Jaime Lumsden Kelly

The Fold Legal is delighted to have made a submission to the Treasury Consultation Paper on Crypto asset secondary service providers: Licensing and custody requirements, which is looking at how the industry will be regulated in the future.

The regulation of the crypto industry is an important step for both the local and global crypto industry. As we have seen with other industries, most notably new energy, uncertainty stifles innovation and a clear pathway to regulation provides the strongest foundation for true innovation, growth, consumer protection and a competitive market.

The scope of regulatory reform outlined in the Consultation Paper is centred on the following key principles:

• ensuring that regulation is fit for purpose, technology neutral and risk-focused
• creating a predictable, light touch, consistent and simple legal framework
• avoiding undue restrictions
• recognising the unique nature of digital assets, and
• harnessing the power of the private sector.

The Consultation Paper presents an opportunity to build a regulatory framework for the future that is technologically agnostic, fit for purpose, has in-built flexibility and strikes an appropriate balance between regulation, consumer protection and innovation. Embarking on legislative change of this nature is no small task and it is critical that we take the opportunity to ensure that the regulatory framework meets the intended objectives and provides the industry with a clear and appropriate transition pathway.

Our submission proposes a regime within the Corporations Act that utilises the existing licensing framework and includes additional obligations for advisory and brokering services undertaken by licensees. In our view, this approach provides:

• the greatest flexibility for current crypto providers to expand their business into traditional markets and for traditional businesses to expand into crypto-assets
• reflects the realities of the provision of services in relation to crypto-assets
• delineates between financial products and crypto-assets
• imposes obligations commensurate with the risks
• mitigates licensing and regulatory duplication
• promotes regulatory certainty, and
• provides appropriate consumer protections.

The Fold Legal is deeply steeped in the fintech space since early 2013 and has been actively involved in the crypto industry since 2015. We are technical specialists that have a broad and deep understanding of blockchain technology, crypto assets, exchanges, DAOs, alternate platforms and crypto product and service offerings. Our crypto knowledge combined with our financial services expertise is market leading. We use our industry knowledge and expertise to deliver practical, compliant and innovative solutions for our clients. We have worked with a range of clients including crypto exchanges, miners, crypto payment businesses, crypto platforms, DAOs and crypto token issuers.

Read the full submission here.

By Jaime Lumsden, Michele Levine or Nicholas Pavouris

The post The Fold Legal prepares submission on the future of crypto regulation appeared first on AdviserVoice.

Jaime Lumsden

Purchasing an Australian financial service licence (AFSL) or an Australian credit licence (ACL) is an exciting opportunity to take your financial service business to the next stage of growth. The process is often much quicker than applying for a licence directly, enabling you to get to market fast. One of the critical steps in purchasing a company that holds an AFSL or ACL is ensuring that the licence does what you need it to do and carries no major regulatory risks.

Most buyers understand the general importance of completing due diligence when they acquire a business or asset, and most purchasers also understand that they need to do some level of regulatory due diligence, however, this is often limited to understanding whether there are any regulatory or compliance risks associated with the way the business has been run. What we rarely see are businesses confirming that the licence authorisations actually enable them to provide their desired services.

Not all licenses are the same, in fact, they vary significantly. Whilst on face value it is easy to tell if the licence is appropriate in some respects (e.g. whether it enables both retail and wholesale client business), there are often elements of the licence that require more careful consideration – in particular, having the correct advice and dealing authorisations for the financial products that your business needs.

Whilst the risk is lower for certain licence types, it is still worth confirming. For example, licences for insurance underwriting and insurance broking are relatively straightforward. However, when purchasing one of these types of licences, you should confirm if you are also required to have a claims handling and settling services authorisation, and if so, what type, as these vary from business to business depending on how claims services are being offered and managed. Most financial planning licences typically cover similar financial products, but there are often subtle differences when it comes to rarer or high-risk authorisations, such as whether they cover products like managed discretionary accounts, margin lending and derivatives.

