AUSTRALIA: An Introduction to FinTech Legal
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CHAMBERS FINTECH OVERVIEW 2022
An Introduction to Australia FinTech
Developments in financial technology (FinTech) have increasingly become a defining feature of Asia-Pacific’s economic and legal standing in the global context. Australia has been a notable driving force behind the proliferation of FinTech, with a broadening of product offerings by the Australian FinTech community and maturing of the Australian policy and regulatory approach. While previous FinTech offerings were limited to operating on the periphery of traditional financial services (including lending, personal finance and asset management), the sector has now moved to disrupt the core product offering of many Australian institutional financial service providers, including payments, wallets, digital assets, supply chain, wealth and investment, and data and analytics.
The Australian Government has also recently taken a more proactive stance on the regulation of digital assets and services and emerging payments models, with a view to attracting new businesses to the jurisdiction. This has included a raft of reviews into Australia’s payments systems, stored value facilities, mobile digital wallets, and crypto asset products and services (as set out below). It is expected that the recommendations from these reviews will have significant effects on the current regulatory regimes relevant to FinTech. This will present the Australian Government with an opportunity to further Australia’s reputation as an innovation-friendly jurisdiction while offering Australian FinTechs a chance to continue to propel Australia as a global leader in FinTech offerings.
Financial services regulation system review
As part of the response to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission), the Australian Government asked the Australian Law Reform Commission (ALRC) to inquire into simplifying the financial services regulatory framework to make it “more adaptive, efficient and navigable for consumers and regulated entities”. The ALRC will provide interim reports on three areas, being the design and use of definitions in corporations and financial services legislation, the regulatory design and hierarchy of laws, and the potential to reframe or restructure Chapter 7 of the Corporations Act 2001 (Cth) (ie, the overarching financial services laws). The first interim report on definitions has been released, with a number of proposals made to reduce redundancy and duplication and to simplify and rationalise legal concepts. Submissions closed on 25 February 2022. The next interim report on regulatory design and legislative hierarchy is expected to be released on 30 September 2022.
Regulatory reform in respect of payments and digital assets
On 8 December 2021, Federal Treasurer Josh Frydenberg announced an intention for the Australian Government to proceed with a reform of Australia’s regulatory framework as it applies to payments and crypto assets.
The announcement comes after the completion of a raft of reviews in this space, including the Council of Financial Regulators’ (CFR) Stored Value Facility Review, the Treasury Payments System Review, the Senate Select Committee on Australia as a Technology and Financial Centre and the Parliamentary Joint Committee Inquiry into Mobile Payments and Digital Wallets.
The Treasurer committed the Government to having the following in place by mid-2022:
• a strategic longer-term plan for the payments system, developed with industry and reviewed annually;
• details of additional powers for the Treasurer to set payment system policy;
• changes necessary to modernise payments system legislation to accommodate new and emerging payment systems, including consideration of ‘buy now pay later’ (BNPL) and digital wallets;
• completed consultation on the establishment of a licensing framework for digital currency exchanges;
• finalised consultation on a custody or depository regime for businesses that hold crypto assets on behalf of consumers; and
• obtained advice from the CFR, working with other relevant agencies, on the underlying causes and policy responses to the issue of de-banking.
Following the introduction of the Australian Prudential Regulation Authority’s (APRA) ‘restricted’ authorised deposit-taking institution (ADI) (ie, restricted bank) (RADI) licensing framework in 2018, there have been a number of new entrants in the Australian banking industry. Last year, APRA revised its approach to licensing and supervising new ADIs to address sustainable market entry challenges. The regime still enables RADIs to conduct a limited range of banking activities for two years while building capabilities and resources but has been amended to reflect APRA’s greater understanding of the operational and financial challenges new entrants face. The framework is designed to balance the promotion of competition and development of innovative new business models with the maintenance of safety and stability in the financial system. Since 2018, there have been many digital banks (also known as neobanks) that have become ADIs through the restricted ADI pathway, with many of these banks broadly focused on retail banking. Neobanks in Australia have been characterised by targeting more digitally-oriented customers with a focus on delivering more convenient and cost-effective products.
