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Fintech Update: August 2017
There have recently been significant regulatory developments for the fintech sector in both Australia and overseas. In Australia, the Australian Securities and Investments Commission is consulting on a revised Australian market licensing regime which is of relevance to any business considering operating an online market in financial products. The open banking inquiry has also released an issues paper, setting out key topics subject of its review in developing consumer’s right to access their data.
In other jurisdictions there have also been important regulatory developments, particularly in relation to initial coin offers. The Monetary Authority of Singapore released guidance which indicates that its previous light regulatory approach to tokensales will no longer continue and that initial coin offerings will be regulated like similar financial products. In the US, the Securities and Exchange Commission released a report on The DAO tokensale which concluded that such tokens were likely regulated financial products. These topics are discussed in full below, please be in touch should you require further information.
Fintech fact: Australia is one of the top five countries in the world for fintech consumer adoption, with one in three digitally active customers using two or more fintech services on average.
The passage of the Corporations Amendment (Crowd-sourced Funding) Act 2017 (Cth) introduced amendments to the Australian market licensing regime and the clearing and settlement licensing regime (discussed here). In light of these legislative amendments, the Australian Securities and Investments Commission (ASIC) has released Consultation Paper 293 (CP 293) and a draft regulatory guide which together propose significant changes to how Australian market licences and exemptions from Australian market licensing requirements are granted. This consultation paper is relevant for, amongst others, operators of markets, operators of market-like venues (ie, those that facilitate the trading of financial products on the basis of an exclusion or exemption from the Corporations Act 2001 (Cth)) and crowd-sourced funding platforms seeking to offer secondary trading. Comments on the consultation paper are due by 31 August 2017.
CP 293 notes that there have been recent changes and developments in markets which include, a proliferation of alternative market venues (ie, growth in organised trading in non-exchange listed products), increased complexity in market venue technology and use of social media to create new forms of market-like venues. This has led ASIC to propose a new two tier approach to market licensing in light of the legislative amendments.
Market licences for tier 1 venues will be used to facilitate oversight of traditional markets and significant non-exchanges (for example, ASIC nominated the ASX, ASX-24 and Chi-X as being tier 1 venues) . CP 293 proposes introducing a “second tier” of market licences specifically targeted at specialised and emerging market venues. The second tier of market licence is designed to facilitate reduced regulatory oversight and a reduced regulatory burden for lower risk financial markets. Determining whether a market is a tier 1 or tier 2 venue will require a risk-based approach, rather than imposing prescriptive requirements.
Under the new proposed regulatory guide, ASIC would only grant exemptions from the Australian market licence regime in rare and exceptional circumstances once the second tier of market licence is introduced. Tier 2 venues will need to comply with a subset of core licence obligations but will continue to be exempt from other licence obligations (ie, ASIC proposes that tier 2 licensees be required to have rules that support the interaction of users on their platform but will not be required to maintain operating procedures such as monitoring listed entities for compliance). CP 293 also proposes:
- updating licensee obligations to supervise participant conduct (which has not been updated since market supervision obligations were transferred to ASIC in 2010);
- amending regulatory guidance regarding adequate financial and human resources, use of outsourcing arrangements and listing principles; and
- clarifying when the Minister must suspend or revoke a licence or exemption and how a change of control in a market operator would be assessed by ASIC.
ASIC also seeks views on the operation of the secondary market for CSF shares. Topics for consultation raised by ASIC include whether there should be relief provided from on-sale prospectus requirements under the Corporations Act (where investors seek to sell CSF shares within 12 months of the issue) and what disclosure requirements which will facilitate informed trading on the secondary market for CSF shares.
Following the publication of terms of reference last month (discussed here), the open banking inquiry has released an issues paper which sets out the scope of its review. The issues paper discusses the background to the inquiry, the nature of open banking (including costs and benefits) and how other key jurisdictions are progressing their regulations, with the issues paper noting that the UK, EU, US, Singapore and Japan have adopted or are progressing open banking frameworks. Key topics addressed in the issues paper include:
- what data should be shared and between whom: the issues paper notes that key topics to be resolved include determining what data sets should be shared based on which promise the largest net benefit to customers and the community, who should be required to share data (including whether compliance would be disproportionately burdensome on smaller banks), who should have the right to direct that data be transferred (for instance, whether small businesses should have such a right) and determining which third parties should have access to the data.
- how data should be shared: the inquiry will consider whether to adopt specific data transfer standards and the best model for such standards noting that such standards would need to be sufficiently flexible to accommodate future innovation and broad participation, while not acting as barriers to entry. The inquiry will also consider how to inform customers of the terms of access and use of their shared data.
