Australian regulators are displaying enviable steadfastness in relation to cryptocurrency regulation, write Peter Reeves, Georgina Willcock and Emily Shen of Gilbert + Tobin
Globally, regulators have moved from observational to enforcement strategies in relation to their approaches to cryptocurrencies. This has impacted the value of (and demand for) cryptocurrencies, the types of cryptocurrency-related projects that have emerged, and the nature of cryptocurrency-related transactions undertaken. As the landscape has matured, so too has the understanding of the risks to consumers, prompting changes to regulation prioritising consumer protection.
In 2019, this focus has been reinforced by Facebook's announcement that it is proposing to enter the payments sector via the release of its subsidiary's cryptocurrency, Libra. The global regulatory response has been swift, with many regulators concerned about the impact of mainstream adoption of Libra. It is likely that regulators will seek to be more proactive in regulating cryptocurrencies and payment infrastructure more broadly.
In Australia, the response to Facebook's announcement has been relatively muted, with the primary corporate regulator, the Australian Securities and Investments Commission (ASIC), remaining publicly silent. In the commentary that ASIC has released in relation to cryptocurrencies (but not Libra specifically), it has been steadfast in its view that the existing framework remains adequate to regulate cryptocurrencies.
The Reserve Bank of Australia (RBA) has been more outspoken, with its governor stating that retail adoption of cryptocurrencies for payments is unlikely as Australia's existing payments system is highly efficient. Further, Australian law does not currently equate digital currency with fiat currency and does not treat cryptocurrency as 'money'. On whether it could become money in the future, the RBA has cited lack of scalability, price volatility and general uncertainty around settlement finality as hindering this possibility, with consumer focus positioning cryptocurrencies as a low-volatility asset, not as a payment tool.
Existing and anticipated cryptocurrency regulatory regimes
The Australian government has taken a relatively non-interventionist approach to the regulation of cryptocurrencies. ASIC has reaffirmed the view that Australian legislative obligations and regulatory requirements are technology-neutral and apply irrespective of the mode of technology providing the regulated service. While cryptocurrencies themselves are not restricted under Australian law, dealings in relation to cryptocurrencies are likely to be captured within existing regulatory regimes.
Anyone carrying on a financial services business in Australia must hold an Australian financial services licence (AFSL) or be exempt from this requirement. Persons or entities dealing with cryptocurrencies should consider whether the cryptocurrency constitutes a financial product. If it does, it may trigger the AFSL licensing requirement and other obligations in relation to disclosure, registration and conduct. The definitions of 'financial product' and 'financial service' under the Corporations Act 2001 are broad, and cover facilities through which a person makes a financial investment, manages a financial risk or makes a non-cash payment. ASIC continues to reiterate its view that cryptocurrencies with similar features to existing financial products will trigger the Australian financial services laws.
ASIC intends to repeal passporting relief and replace it with a foreign AFSL regime to commence March 31 2020
ASIC recently updated its regulatory guidance on cryptocurrencies – 'INFO 225 Initial coin offerings and cryptoassets' – to inform a greater range of cryptoasset participants, including: issuers; intermediaries, miners and transaction processors; cryptoasset exchange and trading platforms; cryptoasset payment and merchant services providers; wallet providers and custody service providers; and consumers. INFO 225 sets out ASIC's approach to determining the status of cryptocurrencies, which is dependent on the rights attached to the cryptocurrencies – which should be interpreted broadly – and structure. Depending on the circumstances, coins or tokens may be subject to the Australian financial services regulatory regime.
An entity that facilitates payments using cryptocurrencies may also be required to hold an AFSL, and the operator of a cryptocurrency exchange may be required to hold an Australian market licence if the coins or tokens traded constitute financial products.
As the market has developed there has been a proliferation of projects dealing in cryptocurrency derivative contracts, raising regulatory concern that retail consumers may not be able to reliably assess the value and risks of products and are exposed to market abuse and financial crime. ICOs may involve a derivative where the relevant product involves a self-executing contract arranging payments when triggered by changes in the price of an underlying product, index or asset.
Unlike regulatory counterparts abroad, ASIC has not proposed banning the sale of derivatives that reference cryptoassets to retail investors. Rather, ASIC has flagged that cryptocurrencies with derivative-like features may fall within the scope of the existing financial services regime and are subject to the obligations already.
In relation to foreign financial services providers (FFSPs), FFSPs carrying on a financial services business in Australia require an AFSL, unless an exemption applies. Currently, Australia has cooperation (passporting) arrangements with regulators in certain foreign jurisdictions, enabling FFSPs regulated in those jurisdictions to provide financial services to wholesale clients (namely, accredited investors) in Australia without holding an AFSL. However, ASIC intends to repeal passporting relief and replace it with a foreign AFSL regime to commence March 31 2020.
