ASIC provides guidance on crypto-assets

Articles Written by Austin Bell (Partner), Jared McLachlan (Law Graduate)

On 29 October 2021, the Australian Securities and Investments Commission (ASIC) released Information Sheet 225: Crypto-assets (INFO 225) to provide guidance on the application of the Australian financial services regulatory regime under the Corporations Act 2001 (Cth) (Corporations Act) to crypto-assets[1] and initial coin offerings (ICOs).

INFO 225 states that crypto-assets and ICOs could be financial products, and if they are, that they are likely to be managed investment schemes, derivatives or securities. Crypto-assets and ICOs may also involve a non-cash payment (NCP) facility. If conduct in relation to crypto-assets or an ICO involves a financial product, the Australian financial services regulatory regime will apply. This means that entities involved with crypto-assets or an ICO will need to consider whether an Australian financial services (AFS) licence, an Australian markets licence or a clearing and settlement facility licence is required. Participants will also need to consider whether any disclosure or the design and distribution obligations apply in relation to the crypto-assets or ICO. All participants must be mindful of the general prohibition on engaging in misleading and deceptive conduct.

Apart from indicating that crypto-assets and ICOs are clearly on ASIC’s regulatory radar, INFO 225 provides little insight or concrete guidance to participants in the crypto-asset and ICO industry.

Background

On 30 June 2021, ASIC issued Consultation Paper 343: Crypto-assets as underlying assets for ETPs and other investment products (CP 343) to seek industry feedback on the regulation of crypto-assets and their use as an underlying asset of other investment-style products, namely exchange traded products. On 29 October 2021, ASIC issued Report 705: Response to submissions on CP 343 Crypto-assets as underling assets for ETPs and other investment products (Report 705). Report 705, among other things, acknowledges the conflicting schools of thought in connection with the regulation of crypto-assets. ASIC notes that some respondents are receptive to the characterisation of crypto-assets as their own asset class or financial product, whilst other respondents believe that crypto-assets can fit within the existing regulatory framework similar to the approach taken by the Financial Conduct Authority (FCA) in the United Kingdom. See FCA Policy Statement PS19/22 for further information on the FCA’s approach to crypto-assets. INFO 225 endorses the approach of treating crypto-assets and ICOs as having characteristics distinct from other forms of property insofar as it refers to new categories of assets (to be held in a registered scheme) being added to the AFS licence application form.

Target audience of INFO 225

INFO 225 should be considered by the following participants in the crypto-asset industry:

  • issuers of crypto-assets;
  • crypto-asset intermediaries;
  • miners and transaction processors;
  • crypto-asset exchange and trading platforms;
  • crypto-asset investment products;
  • crypto-asset payment and merchant service providers;
  • wallet and custody service providers; and
  • consumers.

Classification of crypto-assets as financial products

Section 911A of the Corporations Act provides that a person who carries on a “financial services business” in Australia must hold an AFS licence, become the representative of an AFS licensee or rely on an exemption. A “financial services business” is the business of providing financial services which includes providing financial product advice, dealing in a financial product, operating a registered managed investment scheme, making market for a financial product and providing custodial or depository services.

The requirement to hold an AFS licence under Part 7.6 of Chapter 7 of the Corporations Act must be considered where there is conduct involving a “financial product”.  The definition of “financial product” is in two parts, the first being a general definition and the second, being a list of specific things that are financial products for the purposes of the Corporations Act. 

Pursuant to the general definition, a financial product is a facility through which, or through the acquisition of which, a person does one or more of the following:

  • makes a financial investment;
  • manages financial risk; or
  • makes non-cash payments. 

Section 764A of the Corporations Act provides a list of specific things that are financial products, this list includes:

  • securities;
  • interests in managed investment schemes; and
  • derivatives.

INFO 225 indicates that a crypto-asset or ICO could be one or more of these financial products, but it does not provide definitive guidance. Admittedly, concrete guidance is difficult to provide in an area and industry that is evolving and changing so quickly.

Managed Investment Schemes

Section 9 of the Corporations Act provides that a managed investment scheme (a type of pooled investment vehicle) is a scheme which has the following features:

  • people contribute money (or money’s worth) as consideration to acquire rights (interests) to the benefits produced by the scheme;
  • any contributions made to the scheme are pooled or used in a common enterprise to produce financial benefits or benefits consisting of rights or interests in the scheme property for the people (members) who hold interests in the scheme; and
  • the members do not have day-to-day control over the operation of the scheme.

INFO 225 indicates that crypto-asset issuers will likely be offering interests in a managed investment scheme if the rights and value of the crypto-asset are related to the three features outlined above.

Securities

Section 761A of the Corporations Act provides that a security includes a share or debenture in a body, a legal or equitable right to acquire a share or debenture and an option to acquire, by way of issue, a share, debenture or a legal or equitable right to acquire a share or debenture. Crypto-assets that meet this definition will be a security. Crypto-assets issued under an ICO to fund a company may also be a security if the rights that attach to the crypto-asset resemble those rights that are commonly attached to a share in a company. For example, these rights include ownership of the company or body, voting rights and rights to profit participation.

Derivatives

INFO 225 states that a derivative is a product that derives its value from another thing. This other “thing” is commonly referred to as the underlying instrument or reference asset. This definition is based on the more detailed definition in section 761D of the Corporations Act. In INFO 225, ASIC asserts that a crypto-asset or an ICO may involve a derivative if it is valued and/or priced on the basis of something else, including the price of another financial product, an underlying market index or price fluctuations before a time or event that result in a payment under the rights or obligations attached to the crypto-asset.

