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FINANCIAL SERVICES DIVISION REGULATORY UPDATE

JANUARY 2022

 PART 1 – REGULATORY REFORM

 ASIC

1. CRYPTO ASSETS 

ASIC released Information paper 225 in August 2021 that details ASIC’s intention to update authorisation for Responsible Entities of a registered crypto scheme in the retail space and to begin to regulate this area.

In addition to registered (retail) schemes, if the issuer of a crypto asset is operating a wholesale managed investment scheme, the issuer may need to obtain an AFS licence with the appropriate authorisations and have a robust process to ensure that only wholesale clients invest in the managed investment scheme. 

It is not permissible for the issuer, as trustee of the wholesale managed investment scheme to rely on a corporate authorised representative appointment from another AFS licence to issue interests in the scheme.

Authorisation

If the registered scheme holds crypto assets, there will be a requirement to have ‘operate scheme’ authorisation under the entities AFSL for the crypto assets.

If an AFSL variation or new application is being lodged, ASIC requires the applicant to name at least one, maximum of two, registered schemes in the application.

For the first two years of the authorisation, the RE will be restricted to operating either one or the two schemes. The licensee may then seek to remove this restriction.

Custody

There is no licence authorisation for crypto custodians currently proposed. However, the Treasurer has since announced regulatory reform proposed for this space.

There is no change to the current requirement that the Responsible Entity or custodian engaged to hold scheme property will be required to hold minimum NTA of $10 million;

Crypto assets in a scheme are assets of the scheme and need to be held by an appropriately resourced entity that meets the following requirements:Specialist expertise and infrastructure relating to crypto-asset custody e.g. security and hardware systems appropriate and designed to minimise risk of loss and unauthorised access;

Risk asset management systems and controls that are independently verified to GS007 or the like; and

Compensation systems (e.g. insurance). 

Responsible Managers

Any AFSL application or variation will need to be supported by an appropriately experienced RM.

2. REVIEW ASIC AND APRA REPORTING

In response to the Hayne Royal Commission, the Financial Regulator Assessment Authority’s (FRAA) is tasked with reviewing and reporting on the effectiveness and capability of ASIC and the Australian Prudential Regulation Authority (APRA). 

FRAA’s first review will be a targeted assessment of ASIC’s effectiveness and capability in strategic prioritisation, planning and decision‑making, ASIC’s surveillance function, and ASIC’s licensing function. The first review will also examine ASIC’s use of data and technology in each of these areas of focus.

FRAA’s report to Government is expected by the end of July 2022.

3. ASIC CONSULTS ON COMMUNICATING AUDIT REVIEW FINDINGS TO DIRECTORS

ASIC is seeking feedback on its proposed amendments to its approach to communication of audit quality finding. Communicating audit findings to directors, audit committees or senior managers (CP 352) details ASIC’s proposal to communicate the findings to directors on a routine basis rather than communicating findings on the current exception basis and the circumstances in which that would apply. 

CP 352 proposes that ASIC will routinely communicate findings from its review of audit files where ASIC:

has formed the view that an auditor has not obtained reasonable assurance that the entity’s financial report is free of material misstatement;

• considers that audit work should be improved in future years, even though reasonable assurance was obtained that the financial report for the current year was free of material misstatement;

has concerns that the auditor did not meet the independence requirements of the Corporations Act (including professional requirements), has not addressed the matter, and has not adequately reported the matter in an auditor’s independence declaration; or

• considers any other matter should be drawn to the attention of the directors or audit committee of the audited entity.

Submissions to CP 352 are invited by 11 February 2022.

4. PAYMENT REFORMS

On 8 December 2021 the Federal Treasurer announced an agenda for the most significant reforms to Australia’s payment systems in more than 25 years. The reforms are being considered so Australia can capitalise on the significant opportunities being created by new payment and crypto technologies.

These reforms will build on the government’s Digital Economy Strategy which is delivering on its vision for Australia to be a leading digital economy by 2030.

In relation to payments, by mid-2022 the Government propose to:

• Set out a strategic longer-term plan for the payments system, developed with industry and reviewed annually;

• Settled the details of additional powers for the Treasurer to set payment system policy;

• Determined the 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.