- how to ensure data is secure: a shared data framework increases risks that unauthorised access could lead to financial loss with the inquiry considering what controls will need to be used to manage risks in the release and sharing of data, data collection and storage. This will extend to examining a scheme for determining and apportioning liability for data breaches, providing for redress and compensation, the nature of any privacy safeguard mechanisms and determining a mechanism to provide for the enforcement of consumer rights when data sharing.
- the appropriate regulatory framework: the inquiry will consider how the appropriate regulatory framework for an open banking regime should operate. The issues paper notes the regulatory framework will need to create a broader consumer right that balances economy-wide standardisation and industry-level adaptation. While the ACCC had been proposed as the appropriate regulator, the inquiry will consider alternative regulatory models (such as licensing conditions and industry-specific legislation).
- implementation: a roadmap and timeframe will also be considered by the inquiry in which to develop the regulatory architecture to support an open banking regime. The appropriate model to fund the operation of the open banking regime may also be considered by the inquiry.
The inquiry is seeking submissions on the issues paper by 22 September 2017.
In its first official opinion on digital tokens, the United States Securities and Exchange Commission (SEC) released a report on its investigation into The DAO, a decentralised autonomous organisation that held its token sale in early 2016 and is most well-known for triggering the Ethereum blockchain hard fork. The report inspected whether DAO Tokens could be classified as securities and therefore fall within the scope of US securities law. The SEC found that DAO Tokens did constitute securities under the Securities Act of 1933 and the Securities Exchange Act of 1934, based on the application of the Howey test which asks:
- is there an investment of money?
- is there a common enterprise with a reasonable expectation of profits?
- are the profits derived from the entrepreneurial or managerial efforts of others?
Accordingly, DAO Tokens should have been registered with the SEC or an exemption from registration requirements applied for prior to the launch of the DAO tokensale.
More importantly, the SEC suggested that those who participate in unregistered offers, as well as the platforms that traded unregistered tokens, are also liable for violating securities laws. Exchanges that trade securities tokens must register as a national securities exchange or qualify for an exemption such as by being regulated as an alternative trading system.
Notably, the SEC did not issue a blanket securities classification for all crypto-tokens, instead suggesting that whether tokens were captured under US securities law depended on “facts and circumstances, including the economic realities of the transaction.”
Shortly after the SEC’s report on digital tokens, the Monetary Authority of Singapore (MAS) has clarified its regulatory stance on the offer or issue of digital tokens in Singapore and has also released a joint statement with the Commercial Affairs Department on the risks associated with initial coin offerings (ICOs). Singapore is a popular jurisdiction for ICOs, in part due to its status as a leading fintech hub in Asia.
Broadly, MAS identified key risks for investors assessing ICOs to include risks relating to: foreign and online operators, sellers without a proven track record, insufficient secondary market liquidity, highly speculative investments, investments promising high returns and money laundering and terrorist financing. Significantly, the joint statement suggested that investors should only deal with firms licensed by MAS to capitalise on the “protection afforded under the laws administered by MAS”.
While MAS has taken the position of not regulating virtual currencies, it noted that digital tokens have evolved beyond just functioning as a virtual currency and that tokens that constitute products under the Securities and Futures Act (Cap. 289) (SFA) will be regulated. This includes tokens that represent ownership or a security interest as well as tokens that represent a debt owed by an issuer, considered a debenture under the SFA.
Where digital tokens fall within the scope of the SFA, token issuers would be required to lodge and register a prospectus with MAS prior to the offer unless exempted. Similarly, issuers or intermediaries of such tokens would also be subject to licensing requirements unless exempted and the platforms facilitating secondary trading of these tokens would have to be approved by MAS as an exchange or market operator under the SFA.
Going forward, MAS is assessing how to regulate money laundering and terror financing risks associated with digital tokens whose function extends beyond acting solely as a virtual currency. This poses another regulatory issue with the potential choice of Singapore as a jurisdiction for the conduct of a tokensale.
ASIC has signed a Cooperation Agreement with the Abu Dhabi Global Market (ADGM) Financial Services Regulatory Authority (FSRA), providing a framework for cooperation to support and understand financial innovation in each jurisdiction. As well as information sharing, the FRSA and ASIC are able to refer innovative businesses to the FRSA’s Regulatory Laboratory and ASIC’s Innovation Hub for advice and support under the agreement.
This agreement is significant as the United Arab Emirates, where the ADGM is located, is Australia’s largest trading partner in the Middle East and the ADGM regulates private banking, wealth and asset management – key sectors for fintech activity.
This agreement follows similar individual agreements between ASIC and the Hong Kong Securities and Futures Commission (SFC), Monetary Authority of Singapore (MAS), the UK’s Financial Conduct Authority (FCA), Canada’s Ontario Securities Commission (OSC), the Capital Markets Authority of Kenya (CMA), and Indonesia’s Otoritas Jasa Keuangan (OJK).