Non-Cash Payment Facilities

Section 763D of the Corporations Act provides that an NCP facility is an arrangement through which a person makes or causes payments to be made, other than by the physical delivery of Australian or foreign currency in the form of notes and/or coins. If the crypto-asset allows the holder to use the asset to make a payment, it will likely be an NCP facility. ASIC has indicated that, whilst crypto-assets offered under an ICO are unlikely to be an NCP facility, the ICO itself may be an NCP facility if it includes an arrangement that allows for payments to be made in this form of value to a number of payees or payments to be started in this form and then converted to fiat currency in order to complete the payment.

Licensing requirements for operators of crypto-asset managed investment schemes

ASIC expects that AFS licensees that are proposing to operate registered managed investment schemes that hold crypto-assets will, at least initially, need to apply for a ‘named scheme’ authorisation. This authorisation will allow AFS licensees to operate only the specific crypto-asset registered investment managed scheme named on their AFS licence.

ASIC expects AFS licensees to operate two named crypto-asset registered investment managed schemes for at least two years before it will consider granting the particular AFS licensee a broader ‘kind scheme’ scheme authorisation. This broader authorisation will allow an AFS licensee to operate multiple crypto-asset schemes without the need to vary its licence for each scheme.

Applicants for this new type of authorisation will need to select:

  • crypto-assets that are not financial products, the ‘crypto-asset’ asset kind; or
  • crypto-assets that are also financial products, the asset kind which corresponds to the crypto-asset class of financial product, for example ‘derivatives’ asset kinds.

For the restricted purpose of administering the AFS licensing regime for managed investment schemes, ASIC has defined ‘crypto-asset’ as:

“a digital representation of value or rights (including rights to property), the ownership of which is evidenced cryptographically and that is held and transferred electronically by a type of distributed ledger technology or another distributed cryptographically verifiable data structure.”

ASIC is yet to update its forms FS01 and FS03 to include a separate line for ‘crypto-asset’ on them. Until it does, applicants must specify this election in their covering email to ASIC and A5 Business Description core proof.

Disclosure requirements in connection with crypto-assets

Subject to certain exemptions, all primary offers and all off-market secondary offers of securities in a body held by a controller of that body require disclosures to be made to potential investors. These disclosures are required to be made in the form of a disclosure document that meets the requirements set out under Part 6D.2 of the Corporations Act.

Whilst Chapter 6D of the Corporations Act applies to securities, Part 7.9 of the Corporations Act contains the disclosure requirements that apply to listed and unlisted managed investment schemes, margin lending facilities, derivatives and other similar financial products. Division 2 of Part 7.9 of the Corporations Act provides that a product disclosure statement (PDS) must be provided to a person before they acquire a financial product where that person is acquiring the financial product as a retail client.

Section 1013D of the Corporations Act provides that a PDS must contain information that a person would reasonably require for the purpose of making a decision, as a retail client, whether to acquire the product. This information includes, among other things, the significant characteristics or features of the product and the significant risks associated with holding the product. INFO 225 identifies a number of risks that the issuers of products which involve crypto-assets may wish to incorporate into disclosure documents. These risks include:

  • Market Risk: There is a risk that crypto-assets could have little to no value in the future due to the highly volatile investment performance of different types of crypto-assets historically.
  • Pricing Risk: Pricing risk due to, in some cases, the difficult nature of accurately valuing certain types of crypto-assets as a result of their nature of trading.
  • Custody Risk: Risk that crypto-assets may become inaccessible or accessed by unauthorised third parties due to access keys becoming lost or compromised.

Classification of a crypto-asset trading platform as a financial market

To operate a financial market in Australia, section 791A of the Corporations Act provides that a person must hold an Australian market licence, unless an exemption applies. Subsection 767A(1) of the Corporations Act provides that a person will be considered to be operating a financial market if they operate a facility through which:

  • offers to acquire or dispose of financial products are regularly made or accepted; or
  • offers or invitations are regularly made to acquire or dispose of financial products that are intended to result or may reasonably be expected to result, directly or indirectly, in offers being made to acquire or dispose of financial products or the acceptance of such offers.

INFO 225 states that, in situations involving crypto-assets that are a financial product, any platform that enables consumers to buy (or be issued) or sell crypto-assets may require the platform operator to hold an Australian market licence or rely on an exemption.

Subject to the type of transactions that take place, a clearing and settlement facility licence may also be required if crypto-assets deemed to be financial products are cleared and/or settled.

Conclusion

INFO 225 provides little guidance to entities dealing in crypto-assets and ICOs. It arguably does little more than restate ASIC’s previous position that these products and offerings may be subject to the existing financial services regulatory regime. However, the Select Committee on Australia as a Technology and Financial Centre chaired by Senator Andrew Bragg tabled its final report (aka the Bragg Report, a copy of which can be accessed here) on 20 October 2021. The Bragg Report may lead to greater clarity and guidance being provided to entities that participate in the crypto-asset industry. It makes 12 recommendations in connection with the regulation of cryptocurrencies and other digital assets in Australia. Notably, recommendation 3 of the Bragg Report is that the Department of the Treasury of the Australian Government should, with the assistance of industry regulators, determine the most appropriate manner to characterise, and thereby regulate, the various types of crypto-assets in Australia. Not an easy task, but an essential first step.


[1] Whilst INFO 225 does not expressly define the term ‘crypto-assets’, other than in connection with the administration of the AFS licensing regime for managed investment schemes, in paragraph [67] of ASIC’s submission to the Senate Select Committee on Australia as a Technology and Financial Centre: Third issues paper (a copy of which can be accessed here) ‘crypto-assets’ are defined as “a digital representation of value or contractual rights that can be transferred, stored or traded electronically. Crypto-assets use cryptography, distributed ledger technology or other technology to provide features such as security and pseudo-anonymity. A crypto-asset may or may not have identifiable economic features that reflects fundamental or intrinsic value.”

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).

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