Where we tend to see the biggest risks is with licences for funds and payment products. With these kinds of product offerings, it is important that you take advice on what financial services are being provided and what the licensing implications are. For example, we have seen payments businesses obtain typical payments licences in the past that they believed would cover their product offering, only to find out that they required a licence that not only had authorisations for non-cash payment facilities but also covered basic deposit products and miscellaneous financial investment products which are not as common authorisations in these types of licences. Funds licences tend to vary significantly depending on what the proposed funds will invest in and there is often a need to consider each licence authorisation against the proposed investment offering to ensure that the authorisation suits.

The other common pitfall is in checking that the licence has the right advice and deal authorisations. It is often relatively simple to confirm if the licence supports general or personal advice, but the distinction between the deal authorisations is subtler and less well understood. For example, securing a licence that has an “apply for” authorisation in respect of payments will not support a business of operating a payments system – this business needs the “issue” authorisation. The “arranging” authorisation is even more limited.

What you don’t want to have to deal with is a situation where you need to vary a licence that you have spent considerable money on, in a hope to accelerate your business, because the authorisations are not what is required or because there are other conditions (such as a key person condition) that prevent you from utilising the licence and requiring a lengthy and expensive variation.

What to check for:

• Ask for a full copy of the licence and check the conditions, is there a key person condition, are there any other limits?
• Does the licence allow you to provide advice and deal in the products you need?
• Whether the licence covers retail and wholesale clients and whether you can meet the different requirements that attach to each?

When to engage help:

• if you are unsure what licence authorisations you require
• if you are unsure whether a proposed licence is appropriate
• if you need to vary your licence.

By Jaime Lumsden and Nicholas Pavouris

The post Are you getting the licence you’re paying for appeared first on AdviserVoice.

Jaime Lumsden Kelly

The Australian Finance Industry Association (AFIA) has released a new voluntary Buy Now Pay Later (BNPL) Code (Code) to address criticism that the industry is under-regulated and to enhance consumer protections. The objective of the Code is to encourage a customer centric approach, promote industry standards and drive an uplift in compliance. In doing so, the Code imposes several conditions and protections that go beyond the current legal and regulatory regime for BNPL providers.

Although the Code is not compulsory, 8 major BNPL providers have signed up as members and were Code compliant on the 1 March 2021 launch date.

For many of the current compliant members, it is fair to say that minor (if any) changes were required on becoming Code compliant. Nevertheless, the Code serves multiple purposes that seek to raise the standards of the industry. It does so by setting an industry benchmark that (in some respects) goes beyond the current legal and regulatory framework. It will be interesting to see the impact the Code has on the BNPL industry, providers and customers – particularly whether the Code fuels any competitive or market pressures in the industry or changes to the user experience.

In this blog, we take a look at the Code and highlight where we think the Code raises industry standards, simply maintains the status quo, or may be wanting.

What is the Code?

The Code is a set of 9 standards that BNPL providers that are “Code compliant” pledge to follow.

At a high-level, the standards require BNPL providers to:

1. Focus on customers;
2. Be fair, honest and ethical;
3. Have transparent products;
4. Conduct suitability checks;
5. Review products on an ongoing basis;
6. Fairly deal with complaints;
7. Provide financial hardship assistance;
8. Comply with legal and industry obligations; and
9. Promote the code.

How has the Code gone further than the current regulatory framework?

In answering this question, we have compared the current framework to the standards.

AFCA

One of the more significant changes is that the Code will require members to join AFCA, an external dispute resolution body for the financial services and credit industries.

Although not a current requirement under law, we have definitely seen a recent push by providers in the BNPL sector to join AFCA to provide further recourse to customers and add a level of rigour to the complaints process. It is positive to see a willingness within the Code to be bound by the additional oversight of AFCA, which is also a benefit to customers.

Vulnerability and hardship

The standards do impose a commitment to consider customer vulnerability before providing services. This is a great initiative and particularly important given 21% of BNPL users ASIC surveyed missed a payment in the last 12 months.^[1] It also goes above and beyond the current regulatory regime as currently there is no specific regulatory requirement to consider vulnerability.

