nature of the technology.
FSB Decentralisation Report
The FSB Decentralisation Report assesses some of the benefits of and risks posed by decentralised systems to financial stability at a macro level. Provided at a time where the blockchain industry seems to be advocating a shift towards a wholesale decentralised financial system, this report provides a timely reminder of the implications of such a move.
The FSB Decentralisation Report identifies where decentralisation of financial activity is occurring, makes a preliminary assessment of the implications of these technologies for financial stability, and raises some issues of financial supervision and regulation that might be considered.
What is decentralisation and where is it occurring?
Decentralised applications are already being adopted in the areas of payments and settlements, trade finance, capital markets and lending. In its paper the FSB describes some of the economic and financial stability issues, and legal and governance considerations associated with this.
The FSB Decentralisation Report identifies that decentralised systems that permissionless distributed ledger technology systems have not been developed to achieve the aims of the Principles of Financial Market Infrastructure and that this causes risks, including:
- the way that information is dispersed in decentralised systems using identical technology or computer code may create a concentration in ownership and operation of key infrastructure and technology, creating another centralised point of failure;
- diffused or unclear responsibility and accountability may arise where decentralised systems have not set out allocation of risk between those involved;
- recovery and resolution challenges as the current regime relies on centralised record keeping and claims on market participants whose identity and location is known whereas these technologies enable actions to be undertaken in multiple places at once, and possibly by anonymous actors. This may also enable misconduct as persons hiding behind anonymity believe that they cannot be held accountable; and
- uncertainty of legal liability and responsibility may result in enforceability issues.
The FSB notes that together, these risks may lead to a further erosion of trust in the financial system particularly where transactions can be executed without a clear geographic location and that this has broader implications for regulation, supervision and, ultimately, stability.
The FSB also notes that decentralised financial systems do pose some benefits to financial stability. This includes potential increases to competition and diversity which reduce the systemic importance of, and thus the risk posed by, certain existing entities. The degree to which these benefits are realised may depend on the degree of decentralisation and the prevalence of their application in the financial services industry.
The FSB advocates for an activity-based approach to regulation. This should potentially move away from targeting specific entities and jurisdictions to setting objectives and determining means for achieving and monitoring performance against them. Such objectives should consider issues related to the governance, technological development, and the activities of businesses. This may be achieved by considering the applicability of existing regulations based on the functions or activities performed by entities or persons
What does this all mean?
ASIC’s revised INFO 225, the IOSCO Consultation and the FSB Reports affirm that in some instances crypto-assets and the crypto-asset industry is already subject to regulation, and where regulation is not already in existence, the same principles which underpin existing regulation are likely to be applied consistently to these new assets and decentralised ecosystems.
All four papers advocate a principles and fact based approach. Both INFO 225 and the IOSCO Consultations indicate a trend of considering the status of the crypto-asset first and applying existing laws to businesses in the crypto-asset industry according to their activities. The FSB G20 Report demonstrates that collaboration is occurring at all international regulatory levels, whilst the FSB Decentralisation Report provides an in-depth analysis on the effect of decentralised systems on financial stability and potential areas for further regulatory consideration.
Most importantly, all four papers indicate that regulatory scrutiny has shifted to focus on the broader crypto-industry, including the CTPs at its heart.
These papers seem less focussed on whether a business is regulated or not and concentrate instead on whether it has processes and procedures in place to allow it to comply with the fundamental principles of consumer protection, market integrity and financial stability. Whether tweaks are to be made to a crypto-asset business, the law or both, risk mitigation and management should be front of mind as decentralised technology is adopted in all contexts.
We’re here to help
If you have any questions in relation to the revised INFO 225, the IOSCO Consultation, the FSB Reports or have any other related queries, please feel free to get in touch at any time.