On 30 June 2021, the Australian Securities Investment Commission (ASIC) released Consultation Paper 343: Crypto-assets as underlying assets for ETPs and other investment products (CP343) which calls for submissions on ASIC’s proposed approach to regulating exchange traded products (ETPs) that invest in, or provide exposure to, crypto-assets. CP343 is limited to proposing good practices for ETPs and other investment products providing exposure to crypto-assets under the current regulatory framework.
Despite the immense growth in popularity of cryptocurrencies and other digital assets (crypto-assets) in recent years and the fact that ETPs are one of the fastest growing investment fund categories in Australia, there remains considerable uncertainty around the legal status and listing potential of crypto-related ETPs on Australian exchanges.
The proposals outlined by ASIC in CP343 to accommodate crypto-related asset regulation in Australia may see entities with crypto-related assets able to list them on Australian exchanges with more ease in the future.
Current classification and regulation of crypto-assets
As noted in our previous alert, the regulatory framework around crypto-assets in Australia has so far relied on existing approvals enshrined in the Corporations Act 2001 (Cth) (Corporations Act). As noted in paragraph 11 of the CP343, crypto-assets that do not fall within the existing regulatory perimeter of financial products are generally unregulated by ASIC.
In addition, the Australian Securities Exchange (ASX) and the National Stock Exchange of Australia (NSX) have taken a very cautious approach to entities which currently have any involvement with crypto-assets. Currently, DigitalX (ASX:DCC) is the only listed company on the ASX with crypto-related assets and the ASX and NSX have yet to approve the listing of any crypto-related ETPs.
ASIC proposals
CP343 sets out the following proposals for comment in relation to crypto-related ETPs.
Meeting INFO 230 Expectations
ASIC Information Sheet 230 Exchange traded products: Admission guidelines (INFO 230) sets out good practices to help ensure that admission and monitoring standards for ETPs support fair, orderly and transparent markets, particularly in the context of ETPs that have unique or novel features. ASIC is seeking feedback on proposed good practices for product issuers and Australian market licensees to ensure that crypto-related ETPs can also meet the expectations that are set out in INFO 230.
Suitability of crypto-assets and identifying features
ASIC proposes the following factors as the basis to identify particular crypto-assets that may be appropriate underlying assets for an ETP:
- a high level of institutional support and acceptance of the crypto-asset being used for investment purposes;
- the availability and willingness of service providers (including custodians, fund administrators, market makers and index providers) to support ETPs that invest in, or provide exposure to, the crypto-asset;
- a mature spot market for the crypto-asset;
- a regulated futures market for trading derivatives linked to the crypto-asset; and
- the availability of robust and transparent pricing mechanisms for the crypto-asset, both throughout the trading day and to strike a daily net asset valuation price.
ASIC also proposes to work with Australian market licensees to establish a new category of permissible underlying asset for crypto-assets in their regulatory frameworks that, at a minimum, is consistent with the factors outlined above.
Robust and transparent pricing mechanisms
ASIC proposes the following good practices in relation to demonstrating a robust and transparent pricing mechanism for crypto-assets:
- the basis of the pricing mechanism for crypto-assets held by an ETP should be an index published by a widely regarded provider that:
- reflects a substantial proportion of trading activity in the relevant pair(s), in a representative and unbiased manner;
- is designed to be resistant to manipulation;
- complies with recognised index selection principles such as the International Organization of Securities Commission (IOSCO) Principles for financial benchmarks, the EU Benchmarks Regulation, or other internationally recognised index selection principles; and
- pricing mechanisms which rely on a single crypto-asset spot market would be unable to achieve robust and transparent pricing.
Responsible Entity Obligations
Responsible entities (REs) are entrusted with the funds of their investors and must comply with their legal obligations to act in the best interests of members of the scheme. ASIC is seeking feedback on proposed good practices for REs to ensure they uphold existing obligations when investing in crypto-assets in the following areas.
Custody
There are currently several obligations that apply to REs in relation to custody of crypto-asset schemes, including Regulatory Guide 133 Fund management and custodial services: Holding assets (RG 133) and Regulatory Guide 166 Licensing: Financial requirements (RG 166).
