Yesterday, 20 October 2021, the Select Committee on Australia as a Technology and Financial Centre (Committee) issued its long-awaited report into digital assets markets and regulation (Report).
The Report makes 12 recommendations to develop Australia’s regulatory regime for digital assets and markets. It is hoped that the Australian Government will adopt the majority of these recommendations to support and encourage investment in digital assets in Australia. However, to achieve the Report’s vision of Australia becoming a digital asset and fintech centre, the significant work stream to transform the Report’s high level recommendations into detailed regulation needs to be undertaken as a matter of urgency.
The current lack of certainty is hampering innovation and growth
The Report acknowledges the difficulty for market participants, regulators and legislators created by the lack of clarity in the existing regulatory framework’s classification and treatment of digital assets.
It recognises the opportunity that a clear regulatory framework would provide to these stakeholders and the Australian community more generally. Creating regulatory certainty is a critical step in enabling product innovation and investor confidence. However, the Report also highlights the difficulty in creating a framework that is suitably flexible to manage the risks that digital assets present, whilst also enabling innovation, investment and growth in a sustainable manner.
At the heart of the current lack of regulatory certainty is an issue of categorisation – what types of assets are digital assets? And therefore what parts of our financial products and licensing regime apply? The Report recommends that Treasury, with support from other regulators and experts, undertakes a “Token Mapping Exercise” (Recommendation 3). Good regulation requires deep understanding of the thing to be regulated and, on its surface, the token mapping exercise appear to be a good process to create that understanding.
However, the number of available crypto-currencies, crypto-assets, non-fungible tokens and distributed ledger technology (DLT) networks is growing rapidly, and is only limited by the ingenuity of the mathematicians and engineers that design them. The mapping exercise risks the legislative changes that are needed being kicked down the road, unless it is approached with a sense of urgency by Treasury. For Australia to capitalise on the opportunities offered by crypto-assets and DLT as the Report envisages, the desired regulatory certainty needs to be forthcoming on an aggressive timeline that keeps pace with the sector.
Known risks addressed in the short term
The Report makes some recommendations that will provide immediate benefit to the industry, such as the creation of a market licensing regime for Digital Currency Exchanges (DCE) (Recommendation 1) and a custodial regime (Recommendation 2), detailing specific requirements for companies holding digital assets for investors.
These recommendations will provide necessary customer protections for two important aspects of the digital asset economy. DCEs are an important on and off ramp for crypto to fiat transactions and for crypto to crypto transactions. These platforms are transacting billions of dollars’ worth of real and virtual money, currently with little oversight. Creating a licensing regime for DCEs operating in Australia will create a trusted environment for investors wishing to buy digital assets. Similarly, by developing specific digital asset custodial arrangements, investor confidence in the secure holding of their assets will increase, potentially leading to greater market participation.
The Report also seeks to address the problems of money-laundering and taxation in a balanced manner by recommending the AML/CTF regulations be clarified, in particular with reference to the “travel rule” (Recommendation 5) and suggesting that capital gains taxable events only be recognised when there is a clearly definable capital gain or loss (Recommendation 6). This final recommendation, directed at both Treasury and the Australian Tax Office, highlights the role that clear tax policy has in encouraging investor and operator participation in digital assets, with Singapore’s regime held out as a simplified regime worthy of further consideration.
The Report also acknowledges that the digital asset market faces an existential risk related to de-banking by incumbent banks. Such financial institutions are in the invidious situation of being gatekeepers for these fledgling operations whilst also being required to prevent illegal activity in the financial system. Incumbent financial institutions face the unwelcome task of having to assess these innovative products within a regulatory framework that is ill-suited to regulate, let alone identify, the risks associated with them. The Report’s recommendations in this regard relating to due diligence requirements for banks by June 2022 (Recommendation 9), a process for disputes relating to de-banking (Recommendation 10), and access to the New Payments Platform (Recommendation 11) seek to address the de-banking concerns through multiple channels. They potentially represent an opportunity for financial institutions to more confidently engage with and benefit from the digital asset industry.
A surprising recommendation
The Report’s most surprising recommendation is the creation of a new type of corporate structure for Decentralised Autonomous Organisations (DAO). The Report refers to the Coalition of Automated Legal Applications (COALA) model law for DAOs (here) as a useful starting point for developing the legal structure in Australia. A company structure for DAOs would be intended to clarify the roles and liabilities of actors, as well as the governance requirements and other obligations, in a manner similar to the regulation of limited liability companies. By creating a separate legal personality for DAOs and regulating the roles and liabilities of token holders, the recommendation may provide certainty for innovators and investors, and drive innovation and economic activity in Australia. However, giving DAOs legal personality – effectively giving them a similar legal status as companies and natural people – would be an extraordinary extension of the concepts of corporate existence. In addition, concerns have been raised about the COALA model law, such as a continuing lack of clarity over jurisdiction and enforcement, and the ability of a regulator to license or register a DAO in a manner similar to company registration with ASIC.
Despite the recommendations in the Report, investors in digital assets remain without a clear regulatory position as to the nature of the assets and the rules that apply. Some known risks are tackled in the short term, but the significant work stream of determining specific policy direction and detailed regulation remains. In the meantime, potential operators of, and investors in, digital assets and products associated with them will continue to need to analyse the nature of the digital asset and the regulatory rules that apply under the existing regime and assess the risks this represents.
For more information on understanding the Report, register your interest here.