Separately, foreign companies carrying on a business in Australia, including by issuing cryptocurrency or operating a platform developed using ICO proceeds, may be required to register a local presence or incorporate a subsidiary. Broadly, the greater the level of system, repetition or continuity associated with an entity's business activities in Australia, the greater the likelihood that registration will be required. Generally, a company holding an AFSL will be carrying on a business in Australia and will trigger the requirement.
Australian consumer law
Cryptoasset participants, including issuers and exchange operators, may also be subject to the Australian Consumer Law set out at Schedule 2 to the Competition and Consumer Act 2010 (ACL) and the Australian Securities and Investments Commission Act 2001 (ASIC Act). The ACL prohibits misleading or deceptive conduct, and creates a range of consumer protections, in the context of Australian businesses. The ASIC Act contains comparable prohibitions and protections in the context of financial products and services.
Cryptocurrency-related promotional materials should not contain false information nor mislead or deceive buyers. Promoters and sellers of cryptocurrencies are also prohibited from engaging in unconscionable conduct and must ensure the cryptocurrencies are fit for purpose (regardless of whether the underlying cryptoasset is a financial product).
For offshore cryptoasset participants, Australian courts have affirmed that the ACL is applicable even where representations are made online from a foreign jurisdiction or are made in contracts governed by non-Australian law. The consumer protection provisions in the ASIC Act extend to conduct outside Australia by companies incorporated or carrying on business in Australia, Australian citizens or persons ordinarily resident within Australia.
ASIC has received delegated powers from the Australian Competition and Consumer Commission (ACCC), so it can take action against misleading or deceptive conduct in relation to cryptocurrencies, regardless of whether they are financial products. Consequences for failing to comply with the ACL or the ASIC Act include monetary penalties, injunctions, compensatory damages and costs orders.
Future regulatory developments
Digital currency exchange providers are now captured within Australia's anti-money laundering and counter-terrorism financing (AML/CTF) regime and it is likely that the government will consider further regulation to include a broader range of participants. The Financial Action Task Force (FATF) recently released interpretive guidance in relation to virtual assets and virtual asset service providers, recommending that these providers be required to pass know-your-customer (KYC) information between one another when transferring funds over a certain monetary amount.
The PIP Act introduces design and distribution obligations in relation to financial products, slated to commence April 2021
Currently, in Australia, there are only reporting requirements for the movement of physical currency, which does not capture cryptocurrencies.
Nor are there specific regulations dealing with blockchain or distributed ledger technology (DLT) in Australia. In March 2017, ASIC released 'INFO 219 Evaluating distributed ledger technology', which outlines its approach to the regulatory issues that may arise through the implementation of blockchain technology and DLT solutions. Businesses considering operating market infrastructure or providing financial or consumer credit services using DLT will still be subject to existing compliance requirements. While the existing regulatory framework is sufficient to accommodate current implementations of DLT, as the technology matures, additional regulatory considerations may arise.
The government has recently reintroduced legislation facilitating the introduction of the consumer data right (CDR) in Australia, which allows consumers to control how and the extent to which their data is shared. The proposed first application of the CDR will be in the banking sector from July 1 2019. The CDR legislation, if passed, is likely to improve competition and assist new participants in delivering products and services to consumers.
Initial coin offerings
ICOs have become alternative methods of funding, albeit with little activity in 2019. Generally, cryptocurrencies offered during an ICO that constitute financial products will trigger licensing and disclosure requirements, which will impact how the ICO is marketed. For example, an offer of a financial product to a retail client generally must be accompanied by a regulated disclosure document satisfying content requirements in the Corporations Act and ASIC guidance.
Under the Corporations Act, depending on whether the investor is a 'sophisticated investor' or wholesale client, an offer of financial products may not require regulated disclosure. In INFO 225, ASIC noted that entities should seek legal advice on this and be prepared to justify their eligibility for investor type-based exemptions.
ICO promoters abroad should be aware that they will not be permitted to market cryptocurrencies that constitute financial products to Australian residents unless the requisite licensing and disclosure requirements are met. Generally, a service provider from outside Australia may respond to requests for information and issue products to an Australian resident if the resident makes the first approach and there has been no conduct on the part of the issuer designed to induce the investor to make contact, or activities that could be construed as the provider inducing the investor to make contact. As discussed, Australian laws and regulations prohibiting misleading or deceptive conduct must also be considered even where an ICO product is issued, traded or sold abroad.
