The final Senate report on Australia as a tech and finance hub – An opportunity missed

The Senate Select Committee on Australia as a Technology and Financial Centre produced its Final Report on 20 October 2021 which supplements its recommendations in its first two interim reports. For the Committee’s recommendations in its second interim report, see our Article available here.  

The issues the Committee considered in this Final Report included:

• Regulation and taxation of cryptocurrencies and digital assets;
• Issues relating to de-banking of Australian FinTechs and other companies;
• The policy environment for neobanks in Australia; and
• Options to replace the Offshore Banking Unit

Summary

In summary, the Final Report makes concrete recommendations for a new form of markets licence for digital currency exchanges, custody and depository requirements for digital assets and a review of the AML/CTF laws to ensure they are fit for purpose.

While the Final Report recommends that the different kinds of tokens are reviewed under the various regulatory regimes, it stops short of mandating a new class of ‘digital assets’ for regulation in that way that other international regimes have done. We note that the regime in Singapore has not been followed despite initial rumours that Singapore’s approach may be adopted.

The Final Report did not include any recommendations that ‘buy now pay later’ (BNPL) providers be regulated and also did not include any concrete recommendations in relation to neo-banking.

There are, however, a number of recommendations in relation to the taxation of transactions of digital assets and Decentralised Autonomous Organisations (DAOs).

New Markets Licence

Digital Currency Exchanges (DCEs) are currently required to register with Australia’s AML regulator, AUSTRAC, and comply with AML/CTF laws. While this is a formal registration, it is extremely light touch compared to other jurisdictions and essentially focuses on any previous criminal conduct of key personnel involved in the business. Out of the 464 DCE providers which AUSTRAC states applied for registration since the requirements began in 2018, only 4 were refused registration and 6 have been cancelled. This is a remarkably low refusal rate compared with the experience in other jurisdictions.

The Committee recommends that DCEs be subject to a type of licensing regime similar to that which applies to financial market operators regulated by ASIC, but that a special class be created for DCEs to ensure the licensing regime is not business prohibitive, with minimum requirements of capital adequacy, auditing and responsible person tests. This is a sensible suggestion and will see DCEs needing to have sound prudential arrangements, operational integrity, commit to consumer protection, provide regular reporting and ensure their personnel are fit and proper.

The current financial markets regime broadly covers those markets that are located in Australia, that have participants in Australia or which target Australian investors. It remains to be seen if the proposed new regime will be as broad as this, particularly given the recent change in ASIC’s approach to foreign financial service providers. The current markets regime also requires market licensees to provide for a compensation scheme where participants in the market effect transactions on behalf of retail customers. It is likely that such a scheme will be continued.

No change to the existing regulatory regime for digital assets

It was widely expected in the market that the Committee would recommend that the Singapore model be followed but this was not ultimately pursued. The Committee made no concrete recommendations to overhaul the current awkward and unwieldy, not-fit-for-purpose regulatory regimes under 4 different regulators for digital assets (whether they be tokens, cryptocurrency or other crypto assets).

The Final Report recommends that the various types of tokens be mapped into their current regulatory regime but has not provided any further clarity for those digital assets that are not easily characterised under existing categories or that may fall under multiple characterisations. Digital assets themselves (that are specifically used to make a financial investment, manage financial risk, or make non-cash payments) are not recommended to be regulated (just mapped). This means that digital assets that have certain behaviours that the regulators have deemed worthy of regulation in the analogue world still do not have a clear pathway through regulation. As a result, while any DCE itself will need to have a markets licence, the crypto-currencies exchanged on the exchange (and the various custody or payment wallets) still need to be assessed under the existing regulatory regime and will remain, for the most part, unregulated.

New Custody and Depository services for digital assets

Despite the crypto world being built on the foundations of a decentralised and blockchain-based model, which permits ownership to be verified without the need for the myriad of providers in the traditional financial services industry, such as custodians, the Committee nonetheless recommends that there be a real focus on custodians and depositories moving forward for digital assets. This may create a real weakness in the system as custodians, at least historically, have arguably been more susceptible to cyber security risks.