Under ASIC’s agreements with the CMA and OJK, the regulators have committed to sharing information in their respective markets relating to emerging market trends and the regulatory issues arising as a result of growth in innovation. Under ASIC’s agreements with the SFC, FCA, MAS and OSC, the regulators will also be able to refer to one another innovative businesses seeking to enter the others’ market. Under ASIC’s agreement with the FCA, innovative businesses will also be given help during the authorisation process with access to expert staff and, where appropriate, the implementation of a specialised authorisation process. Following authorisation, the businesses will have a dedicated contact for a year.
AUSTRAC has published a report on money laundering and terror financing (ML/TF) risks for the securities and derivatives sector, assessing the overall risk to be medium, on a scale of low to high. In accordance with Financial Action Task Force guidance, the report considered 26 risk factors across the categories of criminal threat, vulnerability and consequence, using suspicious matter reports (SMRs), intelligence from partner agencies and industry feedback.
AUSTRAC found that Australia’s securities and derivatives sector attracts a wide range of criminal threats that utilise sophisticated tactics and methods. The most commonly reported crimes included fraud, money laundering, tax evasion, insider trading and market manipulation. The report also flagged terror financing as requiring increased awareness to boost detection and SMR reporting.
The report identified key sources of vulnerability for criminal misuse, including products and services such as accounts, trading activity, off market transfers and third-party payments. The use of agents and third parties also created significant vulnerabilities in the sector due to difficulties in obtaining customer identification and authorisation, and conducting assurance activities. Further vulnerabilities were noted such as customers trending towards using online services and ‘white labelling’ trade platforms, creating delivery channel challenges and undermining the AML/CTF framework by not indicating which entities are responsible for AML/CTF obligations respectively.
Accordingly, AUSTRAC indicated that there is considerable scope for improvement in relation to AML/CTF systems. Only 40 per cent of market participants and 26 per cent of CFD/FX providers submitted SMRs to AUSTRAC over the two year sample period despite the significant risks associated with ML/TF activities (ie, reputational damage, increased regulatory action and decreased dividends). The low level of SMRs reflects scope for technology providers to create solutions in the securities and derivatives sector to improve compliance outcomes in relation to AML/CTF.
Following the release of the Senate Economics Reference Committee’s report on the Superannuation Guarantee (SG) system (discussed here), the Superannuation Guarantee Cross Agency Working Group (Working Group) has authored a report on SG non-compliance for the Minister for Revenue and Financial Services. The Working Group’s report echoes the Senate Committee’s in regard to digitising the current system to facilitate the ATO applying more proactive and preventative measure to monitor SF compliance.
With recommendations such as implementing Single Touch Payroll, the Working Group identified improving the visibility of SG obligations and addressing the necessity for the ATO to get “better quality and more timely data” as key priorities. Addressing these issues also brings the potential for substantially improved predictive data models to identify patterns of non-compliance. The report’s recommendations, along with those of the Senate Committee, suggest there is potential for fintech businesses to flourish in the superannuation sector.
The Reserve Bank of Australia (RBA) has released a discussion paper outlining the results of its 2016 Consumer Payments Survey (CPS) regarding how Australian consumers make payments. The 2016 CPS was completed by more than 1,500 participants over a one week period and consisted of three parts:
- a pre-diary questionnaire about the participant’s demographic characteristics;
- a seven-day payments diary; and
- a post-survey questionnaire about the participant’s automatic payment arrangements and preferences about particular payment methods.
For the first time, cards replaced cash as the most frequently used means of payment, accounting for 52% of payments whereas cash only accounted for 37% of payments. Contactless ‘tap and go’ cards were also found to be increasingly popular, especially for lower value transactions, and accounted for two-thirds of in person card payments.
Despite new methods of payment technology, the CPS found that not all new methods have been broadly adopted. For instance, the ability to make mobile payments (eg, with a mobile phone or other portable device) accounted for approximately 1% of point-of-sale transactions. The majority of participants indicated that they were satisfied with existing payment methods. However, consumers are using mobile phones more often to make online and person-to-person payments, and trends to adopt electronic payment methods will likely continue to rise.
ASIC has issued a media release in relation to potential unlicensed activity undertaken by apps associated with binary options trading. ASIC conducted a review in March 2017 that found that over 330 such apps offered to Australians appeared to be unlicensed. A majority of these apps were offered by binary option issuers that facilitated trading, with signal providers and introducing brokers controlling the remaining apps.
Other concerns raised by ASIC included misleading statements about profitability of trading, a failure to outline risks involved, misclassification of introducing brokers as product issuers and collection of personal information for high-pressure cold calling.
ASIC stated that they were encouraged by the speed at which Apple and Google removed the relevant apps from their respective app stores upon notification, with Apple changing its review guidelines to prohibit any apps facilitating binary options trading. The need to ensure any financial service provider is adequately licensed was emphasised by ASIC, especially in light of technology which can conceal certain details.