In its recent commentary, ASIC has placed great emphasis on consumer protection and compliance with the relevant laws. In 2018, it announced that it had taken action to stop several proposed ICOs targeting retail investors due to consumer law issues with disclosure and promotional materials, and unlicensed financial product offerings. ASIC has recommended that entities seek professional advice to ensure compliance with the law, particularly as the design of an ICO or cryptoasset can change over the course of the product development lifecycle.
The Australian Treasury opened a consultation this year on its review into ICOs, to examine the Australian regulatory framework's suitability in harnessing ICO-related opportunities and mitigating associated risks. The Treasury has not yet published its conclusions but submissions are now public. In its submission, ASIC indicated that it did not believe there were substantial gaps in its ability to enforce financial services laws with respect to ICOs; that future law reform should be technology-neutral; and that future modifications are dependent on the broader evolution of the cryptoasset market.
Activities associated with cryptoassets that do not constitute financial products must still comply with the ACL. For financial product-like cryptoassets, the key protections in place for Australian investors relate to licensing, disclosure and conduct.
Wholesale clients include persons either investing at least A$500,000 ($343,000) or having net assets of more than A$2.5million or a gross income of at least A$250,000 in the two previous financial years. Wholesale clients also include professional investors (for example, an AFSL holder, trustees of superannuation funds, listed entities or persons controlling at least A$10million). A retail client is anyone that does not fall within the definition of a wholesale client.
As regards licensing, entities and persons involved in marketing, issuing, managing, or operating the asset generally must hold an AFSL or be exempt regardless of whether investors are retail or institutional and this requirement is itself an investor protection. AFSL holders must comply with a range of conduct and resource-related obligations, including an overarching requirement to provide financial services efficiently, honestly and fairly. In a retail context, licensees must maintain professional indemnity insurance and may be required to hold cash assets to cover claims made in relation to retail client money. Non-compliance attracts substantial financial and non-financial penalties.
There is ‘little current evidence’ that digital currencies have been used to facilitate black economy activities
Exemptions from the requirement to hold an AFSL are typically conditional on the provider complying with certain disclosure and conduct requirements, often limiting the extent of services or type of product that can be provided.
Regarding disclosure, to the extent a cryptoasset constitutes a financial product, offers to retail clients must be made pursuant to a regulated disclosure document that complies with the Corporations Act requirements and ASIC guidance relating to form and content. All disclosure documents given to retail and institutional investors must comply with the prohibitions on misleading and deceptive conduct, and ASIC guidance relating to advertising financial products.
When it comes to conduct, cryptocurrency-related promotional materials must not contain false information or mislead or deceive buyers. Promoters and sellers of cryptocurrencies are prohibited from engaging in unconscionable conduct and must ensure the cryptocurrencies are fit for purpose.
For cryptoassets that are securities, there are prohibitions under the Corporations Act in relation to unsolicited personal advertising or publication of statements that refer to a securities offering or are reasonably likely to induce people to apply for securities (unless an exemption applies), and the practice of selling securities through unsolicited personal sales contact (ie, 'hawking').
The passing of the Treasury Laws Amendment (Design and Distribution Obligations and Product Intervention Powers) Act 2019 (PIP Act) may impact the way cryptocurrencies are structured and distributed, and ICOs conducted and marketed in future. The PIP Act introduces design and distribution obligations in relation to financial products, slated to commence April 2021, and provides ASIC with temporary product intervention powers (PIPs) where there is a risk of significant consumer detriment. The PIPs are currently available for ASIC's use. ASIC intends to release its final regulatory guidance with respect to its PIPs in September 2019 and open consultations on the design and distribution obligations later in the year. The purpose of new regulations is to ensure that financial products are targeted at the appropriate category of potential investors.
The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (AML/CTF Act) and Anti-Money Laundering and Counter-Terrorism Financing Rules Instrument 2007 (No. 1), administered by the Australian Transaction Reports and Analysis Centre (AUSTRAC), impose obligations on reporting entities: entities that provide designated services with a geographical link to Australia.
In the cryptoasset context, the AML/CTF Act may apply to businesses that issue or sell cryptocurrencies characterised as financial products, issuers of stored value cards, remitters, digital currency exchange providers and payment platform operators. The AML/CTF regime has cross-border application where designated services are provided by a subsidiary of an Australian company or are provided in Australia by a foreign company.
In 2017, the AML/CTF Act was amended to introduce new designated services specifically capturing digital currency exchange providers. Beyond this, providers of services relating to cryptoassets are caught by the AML/CTF Act only to the extent such assets fall within the scope of the existing concepts and definitions relating to financial services, bullion, and gaming or gambling designated services.
Most reporting entities, including registered digital currency exchanges, will be required to: enrol (and in some circumstances, register) with AUSTRAC; adopt and maintain a compliant AML/CTF programme; implement KYC processes to verify the identity of their customers; and comply with continuous obligations to monitor and report suspicious and large transactions. Exchange operators are also required to keep certain records relating to customer identification and transactions for up to seven years.