We note that the vulnerability requirements are similar to those that apply in the banking and insurance space – they are quite high level and rely on the customer informing or actively demonstrating that they are vulnerable. As outlined in our previous blog on vulnerability^[2], this approach does pose some challenges from an implementation point of view and requires a fair amount of self-advocacy by customers. This may be particularly tricky for the BNPL sector given the demographic is heavily skewed to younger customers who may have never owned a credit card.

Interestingly, there will be a requirement for BNPL providers to consider hardship requests. The hardship requirements are not as robust as those that apply to consumer credit under the National Credit Code. However, the requirements seem to be appropriately pitched given that BNPL products are not regulated as consumer credit. The standards also impose a number of automated and helpful measures to protect customers who may be suffering hardship, including:

• Taking reasonable steps to exclude customers from receiving promotional material where they have a financial hardship arrangement; and
• If a consumer is behind in payments at the time, not providing any additional BNPL products or services or increasing their current limits.

A further win for customers is that the Code states “we will never initiate bankruptcy proceedings”. This is certainly a positive outcome for customers. However, this protection may be lost if BNPL providers on sell the debt to a debt collection agency.

Credit/suitability assessment

One of the most significant inclusions in the Code is the implementation of a credit suitability framework. While the proposal falls short of the responsible lending criteria in place for credit providers, it is a step in the right direction and seems to strike a reasonable balance between consumer protection and efficient business practice. This is particularly so in light of the changes proposed by the Government last year to water down the responsible lending laws following the ASIC v Westpac case.

While the Code’s credit suitability checks add a further layer of protection for consumers, in our view, credit businesses (especially those that are maturing) often implement some form of credit risk assessment to manage their book of business and mitigate bad debts. For many BNPL providers, this may be a business imperative to ensure future and sustained growth and investor interest to maintain the record valuations we have seen throughout the COVID-19 pandemic.

How has the Code fallen short of the current regulatory framework?

There are a number of areas where the Code falls short of the current regulatory standards of other industries.

Transparent and reviewed products

The BNPL industry will be subject to the new design and distribution obligations^[3] (DDO) that come into effect in October 2021.

Standards 3 and 5 of the Code set out some guidelines for creating products, and providing disclosure around fees, including notice requirements and ensuring that products are transparent and suitable for customers. The DDO requirements will be more involved than those in the Code and it remains to be seen how the Code will lift standards in this space particularly given that BNPL providers should be taking action now to be DDO compliant from October.

Impacts on credit

One thing that the Code doesn’t address is educating consumers on the impact BNPL products may have on their credit rating. While many BNPL customers may not currently hold other credit products, future applications for credit cards and home loans may be impacted if they have had issues repaying any BNPL products.

Impact on merchants and partners

The Code has included some requirements on merchants and retail partners to meet certain standards. While this is a positive initiative, in our view many of the obligations imposed by the Code would already need to be managed by merchants in order to comply with their obligations relating to unfair contracts and misleading and deceptive conduct.

How to join the code?

Any BNPL industry players that think they are Code compliant may apply for membership of the AFIA. All applications are assessed by an independent Committee (which does not have any representatives from current Code compliant members). This should encourage fair dealing and allay any concerns of anti-competitive behaviour.

What does the Code mean moving forward?

The Financial Conduct Authority (the UK’s financial regulator) has recently made moves to tighten the regulatory leash on BNPL providers and there have been growing voices within Australian circles to force BNPL to be completely regulated as credit in Australia. We think that ASIC will be closely watching the UK’s approach. Australia has followed the UK’s lead on a number of initiatives in the financial services space (e.g. Opening Banking) and this could be another example…watch this space!

In time, we will be able to assess the impact the Code has had on the industry standards. It will be fascinating to see if the Code drives market and competitive tailwinds in response to changes in consumer and merchant behaviours, which encourage (or make it essential for) smaller and/or boutique BNPL players to sign up to the Code.

