ASIC has now finalised its good practice information on crypto-asset related products after completing its industry consultation.
Crypto-asset related products will be regulated within ASIC’s existing framework under new regulatory guidelines applicable to crypto-asset participants and licensed Australian exchanges that admit exchange traded products (ETPs). These guidelines, contained in ASIC Information Sheets INFO 225 and INFO 230 respectively, largely reflect ASIC’s proposals in CP 343, which we reported on in our paper titled ‘Putting the “fun” into crypto-funds? ASIC gets set to regulate collective and structured investments in crypto-assets’.
INFO 225 – Crypto-assets
INFO 225 provides good practice guidance to issuers of investment products that provide retail investors with exposure to underlying crypto-assets.
Managed investment schemes
Responsible entities (REs) of schemes offering exposure to crypto-assets (regardless of whether or not those underlying crypto-assets are financial products) must consider matters in relation to custody, risk management and disclosure.
In relation to custody, ASIC considers that REs should comply with the following good practices:
- choose a custodian with specialist expertise and infrastructure in crypto-asset custody;
- segregate crypto-assets on the blockchain;
- generate and store private keys to the scheme’s crypto-assets in a way that minimises the risk of unauthorised access;
- adopt signing approaches that minimise ‘single point of failure risk’;
- ensure that custodians maintain robust systems and practices for the receipt, validation, review, reporting and execution of instructions from the RE;
- REs and custodians should have robust cyber and physical security practices with respect to their operations;
- REs should have the custodian’s cybersecurity practices and controls independently verified to an appropriate standard;
- REs should have access to an appropriate compensation system if crypto-assets held in custody are lost; and
- REs should have the appropriate competencies to assess the custodian’s compliance with ASIC’s guidance on ‘Funds management and custodial services: holding assets’ in RG 133.
REs should also consider whether crypto-asset trading platforms they use have adequate risk management systems. In particular, an RE should:
- take reasonable steps to satisfy itself that any crypto-asset trading platforms it relies on:
- are registered with AUSTRAC or regulated by the laws of a foreign country giving effect to the Financial Action Task Force recommendations relating to customer due diligence and record-keeping; and
- implements risk-based AML/CTF systems and controls; and
- ensure that any 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 these standards.
In relation to disclosure in the context of products with underlying crypto-assets, an RE should, in any product disclosure statement that it issues under the Corporations Act 2001 (Cth) (PDS) in relation to a scheme that will invest in crypto-assets, include sufficient information about the characteristics and risks of those crypto-assets.
Some relevant crypto-asset characteristics may include:
- the technologies that underpin those crypto-assets (e.g. blockchains, distributed ledger technology and cryptography);
- how the crypto-assets are created, transferred and destroyed;
- how the crypto-assets are valued and traded, and
- how the crypto-assets are held in custody.
In relation to crypto-specific risks, these may include market risk, pricing risk, immutability, political regulatory, and legal risk, custody risk, cyber risk, and environmental impact.
Listed investment companies and structured products
ASIC expects listed investment companies and structured products to follow the same good practices for custody, risk management and disclosure. In addition, their relevant market operators will be expected to comply with regulatory guidelines in relation to permissible underlying assets and pricing frameworks as set out in INFO 230 (examined below).
Licensing of scheme operators and registration of schemes
Operators of registered managed investment schemes are required to hold an Australian Financial Services Licence (AFSL) that identifies the “asset kinds” held by the scheme. As crypto-assets are not currently covered by any existing asset kind, ASIC has indicated that it will establish a new asset kind for ‘crypto-assets,’ defined as “a digital representation of value or rights (including rights to property), the ownership of which is evidenced cryptographically and that is held and transferred electronically by a type of distributed ledger technology or another distributed cryptographically verifiable data structure.”
The ‘crypto-asset’ asset kind will apply to crypto-assets which are not themselves financial products. If the relevant crypto-asset is a financial product, applicants should select the asset kind which corresponds to the class of financial product (e.g. the ‘financial assets’ or ‘derivatives’ asset kinds).