ASIC notes that the safekeeping of assets is a critical function. ASIC considers the unique characteristics of crypto-assets mean that specialised infrastructure and expertise is required by custodians to hold crypto-assets in safe and secure custody and suggests various good practices that may be adopted by REs in relation to the custody of crypto-assets. These include, amongst other things, ensuring that:
- the private keys used to access the scheme’s crypto-assets are generated and stored in a way that minimises the risk of unauthorised access;
- multi-signature approaches are used rather than single private key approaches; and
- an appropriate compensation system is in place in the event a crypto-asset held in custody for REs is lost.
Risk management
There are number of obligations that apply to Australian Financial Services Licence (AFSL) holders and REs including the enforcement of risk management systems as detailed in ASIC Regulatory Guide 259 Risk management systems of responsible entities (RG 259).
ASIC is proposing the following good practices in relation to the risk management systems of REs that hold crypto-assets:
- if the RE undertakes trading activity in crypto-assets, it should do so on legally compliant and regulated crypto-asset trading platforms. ASIC considers the appropriate baseline level of regulation to be know your customer and anti-money laundering and counter-terrorism financing obligations;
- the RE should ensure that authorised participants, market makers and other service providers that trade crypto-assets in connection with the product do so on crypto-asset trading platforms that meet the above standards; and
- the RE is responsible for ensuring its risk management systems appropriately manage all other risks posed by crypto-assets.
Disclosure
Financial product issuers (including REs, and ETP issuers) are required to comply with disclosure obligations, including issuing a product disclosure statement that discloses any risks associated with holding the product.
ASIC considers that the unique characteristics and risks of crypto-assets should be reflected in the disclosure documents of investment products. ASIC proposes that the RE consider disclosing information about the unique characteristics of crypto-assets and provide appropriate disclosure of the risks attached to such assets.
Design and distribution
General product design and distribution obligations (DDO) for issuers and distributors are outlined in ASIC Regulatory Guide 274 Product design and distribution obligations (RG 274). From 5 October 2021, issuers and distributors of crypto-asset related investment products will need to comply with the DDO.
ASIC doesn’t propose to issue any additional expectations about how the DDO can be met for investment products that invest in, or provide exposure to, crypto-assets.
Listed Investment Entities
Listed investment entities are closed-ended investment vehicles which are listed on licensed financial markets and available to retail investors. To ensure fair, orderly and transparent operation of Australian financial markets and minimise opportunities for regulatory arbitrage, ASIC proposes to work with market operators to establish that:
- the approach used to determine and classify appropriate crypto-assets for investment entities is the same for ETP’s;
- a listed investment company that invests in crypto-assets is expected to have custody solutions that align with the proposals for ETPs, regulated trading practices on crypto-asset markets and adhere to pricing mechanisms as proposed for ETPs;
- a listed investment trust that invests in crypto-assets will need valuation mechanisms that are consistent with those proposed for ETPs to be considered to have a structure and operations that are appropriate for a listed entity; and
- the above criteria should be ongoing requirements of listing.
ASIC considers that investment entities should seek member approval with sufficient disclosure before investing in crypto-assets.
AFS Licencing
Currently, crypto-assets do not fall within any existing asset kind that an applicant must select when applying for or varying an AFSL to operate a registered managed investment scheme (MIS). As such, a MIS cannot be authorised to directly hold crypto-assets.
ASIC proposes to establish a new asset kind that will cover crypto-assets so entities with the appropriate authorisation can hold these assets directly. Despite the proposal to define crypto-assets broadly, ASIC proposes to restrict the AFSL authorisations to operate a ‘crypto-asset scheme’ to bitcoin and ether.
For the future
All comments on the consultation paper are due by 27 July 2021. As this is a consultation paper only, CP343 is limited to proposing good practices for ETPs and other investment products providing exposure to crypto-assets under the current regulatory framework. More significant reform to the regulation and classification of crypto-assets rests in the hands of legislators. Regardless, CP343 indicates that ASIC is exploring the relationship between Australia’s financial regulatory landscape and crypto-assets and we look forward to more concrete guidance in this area to facilitate the quotation, classification and integration of crypto-related assets and entities on Australian securities exchanges.
If you would like assistance with any of the matters discussed in this alert, or more generally in relation to your corporate matters, please contact our Corporate Advisory and Governance team.