By Jaime Lumsden, Michele Levine and Nicholas Pavouris

———

[1] https://download.asic.gov.au/media/5852803/rep672-published-16-november-2020-2.pdf
[2] https://www.thefoldlegal.com.au/blog/fairness-vulnerability-and-fintechs
[3] https://www.thefoldlegal.com.au/blog/credit-where-credit-is-due-your-design-and-distribution-obligations

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Katie Johnston

Last year innovative and landmark reforms were introduced that gave companies limited by guarantee the ability to raise capital by issuing mutual capital instruments ( MCIs) without risking their status as a mutual. Now 12 months on, we share our top 3 tips for any mutual looking to streamline the process.

Tip 1: Make sure your constitution is ready

Before you can offer and issue an MCI, your constitution must specifically empower the board with flexibility to issue MCIs and facilitate their issue in multiple classes.

Key touch points to cover in your constitution include:

• Giving the board power to issue and allot MCIs;

• Allowing the board the flexibility to determine and approve the class rights of MCIs. At the same time, you should ensure that the proposed MCIs meet the requirements of the Corporations Act, such as to be issued as fully paid;

• Allowing the mutual to accept subscriptions for money for MCIs;

• Facilitating payment of dividends to MCIs;

• Addressing membership of the MCI holder in the mutual;

• Governance points like board composition rights; and

• Setting out the terms of issue of the MCIs (Class Rights), including voting and redemption rights and the transfer of MCIs.

If your mutual has already been formed, you will need to change your constitution to include these points.

If you’re forming or planning a new mutual, you should prepare your constitution so that it facilitates the issue of MCIs from day 1. Even if you’re not planning to issue MCIs, we recommend your constitution is ready to maximise your options and reduce future delays and expense.

Tip 2 – Bed down class rights

It’s important to recognise at the outset that MCI holders are unlikely to be members of the mutual and your class rights should reflect this.

A mutual provides significant financial benefits for members. It offers them the ability to share risk and is designed to promote the interests of the members by protecting their assets and people.

MCI holders shouldn’t expect significant returns on their investment. This is because their investment is primarily made to support the wider interests of the community formed by the members. Their capital provides a sustainable model to offer discretionary protection to members.

The class rights should reflect the context of the mutual. It should also reflect that MCIs offered by mutuals are very different from other forms of capital used by other types of companies to raise funds.

There are 4 key types of class rights that you should consider.

1.   Voting rights

Mutuals do not have to give MCI holders the right to vote at members’ meetings or sit on the board. It’s up to the mutual to determine this in light of the rights of its members and its commercial objectives.

Importantly, if a class of MCI does give its holder the right to vote, the investor will only have one vote for that class of MCI regardless of the number of MCIs they hold in that class.

2.   Dividend rights

The ability to offer and issue MCIs was introduced to accelerate mutual growth and market share. While mutuals can issue MCIs with dividend rights, MCI investors shouldn’t expect significant returns on their investment. If they do, then MCIs probably aren’t the right investment for them.

That being said, we recommend that the constitution and class rights support payments of dividends to MCI holders so that you have flexibility moving forward. These rights need to be compliant with the Corporations Act requirements around dealing with surplus assets and profits and any dividend that is paid being non-cumulative. The point is to maximise flexibility and options for the mutual.

3.   Redemption

The class rights should also set out whether the MCIs in a particular class should be redeemable and what the terms of redemption would be. Redemption terms could include:

• Time: Can they be redeemed at any time or after a set time?

• Who: Who has the ability to redeem the MCIs? Are they redeemable only by the company in its absolute discretion or can the MCI holder redeem them as well?

• Price: What price should be paid to the MCI holder on redemption? Will this be the original subscription amount or something else?

• How: What is the process for redemption? Does the mutual need to give the MCI holder a redemption notice?

4.   Transfer

Your constitution should also contemplate whether MCIs can be transferred to others. If you want to restrict the transfer of MCIs, the specifics of this should be covered off in the class rights. For example, is board approval required? Can you transfer to a related party or within the same corporate group? Are any dealings, such as encumbrances over the MCIs, restricted?

Tip 3 – Streamline your offer and documentation

To have a streamlined process, you need to sort out your constitution and class rights before you set your offer and documentation.