The crypto-asset kind will have two forms of authorisation:
- the ‘named scheme’ authorisation for specific crypto-asset registered schemes named in the AFSL; and
- the ‘kind scheme’ authorisation for multiple crypto-asset schemes – this form of authorisation will allow the licensee to operate multiple schemes without varying the licence for each new scheme, but ASIC has indicated that applicants will be expected to operate two named crypto-asset registered schemes for at least two years before it considers granting a broader ‘kind scheme’ authorisation to the applicant.
In assessing AFS licence applications for the crypto-asset kind (regardless of whether the crypto-asset is a financial product or not, and regardless of the type of authorisation sought), the key matters that ASIC will consider are:
- whether managers can demonstrate both the ‘operate scheme’ and ‘assets under management’ elements of the organisational competence standards set out in RG 105;
- the extent to which the applicant can meet the good practices outlined above – particularly in relation to custody and risk management, and
- whether the applicant has appropriate human, financial and technological resources.
INFO 230 – ETPs: admission guidelines
In INFO 230, ASIC has updated its guidance on underlying assets to clarify the circumstances in which licensed exchanges may determine that crypto-assets can be permissible underlying assets for ETPs admitted to their market.
Crypto-assets that are financial products may be considered a permissible underlying asset on the basis that its relevant financial product class is a permissible underlying asset. However, in relation to crypto-assets that are not financial products, market operators should be satisfied that:
- there is a high level of institutional support and acceptance for the particular crypto-asset;
- there are reputable and experienced service providers (including custodians, fund administrators, market makers and index providers) to support the product;
- there is a mature spot market for the crypto-asset;
- there is a regulated futures market for trading derivatives linked to the crypto-asset – the standard of regulation is that required to maintain a fair, orderly and transparent market for trading in crypto-asset futures, or equivalent regulatory outcomes (Market Obligations); and
- there are robust and transparent pricing mechanisms for the crypto-asset, both throughout the trading day and to strike a net asset value (NAV) price (examined below).
Some of the factors relevant to determining whether requirement (a) (institutional support and acceptance) has been met include:
- whether ETPs hold that crypto-asset in comparable jurisdictions;
- whether listed companies deal with that crypto-asset in Australia or comparable jurisdictions;
- whether large and well-regarded traditional financial institutions, in Australia or comparable jurisdictions, provide services in relation to that crypto-asset to institutional clients; and
- whether registered managed investment schemes (or similar unlisted investment products available to retail investors in Australia) have a proven track record that indicates the relevant crypto-asset can meet the requirements for being held by an ETP.
In relation to requirement (c) (mature spot market), some relevant considerations include:
- the number of major platforms dealing in the crypto-asset;
- the value and frequency of trading activity across platforms;
- the level of trading fees and bid–offer spreads;
- the diversity of buyers and sellers;
- whether the relevant trading platforms have policies and procedures to support Market Obligations and address manipulation and other market integrity risks; and
- the effectiveness of arbitrage activity between major platforms and consistency of pricing across major platforms.
In relation to requirement (e) (robust and transparent pricing mechanism), ASIC’s good practice guidelines are that market operators should verify that:
- the basis of the crypto-asset pricing mechanism is a benchmark price or index published by a widely regarded provider that reflects a substantial proportion of trading activity in the relevant currency pairs in an unbiased manner, is designed to be resistant to manipulation and complies with recognised benchmark selection principles;
- the pricing mechanism does not rely on a single crypto-asset spot market; and
- in the case of crypto-assets that are also financial products, the pricing mechanism is as robust and transparent as those used by non-crypto-assets in that class of financial product.
As well as being satisfied that the product accounts for the characteristics and risks of crypto-assets, market operators should verify that the product seeking admission complies with the good practices set out in INFO 225 (examined above), and periodically assess compliance.
Issuers of ETPs and other products focused on crypto-assets, and licensed exchanges, should have regard to the good practices contained in INFO 225 and INFO 230 when dealing with crypto-assets and products based on them as an investment class. While ASIC’s good practices are not strict legal requirements, they will assist crypto-asset participants with meeting their market obligations and other relevant obligations, and provide an insight into ASIC’s approach to examining and regulating conduct by participants in this exciting new investment sector.