The Treasury has been consulting on an economy-wide cash payment limit of A$10,000 for goods or services, with limited exceptions. The consultation proposes to remove the requirement for reporting entities to report transactions above A$10,000 to AUSTRAC. The consultation proposes implementation from January 1 2020 and, for reporting entities, January 1 2021. Breaching the payment limit will result in up to two years' imprisonment and/or a fine of A$25,200.
Notably, payments made in digital currency have been exempted from the cash payment limit regime including payments made only in part in digital currency, so long as the remainder of the payment is below A$10,000. Digital currencies have been exempted to promote innovation in the sector and because there is 'little current evidence' that digital currencies have been used to facilitate black economy activities. However, whether this exemption is appropriate will remain subject to ongoing scrutiny.
The Australian Tax Office (ATO) has attempted to clarify the operation of tax law, but the taxation of cryptocurrency remains subject to debate. For income tax purposes, the ATO views cryptocurrencies as assets that are held or traded and not money or a foreign currency.
The tax implications for investors, holders and users of a cryptocurrency depends upon the intended use of that cryptocurrency.
Currently, investors who are Australian residents for tax purposes in the business of trading cryptocurrencies are likely to be subject to the trading stock provisions; meaning that the taxation of cryptocurrencies is akin to that of goods for sale. The gain on the sale of cryptocurrencies will be taxable to such investors on 'revenue account' as ordinary (assessable) income, and any losses will be deductible on a similar basis.
Otherwise, the ATO has indicated that cryptocurrencies will likely be a capital gains tax (CGT) asset. The gain on their disposal will be subject to CGT. Capital gains may be discounted in certain circumstances, most notably in the case of a taxpayer who is an individual that owns a cryptocurrency asset for 12 months or more, before being subject to tax.
Capital losses can ordinarily can be used to reduce capital gains in current or future tax years, but capital losses on cryptocurrencies which are 'personal use' assets (for instance, acquired or kept for personal use or consumption) are disregarded where the asset was acquired for less than A$10,000.
Meanwhile, companies that are tax residents of Australia are subject to tax on income they source worldwide. Generally, if a company is not a tax resident of Australia, it is only subject to income tax on income from sources in Australia. For companies that are resident of countries that have a double taxation treaty with Australia, taxes are generally limited to profits attributable to a 'permanent establishment' in Australia.
The tax treatment of an ICO will depend on the nature of the rights and obligations attached to the product being offered. Cryptoassets may be akin to a debt or equity instrument, in which case the proceeds will not be assessable to the issuer. Alternatively, they could be issued as a prepayment for a service, or as part of the ordinary business of the issuer, in which case the proceeds could be taxed to the issuer.
In relation to the Australian Goods and Services Tax (GST), supplies and acquisitions of digital currency made after July 1 2017 have not been subject to GST on the basis that they will be input taxed financial supplies. Consequently, suppliers of digital currencies are not required to charge GST on these supplies, and purchasers are not entitled to GST refunds for corresponding acquisitions. The normal GST rules apply to the payment or receipt of digital currencies for goods and services, whereby digital currencies are used as an alternative to money. However, this is subject to the cryptocurrency being a digital unit of value characteristics including fungibility and not being denominated in any country's currency.
|About the author|
Peter Reeves is a partner in Gilbert + Tobin's corporate advisory group and leads the fintech practice at G+T. He is an expert and market-leading practitioner in fintech, financial services regulation and funds management. Peter advises domestic and off-shore corporates, financial institutions, funds, managers and other market participants in relation to establishing, structuring and operating financial services sector businesses in Australia. He also advises across a range of issues relevant to the fintech and digital sectors, including platform structuring and establishment, payment solutions, blockchain solutions and global cryptoasset strategies.
|About the author|
Georgina Willcock is a lawyer in Gilbert + Tobin's corporate advisory group with a focus on Australian financial services laws, anti-money laundering regulation and fintech. Georgina has been involved in a range of transactions and advisory matters, in relation to the establishment and operation of retail and wholesale funds, private mergers and acquisitions, and compliance with the Corporations Act 2001 (Cth) and Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth). Georgina has also advised on issues relevant to the fintech and digital sectors, including platform establishment, blockchain solutions, digital fundraising and digital currencies.
|About the author|
Emily Shen is a graduate in Gilbert + Tobin's corporate advisory group with a focus on Australian financial services regulation, funds management and fintech. She has been involved in advising a range of clients across the fintech and digital sectors on issues including platform and fund establishment, structuring tokenisation deployments, and implementing payment and blockchain solutions.