Warnings and opportunities for Australian crypto funds and trading platforms

Australia’s financial regulator, ASIC, has published regulatory signposts around crypto-assets and guidance for exchange traded products.

The guidance and signposts have been treated as Australia’s long-awaited green light for crypto-asset investment products and crypto trading platforms. That interpretation miscasts ASIC’s position. ASIC position is, in effect, that no green light has been necessary; for the most part, crypto funds and trading platforms have always been possible under the current regulatory regime. (Although Australia’s regulatory regime will evolve in a yet-to-be-seen way following the 12 recommendations of the Senate Select Committee on Australia as a Technology and Financial Centre.)

New products and technology, venerable legislation and regulations

Although no green light was necessary, ASIC’s guidance and signposts give comfort to promoters who have been waiting to implement crypto related initiatives. However, be aware that Australia is tasking legislation and regulations of varying ages with governing the newest of technologies and financial products.

ASIC signposts and guidance relate specifically to:

• Anyone issuing, advising on or distributing crypto-related assets (broadly, including cryptocurrency, tokens or stablecoins and fundraising through initial coin offerings (ICOs)) — ASIC information sheet 225
• Exchange traded products (ETPs) — ASIC information sheet 230

In giving guidance, ASIC has paved the way for crypto-assets to become a more readily accessible asset class, including through unlisted and listed products traded on licensed Australian exchanges.

Notably, ASIC studded its guidance with caveats. Those caveats can be read as opportunities for the well-prepared, as we discuss below. At the same time, the caveats are warning shots aimed at those who might leap into the Australian market without deference to the rules.

This situation will be familiar to promoters with an eye on global regulators as they firm up their positions on crypto-assets.

Why entrants to the Australian crypto-market should consider working backwards

ASIC is explicit that Australian financial regulation applies when a crypto-asset, fund or trading platform meets the definition of a financial product or service. As a result, most (if not all) entities dealing in crypto will need to hold the correct Australian financial services (AFS) licence.

AFS licence requirements mean that players entering the Australian crypto market should consider working backwards from the assumption that they offer a financial product.

This assumption is arguably the safest starting point because a crypto-asset, fund or exchange has only the slimmest chance of slipping through Australia’s broad financial services licensing regime.

Assuming the offering is a financial product, the next questions are:

• What category does the financial product fall into?
• What is the nature of the entity offering the product?

The answers will determine which AFS licence applies and whether anti-money laundering (AML) and know-your-customer (KYC) laws also apply. In particular, ASIC has made clear that a crypto-asset or ICO might be a security (including an option to acquire a security). 

To understand which licence may be applicable to your business, use our Australian Financial Services Licence Navigator.

New crypto-asset licensing authorisations

ASIC has updated its Australian financial services authorisations to include crypto-assets.

Operators of collective investment schemes investing in crypto-assets that don’t fall within the traditional financial asset or derivative characterisations will need to hold a crypto-asset type of scheme licence authorisation. For these purposes, a crypto-asset is defined 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 distributed ledger technology; or
• another distributed cryptographically verifiable data structure."

Marketing crypto-assets, funds and exchanges in Australia is also regulated

ASIC’s licensing rules are essential to consider even where an entity’s only activity in Australia is marketing an offshore crypto-asset, fund or trading platform. Depending on the circumstances, marketing financial products in Australia might be enough to require an Australian financial services licence.

Offshore operators should consider whether they need to restrict their marketing and amend their disclosures and warnings. They might also consider geo-blocking technology to keep out Australian users to ensure they are not considered to be operating a financial market in Australia.

A world of reasons to comply with Australian crypto regulation

Failure to comply with Australian financial services regulations could do more than attract penalties in Australia. Penalties in one jurisdiction can cause global reputational damage and attract the attention of regulators in other jurisdictions.

The opportunities for well-organised market entrants

ASIC’s regulatory signposts and guidance make several things clear:

1. The onus is on the promoter to determine whether they’re offering a financial product
   “Entities and their advisers need to consider all the rights and features of the proposed crypto-asset, as well as the way in which it will be offered. This analysis is critical to determining whether the crypto-asset is a financial product or involves a financial product.” — Part A, ASIC Information Sheet 225
2. When it comes to crypto, the regulator is concerned about misleading and deceptive conduct, having assumed delegated powers from another Australian regulator, the Australian Competition and Consumer Commission (ACCC)
3. The regulator is aware of specific custody challenges with crypto products
4. The regulator “expects” or at least “strongly encourages” entities to get professional advice:

“Entities are expected to seek professional advice and ensure ongoing compliance with the law”. — Part A, Information Sheet 225

“We strongly encourage entities to carefully consider their proposal and seek professional advice (including legal advice).” — Part G, Information Sheet 225

Product disclosure for crypto-asset investment products

Adding to the list of considerations for market entrants, ASIC has not yet issued specific disclosure benchmarks for crypto-assets. So far, ASIC has only emphasised some matters that will need to be addressed.

Notably, the characteristics of the crypto-asset itself will need to be carefully disclosed, including how they are created, transferred and destroyed, and how they are valued and traded. Issues such as custody of the crypto-asset and the details of the technology underpinning the crypto-asset will also need to be disclosed.

Offering a crypto-asset investment product will require a product disclosure statement (PDS). Without specific disclosure benchmarks from the regulator, it will be up to the issuer and their advisors to think extremely carefully about what to include in product disclosure to be confident of compliance.

