As promised in the Federal Budget earlier this year, Treasury has released draft legislation and draft regulations proposing an expanded legislated sandbox for testing financial services and consumer credit businesses. Together, the draft legislation and draft regulations propose significant reforms to Australian Securities and Investments Commission's (ASIC) regulatory sandbox which will greatly expand the scope of the licensing exemptions. Currently, the licensing exemptions are facilitated by ASIC legislative instruments and permits an entity providing certain financial services or engaging in certain consumer credit activities to do so without holding an Australian financial services (AFS) licence or an Australian credit licence.
We discuss below key features of the draft legislation and draft regulations, including the main differences with the existing licensing exemptions in ASIC’s regulatory sandbox. We also offer some observations on the likely effectiveness of these proposed reforms. Treasury is inviting submissions on the draft legislation until 3 November 2017 and on the draft regulations until 1 December 2017. Please be in touch should you wish to discuss.
The draft legislation is proposed to support start-ups and innovative businesses to develop, test and launch their financial and credit services and products. These reforms are designed to balance competition, innovation and the integrity of the financial system. The draft legislation introduces:
- a power to make regulations providing conditional exemptions from AFS licensing obligations under the Corporations Act 2001 (Cth) and Australian credit licensing obligations under the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act) for testing financial and credit services and products;
- a requirement that entities accessing a conditional exemption comply with all relevant conditions. Such conditions are to be prescribed in the regulations proposed to be made under the Corporations Regulations 2001 (Cth) and the National Consumer Credit Protection Regulations 2010 (Cth);
- a power for ASIC to determine under the draft regulations when the exemptions commence and cease to apply to businesses. ASIC will monitor access to the regime to prevent misuse of the exemptions and provide effective arrangements to allow providers to transition out of the regulatory sandbox and become licensed;
- a right to merits review in the Administrative Appeals Tribunal of decisions by ASIC relating to the application of the licensing exemptions to a particular business (under the credit licensing exemption this is a right conferred by the regulations); and
- a right for an entity relying on the AFS licensing exemption to appoint authorised representatives under its exemption.
The intent of these amendments, including a power to determine the scope of the exemption in the regulations rather than legislation, is to facilitate timely changes to the licensing exemption regulations in response to changing market dynamics and to provide flexibility to ensure the exemptions operate appropriately.
The basic structure of the licensing exemptions remains the same as that currently in effect. Relevantly, certain obligations that currently exist under the ASIC legislative instruments will continue to apply:
- an exposure limit of 100 retail clients and 100 consumers for each financial service and each credit activity;
- investment limits have been maintained (ie, a retail client’s commitment to investing in general financial products remains capped at $10,000);
- an aggregate exposure limit of $5 million applies to all financial services and credit activities;
- an eligible person must comply with certain requirements including disclosure obligations (ie, particular disclosures that the person is unlicensed and the service or product is provided under the licensing exemption) and dispute resolution arrangements;
- best interests and statement of advice obligations will continue to apply to those persons relying on the AFS licensing exemption;
- responsible lending obligations, hardship variation application obligations and unfair contract term protections will continue to apply to those persons relying on the credit licensing exemption; and
- a person is to provide a notice to ASIC indicating it has fulfilled the relevant conditions for the exemption, with the exemption commencing 14 days after the notice is provided to ASIC.
The draft regulations do contain some key changes to expand the scope of the regulatory sandbox from that currently in effect under the ASIC legislative instruments. These proposed changes include:
- expanding the definition of eligible person that can qualify for a licensing exemption. For instance, current AFS and credit licensees will be able to access the licensing exemptions if their existing licence does not include an authorisation to provide a relevant financial service or product or credit activity (previously, licensed persons could not access the licensing exemptions);
- where previously a person could only (in effect) rely on the exemptions once, an eligible person is now able to rely on the:
- AFS licensing exemption multiple times, although a person cannot test a particular financial service in relation to a particular financial product more than once;
- credit licensing exemption for two types of eligible credit activities once;
- the exemptions will be available for a period up to 24 months, as opposed to the current licensing exemption period of 12 months;
- the scope of financial products and services being expanded to include deposit-taking facilities issued by an ADI, general insurance products, life insurance, superannuation products, shares offered in crowd-sourced funding (CSF) offers and short term credit contracts;
- increase to the investment limits, as appropriate for the new categories of financial products and services being introduced (ie, retail clients will be permitted to invest up to $85,000 as a result of financial services relating to general insurance products under the licensing exemption, as compared with current cap of $50,000);
- creation of an ASIC power to cancel an exemption where:
- a person has not complied with the conditions on the relevant licensing exemption;
- ASIC reasonably believes a person is not of good fame or character or has not acted fairly, efficiently or honestly, or,
- ASIC believes the exemption is being used repeatedly to offer the same financial or credit product or service, or, to avoid individual or aggregate exposure limits;
- the imposition of client money obligations on persons relying on the licensing exemptions where financial products or services, such as CSF offers, are provided which involve dealings in client money; and
- the imposition on persons relying on the credit licensing exemption of the limits on fees and charges under the National Credit Code and the unfair contract term provisions of the Australian Securities and Investments Commission Act 2001 (Cth).
Under the draft regulations, when a person becomes licensed, the relevant licensing exemption will cease to apply. This will allow ASIC to transition businesses from relying on the licensing exemption to becoming licensed in a seamless manner.
The release of the draft legislation and regulations occurs in a context where ASIC’s regulatory sandbox has been subject of significant industry criticism for offering an ineffective testing environment for fintech businesses. Criticisms have included the limited scope of testing opportunities and the reasonably onerous requirements in accessing the exemption (for instance, the costs associated with obtaining sufficient insurance). As a consequence of these issues, as at the date of this article, only three companies have relied on the regulatory sandbox licensing exemption to test products and services.
It is hoped that the enactment of the proposed legislation and regulations will facilitate more businesses entering the sandbox. There are some particularly welcome reforms in the draft legislation and draft regulations, including the longer testing timeframe of 24 months, access to the exemption for current licensees and testing of a wider range of financial and credit products and services being permitted.
However, we query whether these reforms will deliver the desired access to a testing environment given many of the key features of the regulatory sandbox will be maintained. Key restrictions which are maintained under the legislated sandbox, as compared to ASIC’s sandbox, include the aggregate number of retail clients who can contract with the business being limited to 100 and a $5 million aggregate exposure limit being imposed. The consultation period may lead to these restrictions being ameliorated or a more dynamic or flexible approach to such restrictions being adopted.