While the product rollout of these neobanks has been staggered, retail consumer uptake has been significantly higher than broader sector expectations, demonstrating a trending market sentiment towards accepting FinTech offerings as markedly competitive with traditional offerings. Over the next few years, it is likely the market will see more sophisticated offerings from these neobanks as well as the introduction of neobanks focused on a broader range of services (eg, the provision of small and medium-sized enterprise credit).
Credit and BNPL
There has been a continued increase in deferred payment solutions in the market following deep consumer interest and uptake compared to more traditional short-term credit (e.g., credit cards). Most significantly, there has been mass consumer adoption of BNPL as a payment model. As a result, there has been heightened regulatory scrutiny of BNPL service providers and the Government’s announcement of its intention to modernise payments system legislation to accommodate BNPL structures. Australia’s corporate and financial services regulator, the Australian Securities and Investments Commission (ASIC) has also released an industry update on key observations on Australia’s BNPL industry. ASIC’s update reports on the growth of the industry, the impact on consumers and upcoming regulatory developments but notes that these developments have used existing and impending regulatory changes rather than new industry-specific policy and regulation. Notably, the report states that BNPL arrangements are subject to the Australian Securities and Investments Commission Act 2001 (Cth), which makes them subject to ASIC’s product intervention power and the recently implemented design and distribution obligations.
As a result of COVID-19, there have also been further developments in the consumer credit landscape, with the Treasurer announcing the proposed simplification of the existing consumer credit framework (particularly the responsible lending provisions) as part of the Australian Government’s economic recovery plan; however no new legislation has been passed to date.
Digital assets and the transfer of value
As digital platform offers have grown significantly in Australia, so too have the use and offering of digital wallets and payment providers. Given the global rise of digital payment systems (notably through WeChat Pay and AliPay) Australian startups and institutions are entering this space via specific products, ecosystem strategies and broader peer-to-peer payment models. This has historically presented itself in the form of in-game and purpose-specific currencies that only exist within an environment as a store of value. However, more recently such models have blended with traditional financial infrastructure allowing value to shift in and out of these systems in a manner that can provide greater financial exposure to digital environments. The maturation of digital assets as products providing financial exposure to both real-world and created environments has also led to a rise in traditional fund inclusion of these assets. There is a growing trend of listed and unlisted funds including investor exposure to digital assets in their investment mandate, which brings its own challenges associated with aligning existing financial regulation in the context of new technologies (eg, valuation and custody of digital assets).
Regarding digital wallets and environment-based payments, there are nuances resulting in a range of regulatory treatments under Australian law. Significant regulatory requirements can arise for businesses, and recent rhetoric in the FinTech community is associated with the challenge presented by these regulations. Australia is an active player in facilitating innovative business models and it is likely that this space will develop significantly over the coming years, presenting opportunities for FinTechs to disrupt traditional payment models and markets.
The CFR made recommendations to the Government for a new graduated framework for stored value facilities (ie, digital wallets that are widely used as a means of payment and store significant value for a reasonable amount of time) to be overseen by APRA. As noted, the Government (both directly and through subsequent reviews) provided its support for these recommendations and is currently consulting with industry on proposed implementation.
Decentralised finance and new governance models
For the past few years there has been sustained attention on blockchain technology and a growth in interest in the technology by established businesses in the financial services sector. In particular, there has been sustained attention on how decentralisation and new governance models can exist using blockchain and distributed ledger technology.
