Creating or selling software used to hold or deal in digital assets (i.e. custody software) would not be an asset holding arrangement and therefore not subject to regulation. However, a business with the necessary level of control of digital assets (whether using custody software or not) would be in scope. This is intended to deal with frauds and scams which label themselves ‘decentralised finance’ but retain (and exercise) the ability to steal customer tokens.
The broad approach is intended to be technology agnostic. It aims to capture the risks consumers are exposed to when relying on any third party to hold assets. However, the broad approach would not block the path to regulatory compliance for asset holders that use specific types of technology as part of their product. The obligations would be designed such that it would be possible (and required) for a business that controls customer tokens using custody software, such as smart contracts, to comply with the same requirements as any other business.
Start-up exemption
At the core of the proposed regime, is the requirement for platform providers to hold an AFS licence. However, the licensing requirement will only apply once a platform holds assets that exceed one of the following thresholds:
- A$1,500 for an individual account, or
- A$5,000,000 in total for all holdings.
The purpose of these thresholds is ‘to allow for innovation and experimentation in the early stages of developing a novel service offering’. The government is seeking feedback on these thresholds as well as how they should be monitored and implemented in the context of high volatility or where illiquid markets may make it difficult to price tokens.
AFS licensing
All relevant parties that provide financial services in relation to a digital asset facility, such as issuers, brokers, arrangers, agents and advisers engaged in organising or transacting in digital asset facilities would be required to hold an AFSL. The Proposal Paper refers to market makers, but it is hard to see how they would be caught unless specifically brought in given the underlying digital assets and tokens are not themselves proposed to be regulated. However, the Proposal Paper indicates there will be an exemption for certain dealings by businesses where their business is not primarily a financial services business.
The Proposal Paper suggests applying the standard AFS licensing financial requirements for solvency, positive net asset and cash needs to platform providers, as well as a net tangible assets (NTA) requirement. This requirement will vary depending whether the platform provider uses an external custodian or not:
- if assets are held through a sub-custodian digital asset facility that has NTA of at least A$5m, the platform provider must have NTA of at least A$50,000 or 0.5% of the value of the facility (whichever is greater)
- if the platform provider is not using a sub-custodian, it must have NTA of at least A$5 million or 0.5% of the value of the facility (whichever is greater).
Facility guide
Before offering services to retail clients, platform providers will be required to provide a 'facility guide' that includes:
A summary of the significant characteristics or features of the platform
A summary of the rights, terms, conditions and obligations arising under the facility contract
Information required to be included in a financial services guide (FSG)
References and links to information on the platform provider's website, including the facility contract and information a retail client would reasonably need to decide make a decision whether to become a client, including information required to understand:
- the facility's nature and the risks of participating on the platform
- the roles of platform providers and custodians
- any differences between a platform entitlement and directly holding an asset, and
- rights to disclosure in relation to assets and tokens held through the platform.
In some cases, the facility guide will need to be lodged with ASIC, e.g. where the platform facilitates fundraising (i.e. the sale of entitlements to fund the development of ‘non-financial’ products and services).
Facility contracts and minimum standards
There will need to be a written agreement (facility contract) in place with each client which meets certain minimum standards relating to:
- holding assets
- non-discretionary rules and arrangements that meet minimum standards for platform entitlements (including creating and recording them) and for transactional functions
- transparent and non-discriminatory criteria for access to the platform, and
- fees, commissions, rebates, or benefits paid or received by users and platform providers, including whether benefits received by platform providers are passed through to clients.
Rules will need to be built into the system’s protocols or operating procedures, which can include procedures embodied in computer software. The facility contract will not be able to exempt the platform provider from liability for misstatements in information related to tokens with no entitlements. Complex platform entitlements will not be permitted and platform entitlements would need to be fully-backed.
Separate and more limited requirements would apply to custody only arrangements.
Tokens would need to be held on trust (where feasible) or bailment (for related tangible assets). Minimum standards would also require safeguarding of tokens using the highest level of safety that reasonably balances security and the timely processing of requests to exercise platform entitlements, continuous monitoring and regular auditing, appropriate business continuity arrangements and minimum standards for external custodians. There is no suggestion that custodians need to be located in Australia.