Signposts but no maps

In short, the regulator has pointed out (some of) the minefields but provided no maps. As a result, businesses enter the Australian crypto market with more risk than they would if they entered a more established area of the Australian financial market.

This risk is an opportunity for the well-prepared because it’s entirely possible to map a confident path into the Australian market. As ASIC makes clear, the crypto market is covered by known legislation and regulation (albeit legislation and regulation that hasn’t yet been applied to crypto).

Well-prepared entities can map their path confidently if they have access to guides with expertise in the regulation, an understanding of crypto and a considered approach to product, market and regulation.

The more considered the approach and the greater the expertise brought to bear, the lower the chances of attracting the regulator’s attention.

An emphatic warning shot on misleading and deceptive conduct

The regulatory considerations extend beyond financial services laws and regulation. That’s because a crypto-asset or ICO doesn’t have to be considered a financial product in Australia to be covered by the consumer protection provisions of Australian law.

Protecting consumers is clearly a primary consideration for the regulator when it comes to crypto. Specifically, ASIC has indicated that potential harmful conduct will include:

• Using social media to create the appearance of a greater level of public interest in a crypto-asset or ICO
• Undertaking trading strategies to create an appearance of increased buying and selling activities

“Finfluencers” take note

Australia’s consumer protection laws apply to “finfluencers”, too. While a finfluencer might not themselves be offering products or advice in the traditional sense, they can expect scrutiny from the regulator if their pronouncements could affect the decisions of retail investors.

Consumer protection an obvious trap for new entrants

The regulator’s pronounced warnings about misleading and deceptive conduct should be of particular interest to entrants without an Australian financial services background.
Australian financial services businesses should be fluent in what they can and can’t say under Australian law. However, entrants to the Australian crypto market may come from overseas or another sector within Australia, particularly the technology sector.

Entrants from outside Australia will need to invest in understanding how consumer protection laws apply in financial services. Understanding consumer protection laws is essential when a single misstep on Twitter, in a media interview or on a prospective investor call could undo the most careful work of presenting a compliant offer document.

Green light, but is the handbrake still on for crypto trading?

Although ASIC has been seen to flick the crypto light to green, the regulator might have left the handbrake on for crypto trading platforms.

In the custody section of its information sheet on crypto-assets, ASIC refers to section 601FC(2) of the Corporations Act, two class orders and two regulatory guides. ASIC describes them collectively as “minimum requirements when dealing with crypto-assets” (our italics).

In particular, the regulator warns asset holders that custody must be handled by crypto-asset custody specialists. (We would also suggest regular independent audits of the effectiveness of the controls of custody service providers.)

ASIC adds that it sees custody as likely to involve “cold storage”. Cold storage is where the private key material necessary to transfer ownership of crypto-assets is kept on hardware that is physically isolated from other computer systems.

The regulator has understandably high expectations for security. At the same time, crypto-asset owners are likely to expect to trade at market speed. That could be difficult if private keys are too hard to access. ASIC seems to anticipate this:

“Private key material should not be held on internet-connected systems or networked hardware (hot storage) beyond what is strictly necessary for the operation of the product.”

However, there is much to consider in the words “strictly necessary”. No one should want to be the first platform or custodian put to proof that they didn’t go beyond the strictly necessary.

What’s next for businesses interested in entering Australia’s crypto market?

There’s no disputing that ASIC has given confidence to the market that crypto-assets, funds and trading platforms can be set up fully compliantly in Australia. Even if these things have always been possible, the confidence is new, as is the certainty that crypto financial products will be subject to the supervision of the financial regulator.  In addition, we know which parts of the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 that the regulator sees as most relevant to crypto financial products.

Also new are the insights into where the regulator will be looking closest, including the custody concerns and the potential for breaching Australian Consumer Law.

Fortune favours the bold and prepared

The lack of specifics in the regulatory signposts and guidance can be seen to create a fertile opportunity for well-resourced entrants. The opportunity is there because everyone who steps onto this fresh field is going to be watched closely.

Promoters who step in with the resources to consider every angle have an opportunity to define the boundaries of their market. They can also achieve a first-mover advantage over entrants without the resources to draw their own map. Those entrants might stay out of the market until the situation is more settled.

Others who enter the market without the professional advice ASIC recommends could find themselves being used in test cases to define what’s outside the boundaries.

We know from other areas of financial services that some mistakes are easy to make. The same easy mistakes can be made in the case of crypto-assets. And these mistakes could be what trip up entrants coming from an unregulated mindset into a financial services environment.

A disciplined approach is well-advised

The emerging market for crypto-assets in Australia is exciting, but ASIC rightly expects to see a disciplined approach to realising the potential.

Overall, we expect the regulator’s eye is more likely to fall on anyone who looks to be navigating the regulatory landscape without sufficient attention to the signposts and guidance that ASIC has given. Conversely, those seen to be proceeding with diligence and the expert help that ASIC at least “strongly encourages” are less likely to find themselves on the front pages while they are used as crypto test cases.

Our lawyers are experts in the Australian regime and approach. They are also part of Allen & Overy’s worldwide network with lawyers and experts in your jurisdiction. If you are considering entering the Australian crypto market or think your activities might attract regulatory interest in Australia, please get in touch with one of the contacts on the left.