This update examines legislative and regulatory developments occurring in the fintech space over the past month.  In legislative developments, Australia’s crowd-sourced equity funding regime has continued to develop and cryptocurrencies are to become subject to Australia's anti-money laundering and counter-terrorism financing (AML/CTF) regime.  The Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulation Authority (APRA) have reinforced their commitment to digital innovation and reducing barriers to entry to the banking sector.  

Globally, there have been significant developments particularly in relation to initial coin offerings (ICOs). Regulators in the UK, Canada and Hong Kong have followed the approach of the United States Securities and Exchange Commission (SEC) and the Monetary Authority of Singapore (MAS) in regulating ICOs within existing securities law (as discussed in our recent update).  However, in contrast, Chinese regulators have declared ICOs to be illegal under domestic law.  Please be in touch if you would like to discuss any of the below.

Fintech Fact: Between Q2 2016 and Q2 2017, half of the ten largest fintech deals outside of core markets occurred in Australia with lending and loan quote platforms topping Australian deals.

Further development of Australia’s crowd-sourced equity funding regime

Corporations Amendment (Crowd-sourced Funding for Proprietary Companies) Bill 2017

Following the release of draft legislation extending the crowd-sourced equity funding (CSF) regime to proprietary companies (discussed in our earlier update), the Government has introduced a Bill to Parliament based on the draft legislation.  Key features of the Bill remain the same as the draft legislation, such as the exemption of proprietary companies making CSF offers from the takeover provisions of the Corporations Act 2001 (Cth) (Corporations Act) (although the Bill proposes the Government have power to impose regulations on the exemption) and the two director requirement.  However, the Bill has been amended in some respects following consultation on the draft legislation.  These changes include:

  • Exemption of secondary transfers by CSF shareholders from the 50 shareholder cap: Proprietary companies are required to have less than 50 non-employee shareholders.  The draft legislation provided that CSF shareholders who on sell their shares would become shareholders.  However, sensibly, this has been amended with purchasers of CSF shares remaining CSF shareholders provided the company is not listed on a financial market.  CSF shareholders can now exit their investment without the company inadvertently breaching the shareholder cap and forcing it to convert to a public company.
  • Grandfathering public company reporting concessions of current regime:  The Bill removes temporary concessions for public company reporting and governance obligations that are part of the current CSF regime.  Public companies which make CSF offers and obtain access to those benefits will have those benefits those grandfathered.
  • Increase in threshold at which proprietary companies must comply with reporting and record keeping obligations:  The CSF fundraising threshold, at which additional financial reporting and record keeping obligations will apply to proprietary companies raising funds from CSF offers, has been raised from $1 million in funds raised to at least $3 million in funds raised.  The threshold for compliance with the revised financial reporting regime, which grandfathered public companies will be required to comply with under the current CSF regime, will also be increased from $1 million to $3 million.
  • Shorter withdrawal period:  The Bill also amends the current CSF regime to reduce the withdrawal period for CSF investors when a company issues a supplementary or replacement offer document from one month to 14 days.

The proprietary company CSF regime will take effect six months after the date the bill receives royal assent.  However, the Bill’s proposed changes to the current CSF framework, excluding the removal of grandfathered corporate governance concessions for public companies, will commence on royal assent. 

ASIC publishes policy for assessing applications for CSF intermediary authorisations

ASIC has announced its policy for assessing applications for Australian financial services licence (AFSL) applicants seeking CSF intermediary authorisations.  Applications can be made from 29 September 2017, when the CSF regime for public companies commences.  Our most recent update on the current CSF regime and the AFSL application process which will apply can be found here.  Key features of ASIC’s policy for assessing applications for a CSF intermediary authorisation on an AFSL include:

  • considering CSF applications lodged between 29 September 2017 and 27 October 2017 in batches, where ASIC considers those applications will be positively assessed;
  • refusing, or placing in batches for assessment, those applications that are lodged late in the period from 29 September 2017 and 27 October 2017, applications which are incomplete, inadequate, or do not contain mandatory information and supporting proof documentation; and
  • publication of specific CSF authorisation questions to be answered in the AFSL application, a specific CSF authorisation proof and an amended adequacy of resources statement, relating to IT capacity, for CSF authorisation.

ASIC has developed this process to expedite the licensing process, while ensuring initial assessments are fair and equitable for all applicants, facilitating orderly entry to the market.  ASIC notes that these arrangements will apply only to AFSL applications and will not extend to Australian market licence applications.  Despite the ‘batch’ approach, ASIC will only discuss issues relating to AFSL applications with individual applicants.