The offer of MCIs is an offer of securities so there are minimum disclosure requirements that you must follow, just like other forms of capital raising. But MCIs are also their own beast that have their own individual disclosure requirements.

When disclosing your MCI offer you should clearly articulate:

• The investment proposition: Investment in MCIs is not about returns. It’s about providing discretionary insurance protection for its members. Where they have discretion, the board will give priority to providing protection to members. Any return on investment for MCI holders will be secondary to the interests of members whose claims are being considered. This should be clearly stated so that investors are not misled about potential returns.

• The risks specific to mutuals: These include significant claims by members which will impact the mutual’s ability to fund future claims and pay distributions. Other risks may include the loss of members which will mean the amount of contributions that may be pooled to pay claims and fund the purchase of insurance and reinsurance programs will reduce. Market risks may include the availability and appetite of local and global insurers and reinsurers to support the mutual with insurance and reinsurance programs. Other risks include the detrimental impact of external extenuating circumstances such as the current global pandemic and regulatory and compliance risks.

• Class Rights: These are the rights attached to the class of MCIs being offered. These include those noted above on voting, restrictions on transfer and redemption.

This list is not exhaustive and will depend on your mutual and business proposition.

By Katie Johnston and Nicholas Pavouris

The post Issuing MCI securities – Practical learnings 12 months on appeared first on AdviserVoice.

The change is bigger than it looks

Previously AFS licensees had a lower threshold test that a person be of ‘good fame and character.’ On the face of it, the change may seem trivial, but the effects are wide reaching.

ASIC now has the ability to:

• Assess the suitability of entities applying for a licence or that control an AFS or credit licence by requiring applicants to provide information on all officers of the licence applicant and any controllers of the licence applicant (or its officers);
• Refuse to grant a licence if any of the officers of the licence applicant, or its controllers, if any, or the controller’s officers, are found not to be fit and proper;
• Consider previous conduct in other businesses to determine whether an officer of a licence applicant will satisfy the fit and proper test; and
• Vary or revoke an AFS or credit licence if the licensee, its officers, or controllers (or its officers) no longer satisfy the ‘fit and proper person’ test.

Who must be a fit and proper person?

All ‘officers’ of both a licensee and the controller of the licensee, and the controller itself (if not a company), must meet the fit and proper person test.

An ‘officer’ typically includes:

• directors;
• company secretaries;
• responsible managers;
• chief executive officers;
• chief financial officers;
• senior managers; or
• any other person who influences the whole, or a substantial part of the decisions made by the business. This will of course vary from business to business.

This means that an applicant must demonstrate to ASIC that each of these people are ‘fit and proper’ when applying for an AFS or credit licence.

What will ASIC consider when assessing a ‘fit and proper’ person?

To grant an AFS or credit licence, ASIC must have no reason to believe that the applicant is not a ‘fit and proper person’ to engage in the activities authorised by the licence.

Practically, ASIC now requires each ‘officer’ to provide the following:

• Criminal history check;
• Bankruptcy check; and
• A statement of personal information.

This allows ASIC to consider:

• Any previous AFS or credit, or other professional licence, suspensions or cancellations of the person or any company for which they were a director;
• Whether the person has had any banning orders;
• Whether the person has ever been insolvent or has been the director of a company that has been placed into administration;
• Whether the person has had any criminal offences; and
• Any additional information that ASIC requests.

Licence applicants must also now provide ASIC with an express declaration that there has been no material changes to the person and the information that was lodged to ASIC before a licence is granted.

How will this impact existing licensees?

Even if you already have an AFS or credit licence, you will need to meet the ‘fit and proper person’ test moving forward. If you apply for a variation to your licence ASIC will assess whether all existing and new ‘officers’ are ‘fit and proper’. Consider putting measures in place to ensure you regularly check that ‘officers’ remain ‘fit and proper’. This could include:

• Periodically conducting police and bankruptcy checks; or
• Asking officers to complete a declaration about any conduct of theirs that may affect their standing as a ‘fit and proper’ person.

By Sónia Cruz and Nicholas Pavouris

The post More than a synonym – what is a fit and proper person? appeared first on AdviserVoice.