Listed funds holding crypto-assets: ASX’s position
Increasingly, clients are coming to us for regulatory advice surrounding the mining of cryptocurrency tokens, operating digital currency exchanges, raising funds through Initial Coin Offerings, and investments involving cryptocurrencies.
On the heels of such heightened interest in investing in cryptocurrencies, the Australian Securities Exchange (ASX) has released their guidance with respect to Listed Investment Companies (LICs), Listed Investment Trusts (LITs) and Exchange Traded Funds (ETFs) that wish to invest in and hold cryptocurrencies as underlying assets.
In its Compliance Update released on 16 February 2018, the ASX advised that:
“an applicant seeking to list a cryptocurrency-related business will need to satisfy ASX not only that it has a structure and operations appropriate for a listed entity, but also that its business is bona fide, that it will comply with all applicable legal requirements in Australia and in all jurisdictions where it is proposes to carry on business, and that proper disclosure has been made to investors of the risks (including emerging regulatory risks) involved.”
The ASX’s guidance comes in the wake of a letter from the US Securities and Exchange Commission (SEC) in January 2018 to industry stakeholders seeking consultation on identified issues and questions surrounding cryptocurrency-related holdings by ETFs and listed fund entities. In this letter, the SEC considers matters of valuation, liquidity, custody, arbitrage, potential market manipulation and other risks. This suggests that the US regulator is turning its mind to the need for a formal regulatory approach. We anticipate the Australian Securities and Investments Commission (ASIC) and ASX following the US regulator and importing many of the US developments into the Australian jurisdiction.
In the meantime, Australian LICs, LITs and managed ETFs that wish to invest in cryptocurrencies or cryptocurrency derivatives will need to satisfy the ASX that they comply with ASX Listing Rules, have dealt with the legal and regulatory issues outlined in ASIC Information Sheet 225 and have addressed the following:
- their proposed investment strategy, including how and when they will provide a return to investors and, if applicable, how they will hedge the risks in the underlying investments and any related cryptocurrency risks;
- if they intend to invest in cryptocurrencies directly, their understanding of the market volatility and liquidity risks associated with cryptocurrencies and how they will manage those risks;
- if they intend to invest in, or hedge using, cryptocurrency derivatives, their understanding of the margin risks associated with cryptocurrency derivatives and how they will manage those risks (including in particular what liquidity lines they will have available to meet margin calls);
- specific details and experiences of the individual fund managers who will be making investment decisions and otherwise managing portfolios that involve cryptocurrencies; and
- why they consider their LIC, LIT or ETF is a suitable investment for retail investors.
Changing the digital currency game: new laws to regulate Bitcoin in Australia
Ever since the infamous Silk Road website was investigated and shut down by the US Federal Bureau of Investigation in 2013, and again in 2014, for facilitating the trafficking of illegal narcotics on the “darknet” using Bitcoin, the world of digital currencies has never been the same. Once upon a time Bitcoin was often used as an anonymous way to transfer large amounts of value across international borders – setting the perfect conditions for drug dealing, money laundering and other criminal activities.
By their very nature and design, digital currencies such as Bitcoin were developed to facilitate anonymous, de-centralised financial transactions, and fittingly, even the true identity of Bitcoin’s founder, “Satoshi Nakamoto” remains a mystery. Unlike traditional currencies, digital currencies only exist by means of computer algorithms, and have no backing from any central bank or government authority. Despite the elusive nature of Bitcoin, its value remains high, with each Bitcoin trading today at approximately USD$16,000 (over AUD$21,000). Nevertheless, it is because of Bitcoin’s elusiveness that resulted in the Australian Government’s 2016 Statutory Review of Anti-Money Laundering Counter Terrorism Financing (AML/CTF) Act, Rules and Regulations highlighting the risks associated with the anonymity of transactions and lack of identification and verification protocols associated with digital currency users.
In a bold move to regulate a technology that was ultimately designed to be un-regulated, both Houses of the Australian Federal Parliament, passed the Anti-Money Laundering and Counter-Terrorism Financing Amendment Bill 2017 which, in Part 2, deals directly with strengthening the regulatory regime with respect to digital currency exchanges in Australia and reduces the anonymity of digital currency users and transactions.
The Explanatory Memorandum to the Bill for the newly passed legislation recognises that digital currencies are “growing in popularity as a method of paying for goods and services and transferring value in the Australian economy”. However, up until now, their use in Australia has largely been outside the scope of the regulated financial system. The new legislation amends the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 and the Financial Transaction Reports Act 1988 and adopts the term “digital currency” to expand the law to include any digital representation that functions as a medium of exchange, which is not issued by a government body, and which is capable of being exchanged for goods and services by the public without any restriction on its use.
Thanks to the amending legislation, the AML/CTF Act now clearly covers convertible digital currencies such as Bitcoin, Ethereum, etc. and requires those who operate an exchange market for such convertible digital currencies to be registered with the Australian Transactions Reports and Analysis Centre (AUSTRAC) and to comply with certain obligations that are in line with the existing AML/CTF requirements imposed on traditional financial transactions, such as Know Your Customer (KYC), client due diligence and associated record-keeping obligations.