Draft AML/CTF legislation released regulating cryptocurrency exchanges

Australia’s current AML/CTF regime provides for limited regulatory oversight of convertible digital currencies. The Government has recently introduced a Bill which will close the regulatory gap by bringing digital currency exchange providers under the remit of the Australian Transaction Reports and Analysis Centre (AUSTRAC). The Bill defines digital currency as a means of exchange or digital process or crediting declared to be digital currency by the Anti-money Laundering and Counter-terrorism Financing Rules Instrument 2007 (Cth) (AML/CTF Rules), or, a digital representation of money that:

  1. functions as a medium of exchange, a store of economic value or a unit of account; 
  2. is not issued by or under the authority of a government body; 
  3. is interchangeable with money and may be used as consideration for the supply of goods and services; and
  4. is generally available to members of the public without any restriction on its use as consideration.

Notably, the Bill outlines the creation of the 'Digital Currency Exchange Register’, to be overseen by AUSTRAC. Cryptocurrency exchanges will be required to register with AUSTRAC or risk jail time or pecuniary penalties for operating an unregistered cryptocurrency exchange. The AUSTRAC CEO will have 90 days to approve requests for registration, extendable by another 30 days upon notice. Registration may also come subject to conditions relating to the value of virtual or fiat currency exchanged, the volume exchanged, and the types of virtual currency which may be exchanged.

ASIC releases Corporate Plan 2017-18

ASIC has published its Corporate Plan for the next year, outlining key challenges and risks warranting attention as well as how ASIC will continue to strengthen its capabilities. Broadly, the challenges identified include culture and conduct, building financial capability, the globalisation of financial markets, products and services, and the structural and demographic changes in the financial system. Of particular note are challenges regarding digital disruption and cyber resilience in financial services and markets.

Sound market infrastructure and technological resilience are core to maintaining the stability of Australia’s financial markets. Developments in regulatory technology (regtech) and data storage have the potential to reduce costs, improve the efficiency of product and service delivery and empower customers. However, ASIC noted that there are still risks from fintech that need to be addressed, including:

  • misunderstandings as a result of streamlined consumer engagement processes;
  • increased market fragmentation and complexity;
  • new products and services testing regulatory boundaries; and
  • cyber threats in relation to the release of customer data, compromising market integrity.

ASIC re-iterated the success of its Innovation Hub in assisting start-ups, having supported 162 businesses in sectors such as digital advice, marketplace lending, crowd-sourced funding, payments and remittance, consumer credit, superannuation and insurance.

ASIC reports on responses to the Innovation Hub and its approach to regtech

Earlier this year, ASIC released Report 523 which discussed ASIC’s Innovation Hub, regulatory sandbox and approach to regtech (which we considered in an earlier update).  In that report, ASIC sought submissions on its future approach to regtech.  ASIC has now released Report 543, which discusses the submissions it received on Report 523 and its future approach to the Innovation Hub, regulatory sandbox and regtech.  Key findings of Report 543 are:

  • despite receiving some submissions that the fintech licensing exemption should be expanded, ASIC has committed to maintaining its current approach to the regulatory sandbox licensing exemption, until it has completed a review of its approach later in 2017;
  • later this year Treasury will also conduct consultation on an enhanced regulatory sandbox arising from the Government’s commitment to a legislated, expanded regulatory sandbox;
  • ASIC has committed to certain principles in relation to regtech including working towards outcomes in regtech that align strategic objectives and an approach to innovation, undertaking focussed initiatives that deliver outcomes in the near term and learning from industry input, international case studies and ASIC’s own experience with the regtech sector (including maintaining a flexible and adaptive approach to regtech in the future);
  • due to submissions, ASIC will give further consideration to the structure of its regtech liaison group including in relation to the process by which organisations and individuals will be invited to join the group, various proposals concerning the formation of sub-groups or working groups under the umbrella regtech agenda and also creating a broader network regarding regtech;
  • ASIC does not currently have plans to engage with other regulators around the world in relation to regtech liaison but ASIC is open to other domestic regulators participating in the regtech liaison group;
  • while some submissions discussed the regtech liaison group having a broader role (ie, extending to developing industry standards), ASIC reaffirmed its commitment to the proposed purpose of the group, to facilitate networking, discussion of regtech developments and opportunities to collaborate on initiatives that promote positive applications of regulatory technology, but noted that it would be open-minded about the group’s early priorities; and
  • ASIC has committed to greater transparency around the regtech trials that it undertakes extending to sharing additional information on future trials and outcomes and will encourage stakeholders to do likewise.

ASIC intends to establish the regtech liaison group for its first meeting before the end of 2017.  The Report also noted that, based on submissions, ASIC will no longer host a regtech ‘hackathon’ on 18 September 2017 but will instead host a ‘showcase’ highlighting the regtech industry in Australia.