Review of AML regime

As AUSTRAC noted in its submission to the Committee, DCE providers represent a significant AML/CTF risk given that:

• there is greater anonymity or, in some cases, complete anonymity, compared with traditional payment methods;
• transfers of digital currency are unconstrained by national borders and difficult to tie to any particular geographic location;
• transactions can be made on a peer-to-peer basis, generally outside the regulated financial systems; and
• different components of a digital currency system may be located in different countries and subject to varying degrees of regulatory oversight which can lead to regulatory arbitrage or the use of digital currency moving underground.

Despite that, the Committee stopped short of making any concrete recommendations. The Final Report tasked AUSTRAC with reviewing the existing AML/CTF regime to ensure it is fit-for-purpose (hopefully with the increased interest in crypto assets, AUSTRAC will adopt a new proactive approach to adopting changes). In particular, the Committee recommended that AUSTRAC consider aligning to and adopting the FATF international standards. If adopted, this would extend the AML/CTF regime from the current focus on fiat to crypto conversions and vice versa, to also focus on:

• exchanges between one or more forms of cryptocurrency;
• transfers of cryptocurrency on behalf of customers;
• safekeeping or administration of cryptocurrency or instruments enabling control of cryptocurrency (e.g. custodial wallet providers); and
• participation in and provision of financial services related to an issuer’s offer and/or sale of cryptocurrency (e.g. Initial Coin Offerings (ICOs)).

In addition, AUSTRAC will need to consider the ‘travel rule’, which requires financial institutions to include verified information about the originator (payer) and information about the beneficiary (payee) for wire transfers and other value transfers throughout the payment chain. However, technological solutions to enable exchanges/payment providers to comply with the ‘travel rule’ are still under development and only beginning to be rolled out globally. The ‘travel rule’ has been implemented in domestic regulation in a number of jurisdictions since 2019 through a variety of mechanisms, but has not yet been implemented in Australia. A key unknown variable is the extent to which transaction records will be required to be kept.

It is also unfortunate that the Final Report made no concrete recommendations in relation to reforming AML/CTF laws. For example there are good arguments for a public list of registered DCE providers, provided that genuine concerns with debanking can be addressed. It is also worth noting in this context that other regulators typically make those who are regulated public information.

Central Bank Digital Currencies

The RBA has been considering the policy case for a retail Central Bank Digital Currency (CBDC) but does not yet consider that the policy environment is right. Notwithstanding this, the Committee recommended that the policy case be explored again.

The RBA has been participating in a pilot of a wholesale CBDC with a selection of other central banks for use in the central interbank market.

Australian Financial Complaints Authority's jurisdiction with crypto firms

Although not recommended by the Committee, the Australian Financial Complaints Authority (AFCA) wants to be able to consider disputes for consumers accessing digital asset products as it is receiving these complaints already. AFCA noted that a small number of crypto-asset providers have already become members of AFCA on a voluntary basis.

Transparency around de-banking

Work by the ACCC in 2019 recommended that the Government establish a working group to consult on the development of a scheme through which the due diligence requirements of the banks can be addressed. The Council of Financial Regulators has now established this working group. The Committee has recommended that this work to establish a due diligence scheme should be finalised and implemented by June 2022.

The Committee also recommended that in order to increase certainty and transparency around de-banking, the Australian Government develop a clear process for businesses that have been de-banked. This should be anchored around giving those who have been de-banked recourse to a complaints process, namely AFCA which services licensed entities, to ensure procedural fairness and natural justice.

The Committee recommends that, in accordance with the findings of Mr Scott Farrell's recent Payments System Review, common access requirements for the New Payments Platform should be developed by the Reserve Bank of Australia, in order to reduce the reliance of payments businesses on the major banks for the provision of banking services.

