Australian update: PFMIs on Crypto Exchanges

Last month, the Australian Securities and Investments Commission (ASIC) published its Corporate Plan for 2018-2022. One of the action plans is to develop an approach for applying principles for regulating market infrastructure providers to crypto exchanges, officially known as the Principles for Financial Market Infrastructures (PFMIs).

The Principles are 24 global standards that markets infrastructures (such as central counterparties and custodians but not exchanges) are expected to follow. CPMI-IOSCO members including USA and Australia have undertaken to incorporate these principles in their legal and regulatory frameworks.

Note that the Principles do not apply to securities exchanges – yet ASIC is proposing to apply them to crypto exchanges.

This is significant because it suggests that crypto exchanges fall in the same bucket as central counterparties, central securities depositories, securities settlement systems (CCPs, CSDs, SSSs). After all, crypto exchanges are, in addition to operating a market, also facilitating the transfer of digital assets between parties by maintaining an internal ledger and custodying the digital assets on behalf of the customers – roles traditionally maintained separately by CCPs, CSDs and SSSs. 

That is, crypto exchanges are playing three fundamental but distinct roles – market, clearing/settlement, and custodian.  For centralized crypto exchanges, the clearing and settlement may be as simple as updating an internal ledger whilst custodying the digital assets on behalf of the customers. For decentralized or non-custodial exchanges, the “trade is the settlement” is an innovative concept (see Airswap, T0 and R3 talk about this) that if approved by regulators, could radically change or eradicate the clearing industry.

By applying global principles instead of local regulatory frameworks (specifically the Corporations Act 2001 which governs traditional financial markets and CCPs like ASX), this move further reinforces the point that crypto exchanges cannot be regulated under those traditional categories where no financial products are involved. 

It will be interesting to see whether ASIC will:

  1. Distinguish between the application of the Principles on centralized vs decentralized exchanges (DEX);
  2. Extend the application of the Principles to crypto wallets/crypto custodians.

Another observation is that a DEX, whilst not necessarily a CCP or SSS as defined under the Principles because it is non-custodial and transactions are P2P, could potentially be a Clearing and Settlement Facility as defined under the Corporations Act where financial products are involved. However if a DEX is truly decentralized (e.g. operating autonomously via smart contracts without a central point of control or operator), it is unclear whether it falls within ASIC’s scope as the regulation against operating an unlicensed Clearing and Settlement Facility assumes that there is an operator of the said facility/DEX.

If a DEX has no operator, section 820A of the Corporations Act can’t apply, right?

I’ll conclude with recent quotes from some key Australian regulators:

In Australia, we take the view that you cannot avoid liability by saying “My robot did it” — Rod Sims (Chairman of the Australian Competition and Consumer Commission)

[Greg] did not want to see technology platforms or algorithms “shifting risk to consumers and other areas of society” … there needs to be a person who is responsible for its design and its outcomes — you can’t just be pointing at the algorithm— Greg Medcraft (former Chairman of ASIC)

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