ASX to commission review of DLT clearing and settlement system

The ASX will commission a review of distributed ledger technology (DLT) as it considers whether or not to update its clearing settlement system to a distributed ledger settlement system.  The ASX currently uses the Clearing House Electronic Sub-register System (CHESS) to record shareholdings and manage the settlement of share transactions. However, the ASX has been working with Digital Asset Holdings since January 2016 to investigate whether the technology could support the ASX equities settlement demands.

The ASX is expected to make its decision by December 2017 and should the ASX choose to use DLT over a more traditional system upgrade, the scope is expected to be released for public consultation in March 2018.

APRA consults on changes to licensing framework for ADIs

APRA has released a discussion paper on proposed revisions to the licensing framework for authorised deposit-taking institutions (ADIs).  The discussion paper seeks to introduce a phased approach to authorisation to reduce the complexity of navigating the licensing process and increase competition in the banking sector by lowering barriers to entry.

The introduction of a restricted ADI licence, subject to eligibility requirements and a maximum use period, is particularly relevant for fintech businesses seeking to begin limited banking operations while developing the resources and capabilities necessary for full prudential compliance.  Similar steps have been taken in the US to facilitate entry of fintechs to the banking system (discussed in our earlier update).

Submissions regarding the proposed phased approach to licensing new entrants to the banking sector close on 30 November 2017.

Regulators across the globe issue statements regarding ICOs

Global regulators have begun actively commenting on ICOs following regulators in the US and Singapore releasing statements last month (discussed in an earlier update). Now, regulators in the UK, Canada and Hong Kong have followed suit, echoing the notion that cryptocurrencies offered in ICOs could fall within the scope of securities regulation.  In contrast, Chinese regulators have implemented an outright ban. In Australia, ASIC has yet to release an official statement but recent reports indicate ASIC will soon release a light-handed guiding statement on ICOs that supports the US approach.

Regulatory developments in the UK, Canada and Hong Kong

In the UK, the Financial Conduct Authority (FCA) has released a consumer warning on ICOs citing the significant risks attached including no investor protection, price volatility, the potential for fraud, the lack of a prospectus, the usually experimental nature of ICO projects and the lack of regulation in the sector.  Significantly, the FCA indicated an ICO could fall within its regulatory boundaries depending on how the ICO is structured.  If an ICO involves arranging, dealing or advising on regulated financial investments this may be a regulated activity.  The FCA noted the operation of digital currency exchanges, facilitating the exchange of certain tokens, may require FCA authorisation in order for services to be delivered.

In their Staff Notice 46-307: Cryptocurrency Offerings, the Canada Securities Administrators (CSA) noted that “many” of the token sales investigated by Canadian regulators fell under the definition of a security following consideration of the “economic realities of a transaction and a purposive interpretation with the objective of investor protection in mind.” CSA’s Staff Notice also outlined the requirements for issuers wishing to launch ICOs and cryptocurrency exchanges wishing to trade in the tokens under current Canadian securities law.  Importantly, it was noted that ICOs launched in Canada or targeting Canadian investors would fall within the jurisdiction.

The Securities and Futures Commission (SFC) in Hong Kong has also issued a statement that depending on the facts and circumstances of the ICO, the offered tokens may constitute securities as defined in the Securities and Futures Ordinance which will trigger certain obligations.  While tokens are usually characterised as virtual commodities in Hong Kong, the SFC has outlined scenarios where ICOs have terms or features that may result in tokens being classified as securities.

The SFC considers that tokens that represent equity or ownership interests in a corporation may be regarded as shares, while tokens used to create or to acknowledge a debt or liability owed by the issuer may be considered debentures.  Similarly, token proceeds managed collectively by the ICO scheme operator to invest in projects with an aim to enable token holders to participate in a share of the returns provided by the project may constitute a collective investment scheme.  These are all regarded as securities by the SFC and would require licensing or registration with the SFC irrespective of where the business is located.  Notably, if business activities merely target the “Hong Kong public”, this is enough to trigger requirements under Hong Kong securities law.

The Chinese position: a ban on ICOs

Chinese regulators outlawed ICOs in their jurisdiction.  In a joint statement issued by seven key financial regulators including the People’s Bank of China and the State Administration for Industry and Commerce, China has asserted that ICOs are illegal under domestic law.  From September, all types of currency issuance financing activities are expected to cease and currency trading platforms will not be allowed to swap fiat for virtual currency or even provide information regarding virtual currency trading.  Most notably, the regulators have called for completed ICOs to refund investors with a warning of investigation and severe punishment for those refusing to refund investors or cease ICO activity. Certain projects have cancelled their ICOs and refunded investors as a result.