In relation to crypto, by mid-2022 the Government has promised to have:

• Completed consultation on the establishment of a licencing framework for Digital Currency Exchanges to provide greater confidence in the trading of crypto assets;

• Finalised consultation on a custody or depository regime for businesses that hold crypto assets on behalf of consumers so that investors have greater confidence in the safe keeping of these assets;

• Received advice from the Council of Financial Regulators, working with other relevant agencies, on the underlying causes and policy responses to the complex issue of de-banking.

By end-2022 the Government expects to have:

• Settled the framework to replace the current one-size-fits-all payment licensing arrangements with a functionally based framework adopting graduated, risk-based regulatory requirements.

• Received a report from the Board of Taxation on an appropriate framework for the taxation of digital transactions and assets.

• Undertaken a mapping exercise of existing crypto currencies and tokens to better inform consumers and others of the risks and benefits that arise.

• Examined the potential of so-called Decentralised Autonomous Organisations (DAOs) and how they can be incorporated into Australia’s legal and financial regulatory frameworks; and

• Received advice from the Treasury and the RBA on the feasibility of a retail Central Bank Digital.

5. COVID AND THE PRIVACY ACT

On 2 September 2021 the Office of the Australian Information Commissioner (OAIC) released a framework of 5 universal privacy principles which provide a nationally consistent, best practice approach to data management and personal information protection for governments and businesses during the COVID-19 pandemic.

The principles have been released to provide supportive guidance in the handling of personal information in the absence of national legislation for the retention and use of personal and sensitive health information of individuals.

The five discretionary principles are as follows:

1. Data minimisation – Governments and businesses should collect the minimum information necessary to achieve contract tracing purposes and alternative solutions to information; 

2. Purpose Limitation – Information collected for the purpose of preventing or managing the risk and/or reality of COVID-19 should not be used for other purposes, such as direct marketing;

3. Security– Reasonable steps must be taken to protect’ personal information from misuse, interference and loss, and from unauthorised access, modification or disclosure;

4. Retention Personal information should be destroyed once it is no longer needed for contact tracing purposes; and

5. Regulation by the Privacy Act Where personal information is collected or stored through a third party, organisations should ensure the third party is covered by the Privacy Act 1988 (Cth), alternatively where the organisation is not covered by the Privacy Act it should ‘opt in’ to its coverage as per section 6EA.

6. AMENDMENTS TO THE INSURANCE CONTRACTS ACT 1984 (CTH) (ICA)

In response to the Financial Services Royal Commission (Hayne Royal Commission), the Federal Government passed the Financial Sector Reform (Hayne Royal Commission Response) Act 2020 (Cth) that also sought amendments to the Insurance Contracts Act 1984 (Cth) (ICA) and the law relating to pre-contractual disclosure and misrepresentation for insurance contracts. 

Under the new regime, the pre-contractual disclosure duties on an insured for ‘eligible contracts of insurance; were repealed and replaced with a duty to take reasonable care not to make a misrepresentation for; consumer insurance contact. These amendments came into force on 5 October 2021. The range of consumer contacts are broad and includes home and contents, motor vehicle, pet insurance, and may include mixed-use scenarios, for example, a shop with upstairs accommodation.

PART 2 – CASES & SANCTIONS

1. La Trobe Financial Asset Management to pay $750,000 penalty for false and misleading marketing

The Federal Court has ordered La Trobe Financial Asset Management (La Trobe) being the responsible entity of the La Trobe Australian Credit Fund (the Fund), to pay a $750,000 penalty for false and misleading marketing and ASIC’s costs.

The Court found that La Trobe’s advertisements in newspapers, magazines and on websites that included statements that any capital invested in the Fund would be ‘stable’ where false or misleading. ASIC submitted that this gave the impression there could be no loss of capital and that La Trobe failed to express in a sufficiently prominent manner that a person who invested in the Fund could, in fact, lose substantial amounts of capital invested.

