In brief - Buy and sell side participants and enablers need to be aware of ICOs and crypto-asset regulatory requirements and risks
The focus has returned to cryptocurrency with the recent announcement by Facebook of its intention to establish its Libra platform.
Coinciding with the Facebook announcement has been a broad address from regulators and regulatory and government bodies on initial coin offerings and cryptocurrency. The publication of this material provides useful points of consideration as this (possibly) new stage of the cryptocurrency lifecycle commences.
ASIC releases update on initial coin offerings and crypto-assets
The Australian Securities and Investments Commission (ASIC) has updated its information for businesses on ICOs (initial coin offerings) and crypto-assets.
The most important message from ASIC is that based on its recent experiences with ICOs and crypto-assets, these will often be financial products or involve financial products that are regulated under the Corporations Act 2001.
The updated ASIC information is contained in information sheet 225. The information is thorough in its assessment of the supply chain and the participants involved, and fires a warning shot to participants to ensure compliance with the financial services laws and fundraising laws. ASIC's approach is consistent with international guidance.
IOSCO publishes report on issues and risks of crypto-asset trading platforms
The International Organization of Securities Commissions (IOSCO) has led key financial market conduct work in the ICO market. Recently, it published its report on issues, risks and regulatory considerations relating to CTPs (crypto-asset trading platforms).
The aim of the report is to assist IOSCO members in evaluating the issues and risks relating to crypto-asset trading platforms. Key findings are:
- a majority of respondents apply their existing regulatory frameworks to CTPs when the crypto-assets traded qualify as securities or other financial instruments. Some respondents apply a bespoke arrangement
- where the on-boarding processes used by CTPs are limited or opaque, there may be a risk of the platform being used for illegal activities
- where retail investors are permitted to have direct access to CTPs, a consideration of whether CTPs are undertaking any investor suitability assessments prior to account opening is important. Australian financial services law was recently amended to impose a product suitability assessment, refer to our recent article Product intervention power - regulatory action sooner than expected.
- safeguarding participant assets - where the CTP offers custody, the risks that could arise include operational failure, theft/loss/inaccessible private keys, co-mingling
- where a CTP holds participant assets, a key consideration for regulatory authorities is whether prudential mechanisms are in place to support the operations of the CTP
- issues related to market integrity and fairness may arise where a CTP’s role, and therefore potential conflicts of interest between the CTP and its participants, is not transparent
- risks due to a lack of understanding of CTP operations can arise in the absence of clear and transparent rules, policies or other documentation, including those related to price discovery
- without rules governing trading and mechanisms for monitoring trading and enforcing their rules, there is a risk of fraud, manipulation and/or market misconduct that could be detrimental to investors and fair and efficient markets
- CTPs, the system resiliency, reliability and integrity, as well as cyber resilience and security of their trading systems are critical components in managing trading risks, facilitating investor protection, and fostering fair and efficient markets
FSB reports on crypto-assets across financial market sectors
The global Financial Stability Board has also reported on the work underway, regulatory approaches and potential gaps for crypto-assets across main financial market sectors. The report demonstrates active consideration in the crypto-asset space by a broad regulatory group, including BCBS (Basel Committee on Banking Supervision), CPMI (Committee for Payments and Market Infrastructures), FATF (Financial Action Task Force) and the OECD.
It demonstrates that the regulators see how far reaching distributed ledger technology and its application through crypto-assets could be in financial markets. Of note in the report:
- the BCBS may soon provide clarification for the prudential treatment of crypto-assets across various risk categories (eg, credit risk, counterparty credit risk, market risk, liquidity risk)
- implementation of a central bank digital currency is primarily conceptual based on a recent CPMI study
- vigilant monitoring of crypto-assets remains warranted according to the FSB
- the FATF has amended its recommendation 15 and requires virtual asset service providers to be regulated for anti-money laundering and combatting the financing of terrorism. An interpretative note was recently adopted for this.
- stablecoins and other asset-backed tokens remains a focus by the OECD (and others)
ASIC likely to view ICOs and crypto-assets as regulated financial products
The regulatory focus supports the strong message from ASIC. ASIC is particularly concerned with the retail aspect of certain products that are complex and where large losses can be suffered, especially overseas and via the internet. For business-to-business providers ASIC has taken steps to engage with the ICO and crypto-asset market, such as the Innovation Hub, liaison forums and regulatory sandbox initiatives, which in our experience has both a practical and supportive intention for compliant conduct and innovation.
It is critical that buy and sell side participants and enablers prudently assess the regulatory requirements and risks in the ICO and crypto-asset market as it is likely that ASIC will view these as regulated financial products.
This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2020.