Regulator in Quebec accepts ICO into regulatory sandbox

In a ground-breaking move, the Autorite des marches financiers (AMF), Quebec’s financial institutions regulator, has accepted a token sale by Impak Finance (Impak) into its regulatory sandbox despite determining that the tokens on offer are securities.  Impak is building a platform for investing in socially responsible enterprises powered by ‘Impak Coins’ and will be the first regulated ICO based in Canada.

The AMF has provided Impak with relief from certain securities requirements such as needing to provide investors with a prospectus and having to register as a securities dealer.  Impak will be allowed to remain in the sandbox for two years, after which stakeholders will decide how to proceed.  AMF has flagged that it would consider extending the relief on a permanent basis or implementing permanent regulatory amendments to change regulations to permit such offers.

The approach of AMF is aligned with the CSA’s notice on ICOs as discussed above.  Importantly, Impak will be allowed to make offers across Canada’s other provinces and territories via the Canadian securities passport system.

Senate Economics Committee reports on Corporations Amendment (Modernisation of Members Registration) Bill 2017

The Senate Economics Committee has released its report on the Corporations Amendment (Modernisation of Members Registration) Bill 2017 (Bill). The Bill proposed an additional requirement of an email address to be included on a register of members of a company or registered scheme.

While the Committee ultimately recommended not passing the Bill due to its strict liability and onerous burden on corporate structures, privacy and cybersecurity concerns and the lack of submissions during consultation, the Committee noted that if further concerns regarding governance arose, a “more comprehensive investigation may be warranted”. Further, the Committee advocated for a more technologically neutral Corporations Act with respect to communication methods and indicated that the Treasury’s work on this issue be continued following its review undertaken in 2016 (when Treasury released a Proposals Paper seeking submissions on facilitating technology neutrality in distributing company meeting notices and materials).

The addition of email addresses on the register would enable cost effective communication with members and could have a significant impact on the conduct of electronic votes.  The report also raised the issue of who would be responsible for maintaining a register of members.  This is an issue which could be addressed through legislative amendments to introduce a DLT solution to manage corporate records, as Delaware has recently introduced (discussed in an earlier update here).

World Economic Forum releases report on the evolution and impact of fintech

The World Economic Forum has released a report entitled ‘Beyond Fintech: A Pragmatic Assessment of Disruptive Potential In Financial Services’ (Report).  The Report considers the evolution and impact of fintech firms on financial services to date and examines the future of the industry.  The Report found that fintech firms have shaped how financial services innovate and cater to user experience but have struggled to compete with large financial institutions.  Regardless, fintech has the potential to disrupt competition in the financial system significantly in the future, with the Report identifying eight drivers of such change:

  1. Cost commoditisation: financial institutions are embracing new technologies to commoditise cost drivers that do not provide competitive differentiation.  This makes the value chain less vertical, lowering barriers to entry for fintech businesses in cost-sharing utilities and B2B providers.
  2. Profit redistribution: organisations are bypassing traditional value chains through the use of new technology and partnership opportunities. These shifts in profit pools are likely to increase competitive pressures on intermediaries.
  3. Experience ownership: fintechs will find it increasingly difficult to enter the market as distributors, unless engaging with a niche sector. The ownership of customer relationships falls on distributors, pressuring manufacturers as distributors level control of customer experience.
  4. Platforms rising: multiple-provider platforms are becoming the dominant model for the delivery of financial services with the rise of customer choice impacting the design and distribution of products. Platforms provide fintechs with the opportunity to scale in a more timely fashion but the products on offer will need to be standalone profitable to be sustainable in a platform environment.
  5. Data monetisation: tech firms are leading the monetisation of data as they utilise new and engaging data collection strategies, but data ownership and control will be imperative issues to address from a regulatory perspective.
  6. Bionic workforce: technology such as artificial intelligence will drive the merge of employees and machine-enabled solutions in business and will require effective management for successful co-existence in the workplace.
  7. Systemically important technology firms: financial institutions are increasingly reliant on large tech firms for critical infrastructure and technology, which may impede incumbent fintechs from competing with new entrants.
  8. Financial regionalisation: financial globalisation is giving way to financial regionalisation as differing customer needs result in different financial models and solutions across the world. Fintechs therefore face increased barriers to success in multiple jurisdictions and will need to implement multiple strategies to ensure regional competitiveness as they expand.

The Report builds on other projects relevant to fintechs which the World Economic Forum is developing, for instance, its work in releasing a blockchain white paper (which we discussed previously).