2021 has seen a rapid growth in popularity of decentralised finance (DeFi) platforms, which offer peer-to-peer financial arrangements without a central intermediary or operator. DeFi represents a wealth of opportunity for consumers to access capital and returns that may not otherwise be accessible in the traditional banking system. DeFi also offers increased speed and lowered costs in relation to transactions as a result of not needing central intermediaries. The elimination of central intermediaries has propelled the ascension of decentralised autonomous organisations or DAOs as the primary means of governing decentralised applications. Generally, under a DAO, community members submit proposals that are voted on by the members with rules of participation set out in the underlying smart contracts of the DAO. This structure means that there is no central managerial effort and members are incentivised to participate in community governance.
From a regulatory perspective, the Government has shared a broader commitment to facilitate growth and innovation and has taken a relatively non-interventionist approach to date. Australian regulators have generally been of the view that Australian legislative obligations and regulatory requirements are technology-neutral and apply irrespective of the mode of technology that is being used to provide a regulated service. The concept of DAOs in particular is quickly becoming accepted by the Australian community. The Senate Select Committee on Australia as a Technology and Financial Centre recommended the introduction of a new DAO legal entity in Australian corporate law and this recommendation has been agreed to by the Australian Government as part of its regulatory reform package.
Regulatory FinTech initiatives
ASIC has championed various FinTech initiatives to propel the development of the sector in Australia. There has been increased investment in ‘RegTech’ (regulatory technology) and ‘SupTech’ (supervisory technology) by financial services businesses.
ASIC has entered into a number of cooperation agreements with overseas regulators that aim to further understand the approach of FinTech businesses in other jurisdictions in an attempt to better align the regulatory treatment of these businesses across jurisdictions. These cross-border agreements facilitate the referral and sharing of information on FinTech market trends, encourage referrals of FinTech companies and share insights from proofs of concepts and innovation competitions. ASIC has committed to supporting financial innovation in the interests of consumers by joining the Global Financial Innovation Network, which launched in January 2019 and currently has over 70 member organisations.
ASIC has also provided regulatory assistance in various forms. ASIC has certain class orders establishing a fintech licensing exemption and released regulatory guidance detailing its regulatory sandbox for FinTech businesses to test certain financial services, financial products and credit activities without being licensed. There are strict eligibility requirements for both the types of businesses that can enter the regulatory sandbox and the products and services that qualify for the licensing exemption. Once a FinTech business accesses the regulatory sandbox, there are restrictions on how many persons can be provided with a financial product or service and caps on the value of the financial products or services which can be provided. Since 2020, the regulatory sandbox has been enhanced to allow testing of a broader range of financial services and credit activities for a longer duration.
ASIC has also established an Innovation Hub that has assisted both FinTechs and RegTechs in navigating the Australian regulatory framework. ASIC has noted that businesses engaging with the Innovation Hub have covered models including digital advice, marketplace lending, payments and remittance, RegTech and credit. Other Australian regulators have also made sandboxes and innovation hubs available.
There has been a variety of recent regulatory and legislative developments in the FinTech industry, with COVID-19 having been a driver for digital transformation. With the acceleration of digital capabilities, payments implementations and a broader acceptance of technology-based services in conjunction with adapting regulatory models, FinTech is likely to see continued opportunities for growth as the sector moves into a space of accepted maturity. It is likely that, as legislative changes are implemented (arising out of various regulatory reviews and the Australian Government’s announcement that it will reform payments and cryptocurrency regulation), there will be greater opportunities for Australian consumers and businesses in relation to FinTech and RegTech. Despite the Government’s broad commitment to encouraging growth and productivity within the technology and financial services industry, FinTechs should also note the general expectation that regulator engagement is likely to be more rigorous and the regulatory approach to enforcement more proactive given Government and regulatory focus on consumer protection and outcomes.
Generally, the changing regulatory landscape in Australia and active interest from regulators presents FinTechs with opportunities to shape new business models to meet increasing demand for bespoke offerings and tailored services. At the same time, established institutions will continue to face the challenge of redesigning their existing technology platform, strategies and capabilities to better serve consumers.