New Proposals for Regulating Digital Asset Platforms In Australia

The Australian Treasury released a Proposal Paper on Regulating Digital Asset Platforms in Australia on 16 October 2023 (Proposal Paper). Submissions are open until 1 December 2023. Crypto market participants should review the proposals carefully, assess their impact and make appropriate submissions to the Treasury. We can help.

The Proposal Paper builds on the Token Mapping Paper released by Treasury earlier this year. Like the Token Mapping Paper, the Proposal Paper is, in our view, a detailed and conceptually coherent piece of work. It seeks to draw a regulatory perimeter for crypto platform providers in a way that is consistent with how Australia regulates financial services more generally.

Summary

Broadly, the effect of these proposals is that a business which undertakes the types of activities typically associated with a crypto exchange will be regulated by the new regime if not exempted. There is a proposal to exempt a platform provider if the total value of platform entitlements held by any one client of the provider does not exceed A$1,500 at any one time and the total amount held by the provider does not exceed A$5 million at any one time.

If the proposals are implemented:

• The holding of digital assets, or assets backing digital assets, with values above a prescribed minimum, will be regulated as a new category of financial product called a digital asset facility. This regulation will apply despite the underlying assets being held by the platform provider not themselves being financial products for Australian financial product regulatory purposes.
• Certain transactional functions performed by digital asset platforms in respect of digital assets that are not financial products would need to meet additional minimum standards. This is because those functions as financialised functions. The Treasury notes that the ease with which any digital asset may be “financialised” requires a commensurate regulatory response. The regulated financialised functions will include intermediating:
  • the exchange of platform entitlements between account holders (token trading);
  • the account holder’s participation in validating transactions on a public network (token staking);
  • the creation and exchange of platform entitlements backed by tangible and non-tangible product assets (asset tokenisation); and
  • the sale of platform entitlements to fund the development of non-financial products and services (funding tokenisation).[1]

There is a lot to be unpacked in these proposals. They are policy proposals and require policy responses. Treasury has noted that its policies remain subject to future legislative design and development. This is appropriate given that the Australian Law Reform Commission’s Final Report in its Inquiry Into the Potential Simplification of Laws Regulating Financial Services In Australia is due to be released by 30 November 2023.

How do the proposals fit with international approaches?

As the Australian Treasury has noted, “international bodies have endorsed an activities-based approach to establishing a global baseline for digital asset regulation.”[2] That approach “targets risks by regulating specific activities that involve those risks”. [3] The Australian Treasury also adopts the “same activity, similar risk, same regulatory outcome” approach. Although the philosophy is the same, the specifics of Australia’s proposals take account of the financial services regulatory environment in Australia.

How do the proposals relate to the existing financial services regulatory perimeter?

This proposal does not displace existing Australian financial services laws. It will still be necessary to assess whether or not something is a regulated financial product. That assessment is “technology neutral”. The proposed new framework is meant to be complementary to that assessment. The Australian Treasury notes that “the proposed framework is focused on addressing the risks and harms of financialisation which have arisen because of the difference between token-based and account-based systems. In addition to providing a platform for holding and tokenising non-financial assets safely, it proposes to introduce reasonable guardrails around these financialised activities.”[4]

This proposal does not address anti-money laundering and counter-terrorism financing (AML/CTF) requirements for the crypto industry. There is a separate consultation considering that topic. Please see our article of April 2023 entitled Digital Currency Exchanges and Remitters: Is the FATF Travel Rule in Transit to Australia?

How will digital asset platforms be regulated?

Under the proposed regulatory model, the asset holding arrangements of a digital asset platform (i.e. where a customer transfers a digital asset to a digital asset platform “in return for some type of ‘right’ to receive their asset back in future”)” will attract the obligation to hold an Australian Financial Services Licence. The platform provider holding the asset would be the issuer of that facility. Additionally, platform providers and other intermediaries providing financial services in relation to digital asset facilities (such as brokers, arrangers, agents, market makers and advisers) would be required to also hold an Australian Financial Services Licence.[5]

Minimum standards under Facility Contracts

The arrangements between a platform provider and a customer must be set out in a written agreement (Facility Contract). The Proposal Paper proposes that the Facility Contract must meet certain minimum standards. These are set out in the table below.

For holding assets

The Facility Contract must meet the minimum standards for holding assets.[6] These standards include the following.

• Assets must be held for token holders or account holders through an arrangement that meets ‘minimum standards for asset holders’ that apply to holders of financial products.
• Tangible assets may be held on trust or by way of a bailment arrangement.
• Tokens must be safeguarded according the ‘additional standards for token holders’ which are set out in the Proposal Paper.[7]

For intermediating platform entitlements

In relation to the issuance of platform entitlements (i.e. the rights that are received by a customer in exchange for transferring an asset to the digital asset platform), the Facility Contract must meet the minimum standards, including that:

• a platform entitlement must be created to represent each asset held by the platform (or each unit of an asset, if it is fungible); and
• platform entitlements may be recorded using an account-based system or a token-based system.

