Computer code as new corporate citizen? 7 min read
The Senate Select Committee on Australia as a Technology and Financial Centre has released a report (the Report) which makes 12 recommendations largely focused on the 'digital asset/crypto' economy. These include a proposal for legal recognition of a new decentralised, code-driven corporate structure – the 'DAO' – as well as significant reforms to the regulation of aspects of the digital asset economy generally.
If adopted, these reforms would position Australia as a world leader in regulating the digital asset economy.
- The crypto and digital asset economy is a large and growing part of the global financial system. Governments and regulators around the world have been grappling with how to apply existing regulatory frameworks, or develop new ones, in this space and how to allow innovation while protecting consumers and maintaining stability in the financial system.
- While many of the recommendations are only preliminary and will require significant additional work and detail, they represent a significant effort to address the key challenges presented by these emergent industries, while seeking to position Australia as a potential global leader in managing digital assets.
In recent years, there has been a trend in the blockchain ecosystem towards the creation and use of types of computer protocols known as Decentralised Autonomous Organisations (DAOs). These protocols operate in accordance with the rules that are coded into them, and the direction of their decentralised membership, as determined by the processes programmed into the DAO. Recently, these have been particularly popular for use in 'decentralised finance' applications, which seek to bypass traditional financing ecosystems. However, their legal status has been unclear.
In a significant recommendation, the Report proposes the Government investigate the establishment of a new DAO legal structure, in order to bring these entities within the fold of Australian corporate law. It canvasses potentially treating DAOs like a limited liability company, such that they will be able to hold property and enter into contracts, and giving DAO members or 'token-holders' the benefit of limited liability.
While this recommendation is still at an early stage, this potentially represents a major step forward in Australia's regulatory sophistication regarding the rapidly evolving crypto ecosystem, which could see it becoming a more attractive jurisdiction in which to establish DAO investment entities. The detail of this proposal will need to be fleshed out considerably and, based on what's occurred with the policy proposals to introduce corporate collective investment vehicles in Australia, this could take a number of years. But, if introduced, they would be a significant development for the Australian corporate law system. Existing corporate entities may find themselves interacting with a legally recognised, code-governed decentralised organisation. There remain a number of critical questions, such as how a purely digital entity that is governed by code will be accountable for its actions, and when (if ever) it would be appropriate to reach past the coded veil to the decentralised membership base behind it.
In addition to the recommendations on DAOs, a number of other recommendations were made, which would have a significant impact on the broader issues of regulating the crypto-economy:
Market licensing requirements for DCEs
Currently, Digital Currency Exchanges (DCEs) are subject to very limited regulatory oversight through a 'light touch' registration process with AUSTRAC, despite some transacting billions of dollars' worth of assets. The Report calls for a new market licence category for DCEs, which would require certain capital adequacy levels, auditing and responsible person tests, at a minimum. This would be a significant step up in regulatory oversight of DCEs, which represent a key gatekeeper and often custodial function in the digital asset ecosystem.
Custody arrangements of digital assets
Limited consumer protections exist around custody services for crypto-assets. Such arrangements present unique risks, including vulnerabilities around the exposure of private keys for crypto-assets to loss or theft. The Report recommends the development of a clear regulatory framework for custody arrangements of digital assets, which will align with general principles for custody arrangements while dealing with the unique features of digital assets.
Token mapping exercise for digital assets
Most digital assets fall outside the legislative definition for 'financial product' and, accordingly, fall outside ASIC's purview. The Report recommends that the Government undertake a token mapping exercise to understand the various types of digital assets available in the market, noting the approach of other jurisdictions' mapping exercises in recent years. This would likely inform the regulatory model that would follow. Such an exercise would bring significant clarity for projects seeking to operate in this space, which currently deal with significant uncertainty as to their regulatory status.
The Report also makes recommendations to clarify Capital Gains Tax (CGT) rules for crypto transactions, and review potential challenges with aspects of the Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) (AML/CTF) rules that apply to digital asset businesses.
The Report also addresses the challenges that the FinTech industry more broadly, and crypto based businesses in particular, have with 'de-banking' – the inability to obtain, or difficulty with obtaining, core banking services from mainstream financial institutions. It is particularly concerned about such challenges hampering innovation and limiting options for industry.
While acknowledging that there are a diverse set of reasons why certain business classes may have difficulty obtaining banking services (including assessments of risk appetite for certain customers, and AML/CTF regulation), the Report recommends the implementation of a due diligence scheme for banks by no later than June 2022. It also recommends the development of a 'de-banking' process involving the Australian Financial Complaints Authority, with an appeals mechanism.
This will be an area to watch closely, and is likely to have the most immediate impact of all the recommendations. While providing a framework for due diligence may potentially facilitate better risk assessments by banks of the crypto industry, it will remain to be seen whether this can successfully ameliorate the underlying complexities.
New market licence regime for DCEs - Given that Digital Currency Exchanges (DCEs) are currently subject to limited regulatory oversight, the Report recommends the development of a new market licence category for them, which will include requirements relating to capital adequacy, auditing and responsible person tests.
Custodial or depository regime for digital assets - Acknowledging that digital assets have unique vulnerabilities around the loss or theft of private keys, the Report recommends a clear framework for custodial arrangements for digital assets that will generally align with the principles for custody of traditional assets, while dealing with the unique nature of digital assets.
Token mapping exercise - The Report proposes the Government undertake a token mapping exercise to understand and classify the various types of digital asset tokens in Australia, based on the approach taken by other jurisdictions in recent years.
New DAO structure - The Report recommends the introduction of a new DAO legal entity into the fold of Australian corporations law, which will likely adopt the features of a limited liability company.
Clarification of AML/CTF regulations - The Report recommends that AML/CTF regulations be clarified to ensure they are fit for purpose for crypto asset businesses and do not undermine innovation.
Amendments to the CGT regime - The Report proposes that the CGT regime be amended such that crypto transactions only trigger a CGT event when they genuinely result in a clearly definable capital gain or loss.
Tax concession for using renewable energy - The Report recommends that businesses that source their own renewable energy for digital asset mining activities be eligible for a 10% company tax discount.
Review of the viability of a CBDC - The Report acknowledges the work of the Reserve Bank of Australia in exploring options for a wholesale central bank digital currency (CBDC), and recommends the Treasury lead a policy review of the viability of a retail CBDC in Australia.
Due diligence requirements of banks - The Report recognises the work undertaken by the ACCC that led to the establishment of a working group to develop a due diligence scheme for banks. A cross-agency working group established by the Council of Financial Regulators has further examined issues relating to de-banking and further policy responses. The Report recommends the cross-agency working group progress its work as soon as possible, with a due diligence scheme for banks to be implemented by no later than June 2022.
Process for de-banked businesses - Due to the lack of transparency around decision-making of banks in denying banking services to various FinTech businesses, the Report recommends a process be developed for businesses impacted by de-banking, which should involve the Australia Financial Complaints Authority.
Common access requirements for New Payments Platform - The Report recommends that the Reserve Bank of Australia develop common access requirements for payments systems as part of a new payments licence, with the aim of reducing payments businesses' reliance on the major banks for banking services.
Replacement of the Offshore Banking Unit regime - In light of the policy environment for neobanks and the impact of corporate law on new investments, the Report recommends the Government adopt the Australian Financial Markets Association's recommendation to establish a 'Global Markets Incentive', which will replace the existing Offshore Banking Unit.
Consider the impact of proposed reforms
Businesses – particularly within the digital asset industry, as well as banks and other financial services providers – should reflect on the proposed recommendations and their likely impact, and consider key further consultation input as the regime continues to develop.