Therefore, the new legislation seeks to close the regulatory gap relating to such convertible digital currencies and aims to streamline and simplify Australia’s AML/CTF regime. The new regime will also see the “policing” functions of AUSTRAC expanded; improving its existing powers relating to infringement and registration.
To Bradley Brown, AUSTRAC’s acting deputy CEO of international policy, this must come as a welcome change. Mr Brown recently noted concerns relating to the proliferation of digital currency such as Bitcoin being used to facilitate the safe harbour of illegal drugs and weapons transactions on the “darknet”. A report released by the Australian Criminal Intelligence Commission also said that “virtual currencies are increasingly being used by serious and organised crime groups”, which is extremely alarming given today’s global political climate of heightened public concerns over criminal and terrorist activities.
In an attempt to counter this, the legislation will mean that businesses which trade in digital currencies will be subject to greater oversight, diligence and review by AUSTRAC. This echoes similar rules announced earlier this year by the Japanese Financial Services Agency to regulate the trading of digital currencies in that jurisdiction.
Interestingly, virtual “points” associated with airline frequent flyer programs, supermarket loyalty schemes and other common loyalty programs are technically digital currencies too. However, these programs fall within the concept of “non-convertible digital currencies” which, unlike Bitcoin, often restrict the members’ use of their accrued “points” to certain flights and selected goods or services. They are not captured within this new AML/CTF regime. Nevertheless, although airlines, supermarkets and others who offer these non-convertible digital currency programs are not obliged to collect KYC information under the new AML/CTF regime, they often still do so for, presumably, marketing reasons.
In any event, whilst entrepreneurs generally do not welcome increased government regulations, in this case, this new legislation has been embraced by digital currency traders and start-ups alike because, by passing the legislation, Australian law-makers have clearly signalled their intent to give legitimacy to the use of digital currencies in the Australian economy. That said, some start-ups are still worried about the costs associated with implementing KYC procedures for small transactions, resulting in higher barriers to entry for new players.
This new legislation is certainly a ‘game-changer’ with respect to the way the Australian community will view Bitcoin and other digital currencies. This regulatory reform will bring digital currencies more towards mainstream consumer use as to media of exchange. So by requiring convertible digital currency exchanges to be registered with AUSTRAC, to conduct client due diligence, to keep transaction records and to report suspicious matters, the legislation will minimise the risk of misuse of digital currencies for illegal money-laundering and financing of crimes and terror activities. It will also increase regulatory transparency to encourage greater market confidence in the use of innovative peer-to-peer transaction technology.
Possibility of extending the claws of the BEAR
As the financial sector waits for the Australian Prudential Regulation Authority (APRA) to fully awaken the Banking Executive Accountability Regime (BEAR) through the provision of further guidelines, there is already a lot of chatter as to whether BEAR should be extended beyond its initial coverage of APRA-regulated Authorised Deposit-taking Institutions (ADIs).
The Parliamentary Joint Committee on Corporations and Financial Services (Joint Committee) has recently recommended that BEAR should also apply to life insurance and life insurers. In its report on the Life Insurance Industry released in March 2018, the Joint Committee noted that while BEAR is currently designed to enhance the accountability of banks and their directors and senior executives for the prudential conduct and culture within their organisations, it does not cover conduct in relation to customers or shareholders which are matters that come under the watchful eye of the Australian Securities and Investments Commission (ASIC).
This aspect of BEAR is considered to be a slight contrast from the United Kingdom’s Senior Managers and Certification Regime (SM&CR).
With this in mind, the Joint Committee expressed its support for extending the scope of BEAR to cover consumer and investor matters and for ASIC to have the requisite power to take action on conduct in relation to those matters. The Joint Committee is of the view that this would create positive outcomes for consumers and investors.
Further, the report referenced the acknowledgment of the former Chair of ASIC, Mr Greg Medcraft, that “while the BEAR legislation probably needed to start with banks, it should then be broadened to include insurance companies”.
Such comment comes on the back of ASIC’s recognition that in the United Kingdom, the SM&CR applies to financial services more generally.
In fact, the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry that is currently underway scrutinises the behaviour of not only banks and ADIs, but also that of superannuation funds, insurers and other financial service providers.
Additionally, given the comments by the current Chair of ASIC, Mr James Shipton, focusing on the need to “maintain trust” in the financial system, there appears to be a growing appetite for the claws of BEAR to be extended beyond:
- APRA-regulated prudential matters to also include consumer and investor matters that fall within ASIC’s sphere of governance; and
- ADIs to also include trustees of superannuation funds, life insurers and other financial service providers.
That said, the Joint Committee recognised that “widening the scope of BEAR will not happen immediately and that the proposed regime first needs to be bedded down”.
We anticipate that with the Joint Committee’s recommendations, BEAR may ultimately transform into the Financial Executive Accountability Regime (FEAR). The wider financial industry should be prepared to face its FEAR!
Dealing with distress: business restructuring and rescue
Businesses in every sector and geography are having to transition to new ways of operating within a rapidly changing and increasingly uncertain legal and regulatory landscape.