The Proposal Paper contemplates that platforms would have to be non-discretionary, i.e. the client would have sole discretion when to acquire, dispose of or exercise rights in relation to underlying digital assets. However, the paper also asks whether there should be an ability for discretionary facilities dealing in digital assets to be licensed, e.g. under the managed investment scheme framework.
Platform providers will need to have listing criteria, including ensuring there is access to sufficient publicly available information to enable account holders to make a purchasing decision, and notify ASIC if it has reasonably grounds to suspect market misconduct, as well as making reasonable efforts to identify, prevent, and disrupt market misconduct. Interestingly, there is no reference to taking steps to identify or prevent scams, although as noted token holders would be required to have reasonably high security standards.
Token disclosure
Additional disclosure obligations will apply to platform providers relating to underlying digital assets:
- for tokens that are financial products, the platform provider must ensure clients have been given a copy of the relevant regulated disclosure document (e.g. prospectus or PDS)
- for non-financial product tokens, the platform provider must provide a document detailing the rights and obligations of the issuer and token holder and warnings that it is not a financial investment, does not give rise to equity in a business and there is no promise of a financial return or benefit (non-investment warning)
- for tokens with no entitlements other than factual control, the platform provider must obtain explicit confirmation that the client has reviewed the summary of public information about the token, provide the non-investment warning and make available technical information about the operation of any application in which the token is a component, including software audits.
Financialised functions
An important feature of the proposed framework is that platform entitlements in relation to non-financial product assets would not become financial products. It is the platform interest that would be regulated as a financial product, not each digital asset holding.
However, the proposed framework aims to target the ‘financialisation’ of non-financial instruments, such as entitlements related to data storage or video game privileges.
Additional obligations will be applied to four types of activities where they are facilitated by digital asset platforms in relation to non-financial product tokens. The Proposal Paper indicates that a platform will typically only be able to perform one of these types of activities.
Trading - this refers to the exchange of digital asset platform entitlements among account holders. Obligations would include:
- implementing protocols for efficient instruction execution, asset delisting, engaging market makers, suspension conditions, instruction filtering, and fee structures
- publicly disclosing bid and offer prices, including depth
- applying policies and procedures for assessing supported networks, dealing with network congestion, evaluating bridge security, mitigating critical network events, and recovering tokens
- publicly revealing executed transaction prices, volumes, and times, and
- providing public data that meets Australian regulators' requirements.
Staking - this involves participating in transaction validation on a public network. Suggested obligations include:
- allowing account holders to directly 'unstake' (i.e. that account holders are not entitled only to the value of their entitlement but can elect to have the assets transferred to them for their own use) any staked asset from the facility
- applying objective criteria for assessing supported networks, validation software security, and staking software's lawful transaction validation capacity, and
- including prominent statements in the facility guide about risks, potential penalties, rewards, and audits related to deploying capital and investing without a counterparty.
Tokenisation - this includes the creation and exchange of entitlements supported by tangible and intangible assets. Asset tokenisation functions must utilise token standards capable of complying with and enforcing AML/CTF laws. These obligations aim to mirror the EU's MICA framework for asset-referenced tokens, including:
- adding token holder terms and conditions, and order terms in the facility guide
- possessing technical capacity to evaluate networks, operate nodes, and mitigate critical network events
- using token standards that comply with sanctions and access restrictions, address theft, and respond to lawful demands, and
- establishing agreements with market makers for secondary market liquidity.
Fundraising - this entails selling entitlements to finance the development of products and services. Proposed obligations include:
- providing basic non-financial fundraising disclosure documents
- ensuring fair distribution of facility tokens to backers, with appropriate non-fungible or fungible entitlements
- keeping tokens non-tradeable during the product or service's development phase
- meeting financial service provider expectations for KYC protocols, fund release, transparency, token creation and distribution, and audits
- lodging facility guides, terms and conditions, and marketing material with ASIC before client onboarding
- not limiting liability for misstatements in terms and conditions, and
- focusing on one project and wind down after the arrangement loses its financial-like nature.
Next Steps
Consultation on the Proposal paper closes on 1 December 2023. Please contact us if you have any queries or require any assistance with making a submission.
The Government is also inviting submissions on the following issues which are not addressed by measures in the Proposal Paper:
- where consumers lend tokens to businesses, and
- margin lending relating to non-financial product digital assets.
Links to relevant material