In addition, the Court Found that La Trobe made false or misleading representations that investors in its 48 Hour Account and 90 Day Account would be able to withdraw their funds between 48 hours and 90 days of providing withdrawal notice whereas in reality:

La Trobe had up to 12 months to satisfy a withdrawal while the Fund was liquid;

if the Fund ceased to be liquid, investors were entitled to withdraw only when a withdrawal offer was made by La Trobe. ASIC stressed the this matter should serve as a warning to other funds where ‘investments are marketed to considers as safer, lower risk or more liquid when in reality they are not.

2. Stanwell Corporation Limited v LCM Funding Pty Ltd [2021] FCA 1430

The Corporations Amendment (Litigation Funding) Regulations 2020 (CALF Regulations) made amendments deeming that litigation funding schemes are financial products for the purposes of the Corporations Act 2001 (Cth). 

The amendments also require litigation funders to hold an AFSL in order to deal in, or provide financial product advice in relation to, an interest in a litigation funding scheme because such an interest is a ‘financial product.’

The CALF Regulations provided transitional provisions that the new regulatory regime was applicable from 22 August 2020, unless the litigation funding scheme was entered into prior to 22 August 2020 – being the grandfathering provision.

The question of whether the grandfathering provision was applicable to LCM Funding Pty Ltd litigation funding scheme and whether it required an AFSL in respect of a class action funding against Stanwell Corporation Ltd. The question was bought before Justice Beech by Stanwelll Corporation Limited.

Stanwell put forward that LCM’s funding scheme failed to satisfy regulation 5C.11.01 (1)(v)(i) of the Corporations Regulations 2001 (Cth) prior to 22 August 2020 or regulation 7.1.04N(3)(a) of the CALF Regulations. Stanwell contended that the litigation funding agreement with Stillwater Pastoral Company Pty Ltd against Stanwell Corporations & Anor created two separate agreements. One agreement related to the work program that was for the investigation of the merits and quantum of the class action against Stanwell; and the other was the litigation funding scheme where the date of completion of the scheme was after 22 August 2020. 

Justice Beech rejected Stanwell’s submissions that the date of completion was on or after 22 August 2020 and that LCM’s scheme was grandfathered as LCM and the group members entered into the fist funding agreements on 17 June 2020. Additionally, Beach J rejected that LCM was operating a managed invest scheme within the definition of 601ED(5).

Beach J made various comments of the impracticalities of a litigation funder being the operator of a managed investment scheme as their were “unresolved conceptual incoherence in applying Chapter 5C to litigation funding schemes”. 

3. Mayfair 101 Group to pay $30M penalty for misleading advertising

The Federal Court has ordered four companies in the Mayfair 101 Group to pay a combined penalty of $30 million for misleading advertising.

In March 2021, the Court found Mayfair Wealth Partners Pty Ltd and Online Investments Pty Ltd (trading as Mayfair 101), M101 Nominees Pty Ltd and M101 Holdings Pty Ltd engaged in misleading or deceptive conduct and made false or misleading representations when promoting the M+ and M Core Fixed Income Notes (21-055MR).

Mayfair 101 Group products were advertised in newspapers, on websites and via Google search advertising, when potential investors searched for terms such as ‘bank term deposits’ and ‘best term deposit’.

The Court found that the Mayfair companies represented that:

• the Notes were comparable to and of similar risk profile to, bank term deposits, when they were of significantly higher risk,

• the Notes carried no risk of default, when in fact there was a risk that investors could lose some, or all, of their principal investment,

• the principal investment would be repaid in full on maturity when this might not occur because Mayfair could extend the time for repayment for an indefinite period, and/or

• the M Core Notes were fully secured products when they were not.

The Court imposed the following penalties:

• Mayfair Wealth Partners: $10 million

• M101 Holdings: $8 million

• M101 Nominees (in liquidation): $8 million

• Online Investments: $4 million

James Mawhinney is the director of each of the Mayfair companies. In April 2021, the Federal Court restrained Mr Mawhinney from advertising and raising funds through financial products for 20 years.

In handing down the decision, Justice Anderson found that, ‘the Defendants deliberately mislead investors into investing in the Mayfair Products under the belief that they would be of low risk when in fact the Mayfair Products were highly speculative and carried very substantial risk.’

His Honour also found that Mr Mawhinney had shown no remorse ‘for the loss and harm caused to investors in the Mayfair Products.’

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