In relation to the exercise of platform entitlements, the Facility Contract must meet the minimum standards, including that:

• a person with a platform entitlement has sole discretion to decide on and provide instructions in relation to exercising their platform entitlement;
• instructions to exercise platform entitlements must be processed by the platform provider in a timely manner; and
• a platform entitlement can only be exercised once.[8]

For transactional functions

The minimum standards for transactional functions would permit a Facility Contract to include arrangements for ‘transactional functions’. These transactional functions must comply with:

• the existing financial services laws (where a platform entitlement relates to a financial product), or
• the minimum standards for ‘financialised functions’ (where a platform entitlement does not relate to a financial product).

The minimum standards for transactional functions include that:

• subject to the financial services laws and any of the relevant ‘financialised functions’, account holders or token holders have sole discretion to decide on and provide instructions on transactions in relation to platform entitlements, including the disposal of their platform entitlements and the transfer of their platform entitlements (among others);
• the digital asset platform will have and apply ‘listing criteria’ for any product made available for transactional functions on its platform;
• acquisitions of digital assets via a transactional function will only occur if the ‘token disclosure’ has been made;
• the platform provider will notify ASIC in writing if it has reasonable grounds to suspect that a person has engaged in market misconduct, or, for digital assets that are not financial products, conduct that would be market misconduct had the digital assets been financial products; and
• the platform provider will make reasonable efforts to identify, prevent, and disrupt market misconduct (or, for digital assets that are not financial products, conduct that would be market misconduct had the digital assets been financial products) on its platform.

What are the Treasury’s consultation questions?[9]

1. Prior consultation submissions have suggested the Corporations Act should be amended to include a specific ‘safe harbour’ from the regulatory remit of the financial services laws for networks and tokens that are used for a non-financial purpose by individuals and businesses. What are the benefits and risks that would be associated with this? What would be the practical outcome of a safe harbour?

2. Does this proposed exemption appropriately balance the potential consumer harms, while allowing for innovation? Are the proposed thresholds appropriate? How should the threshold be monitored and implemented in the context of digital assets with high volatility or where illiquid markets may make it difficult to price tokens?

3. What would be the impact on existing brokers in the market? Does the proposed create additional risk or opportunities for regulatory arbitrage? How could these be mitigated?

4. Are the financial requirements suitable for the purpose of addressing the cost of orderly winding up? Should NTA be tailored based on the activities performed by the platform provider? Does the distinction between total NTA needed for custodian and non-custodian make sense in the digital asset context?

5. Should a form of the financial advice framework be expanded to digital assets that are not financial products? Is this appropriate? If so, please outline a suggested framework.

6. Automated systems are common in token marketplaces. Does this approach to pre-agreed and disclosed rules make it possible for the rules to be encoded in software so automated systems can be compliant? Should there be an ability for discretionary facilities dealing in digital assets to be licensed (using the managed investment scheme framework or similar)?

7. Do you agree with the proposal to adopt the ‘minimum standards for asset holders’ for digital asset facilities? Do you agree with the proposal to tailor the minimum standards to permit ‘bailment’ arrangements and require currency to be held in limited types of cash equivalents? What parts (if any) of the minimum standards require further tailoring? The ‘minimum standards for asset holders’ would require tokens to be held on trust. Does this break any important security mechanisms or businesses models for existing token holders? What would be held on trust (e.g. the facility, the platform entitlements, the accounts, a physical record of ‘private keys’, or something else)?

8. Do you agree with proposed additional standards for token holders? What should be included or removed?

9. This proposal places the burden on all platform providers (rather than just those facilitating trading) to be the primary enforcement mechanism against market misconduct. Do you agree with this approach? Should failing to make reasonable efforts to identify, prevent, and disrupt market misconduct be an offence? Should market misconduct in respect of digital assets that are not financial products be an offence?

10. The requirements for a token trading system could include rules that currently apply to ‘crossing systems’87 in Australia and rules that apply to non-discretionary trading venues in other jurisdictions. Do you agree with suggested requirements outlined above? What additional requirements should also be considered? Are there any requirements listed above or that you are aware of that would need different settings due to the unique structure of token marketplaces?

11. What are the risks of the proposed approach? Do you agree with suggested requirements outlined above? What additional requirements should also be considered? Does the proposed approach for token staking systems achieve the intended regulatory outcomes? How can the requirements ensure Australian businesses are contributing positively to these public networks?

12. How can the proposed approach be improved? Do you agree with the stated policy goals and do you think this approach will satisfy them?

13. Is requiring digital asset facilities to be the intermediary for non-financial fundraising appropriate? If so, does the proposed approach strike the right balance between the rigorous processes for financial crowdsource funding and the status quo of having no formal regime? What requirements would you suggest be added or removed from the proposed approach? Can you provide an alternate set of requirements that would be more appropriate?

14. Do you agree with this proposed approach? Are there alternate approaches that should be considered which would enable a non-financial business to continue operating while using a regulated custodian?

15. Should these activities or other activities be added to the four financialised functions that apply to transactions involving digital assets that are not financial products? Why? What are the added risks and benefits?

16. Is this transitory period appropriate? What should be considered in determining an appropriate transitionary period?