Neobanking

Taking guidance from the ACCC, the Committee decided to make no recommendations in relation to neobanking but instead will maintain a watching brief.

New Decentralised Autonomous Organisation legal structure

A DAO or decentralised autonomous organisation effectively substitutes traditional governance with rules encoded as a computer program providing transparency and control to the organisation’s members. The Committee’s recommendation that the Australian Government establish a new Decentralised Autonomous Organisation company structure is a bold step and if implemented will result in a new dimension to corporate law where management and governance of a corporation is shared amongst its members through smart contract. This recommendation is a strong indication that Australia is serious about enabling the digital economy although remains to be seen how and when it is implemented. 

For example, the tax treatment of the DAO structure will be a key driver to make it attractive. The report references to the proposed CCIV regime, which for tax purposes piggybacks off the Managed Investment Trust regime. If that structure were adopted, that would provide flow through treatment for participants but a withholding on payments to non-residents, which would make the regime unworkable and unattractive.

Tax

The committee made several recommendations in relation to tax.

Under Australia's current law, the ATO considers crypto-assets do not fall within the definition of a ‘foreign currency’ for tax purposes. As a result, multiple taxable events, under either the capital gains tax regime or as ordinary income provisions, can arise in crypto-asset transactions. In particular on any swap of crypto to crypto or other interactions with a DeFi protocol.

The committee noted that "(a)n example of a swap event where the application of CGT would not appear to be reasonable is a token swap where the underlying blockchain that supports the token is being upgraded or replaced; in this scenario, one digital token is replaced for another at a predetermined rate, and the original token(s) are discarded rather than traded. This event is more akin to a stock split for traditional securities than a trade between assets"

The first recommendation was that the Capital Gains Tax regime be amended so that digital asset transactions only create a CGT event when they "genuinely result in a clearly definable capital gain or loss". It is somewhat ironic that the report does not define what “clearly definable” is.

Deferring a gain for swapping ETH for WETH makes sense, but the implication from the submissions is that a gain arises when using that WETH to buy an NFT would also be ignored. It is not clear what the policy justification for this position would be.

Staking/loaning crypto should probably be exempt in the same way securities lending arrangements are not taxed other than the fee.

It is notable that the committee only referred to the CGT regime and does not on its face cover taxpayers who would hold their crypto digital assets on 'revenue account'. 

Implementing these changes may require creating a new class of assets under the CGT regime and providing specific CGT events that apply to the exclusion of all others.

The committee also recommends that the Australian Government amend relevant legislation so that businesses undertaking digital asset 'mining' and related activities in Australia receive a company tax discount of 10 per cent if they source their own renewable energy for these activities. The committee noted that is important that where cryptocurrency mining and related activities are taking place in Australia, these activities should not undermine Australia's net zero emissions obligations.

How important the energy costs of mining and related activities in a particular protocol depends on whether they use a proof of work (energy intensive) or proof of stake or proof of history (less energy intensive) consensus model. As Ben Thompson noted in Stratechery "that the proof-of-work nature of Bitcoin, which does carry the risk of a mining pool growing large enough to conduct a 51% attack, but also incurs real costs on its participants and requires zero trust, is an essential part of why Bitcoin is rightly considered a commodity and valid store of value. There are many potential crypto applications beyond store of value, for which proof-of-stake makes sense and is better for the environment, but for Bitcoin specifically being expensive to mine is foundational."

Conclusion

Overall, we consider that the Final Report has been useful in exploring critical issues within the FinTech and digital currency sectors, with the industry and consumers caught up in the lack of transparency, regulation and direction. While the Final Report has provided some initial recommendations on the regulation of DCEs, we consider that this has been an opportunity missed to path a clear way forward to regulate digital assets and provide the industry with much needed clarity and certainty. Only time will tell to see if these recommendations are picked up by the Australian Government.