Design, distribution and cryptocurrency investment – a sharp position taken by ASIC

Introduction

ASIC’s Product Intervention Power (PIP) under its Design & Distribution (DDO) regime is still a relatively new tool in their regulatory tool kit. It allows ASIC to stop, or impose conditions on, the issue and distribution of financial products. We have previously considered how ASIC may use the power in connection with overseas financial products which were the subject of comparable regulatory action in our briefing article here.

What we did not consider is crypto investments, though a recent ASIC against Holon Investments Australia Limited (Holon), which offers various crypto funds, offers an illuminating (and troubling) opportunity for us to do so.

Design and distribution

Under the new Part 7.9A of the Corporations Act 2001 (Cth) (the Act), ASIC is empowered to make product intervention orders (PIO) to stop, or impose conditions on, the issue and distribution of financial products, if ASIC is satisfied that a financial product (or class of products):

• is, or is likely to be, available for acquisition by issue, or for regulated sale, to persons as retail clients; and
• has resulted, or is likely to result, in significant detriment to retail clients.[1]

ASIC can make PIOs in respect of an individual product or a market-wide class of products. Importantly, ASIC can exercise the PIP in relation to a product (or class of products) regardless of whether there has been a breach of the law. The duration of a product intervention order will depend on the circumstances of each case. ASIC is empowered to make an initial order for a duration of up to 18 months.[2]

ASIC’s Regulatory Guide 272 – Product Intervention Power, provides additional clarification on the scope and operation of the PIP. The guide notes (non-exclusively) three classes of products that PIOs can be issued for, including:

• financial products under the Corporations Act (including securities, interests in managed investment schemes, derivatives, insurance products, superannuation products and deposit taking facilities);
• credit products under the National Credit Act (including a credit contract, mortgage, guarantee or consumer lease); and
• financial products under the ASIC Act (including some types of extended warranties, some types of short-term credit and certain buy-now-pay-later arrangements).

Stop orders / target market determinations

ASIC has issued a number of interim stop orders since July 2022 on companies with Target Market Determinations (TMD) which arguably do not match up with the products they are offering. Save for Cigno Pty Ltd, in relation to a short term lending product, which you can read about here, ASIC has targeted retail fund managers whose TMDs do not match the risk profile of the product being sold as set out in their Product Disclosure Statements (PDS).

A TMD is a document which describes who a product is appropriate for (target market), and any conditions around how the product can be distributed to customers. It also describes the events or circumstances where the provider may need to review the TMD for a financial product. TMD obligations apply to issuers and distributors of products. Issuers must prepare a publicly available target market determination and take reasonable steps so that products are distributed consistently with the TMD.  Distributors must not distribute a financial product unless a TMD for the product has been made, take reasonable steps so that distribution is consistent with the TMD and notify the issuer of any significant dealings in the financial product that are not consistent with the TMD.

Cryptocurrencies

ASIC has just issued an interim stop order on Holon (its tenth to date), which offers various crypto funds to retail investors, on the basis that it thinks that Holon has not appropriately considered the features and risks of the funds in determining their target markets. Holon cannot issue interests in, give a PDS for or provide general advice to retail clients recommending investments in its crypto funds.

Each of Holon’s funds are invested in an individual crypto-asset – bitcoin, ether and filecoin. ASIC has said that “Crypto-assets are highly volatile and complex, making concentrated investments in individual crypto-assets very risky and speculative. Investors are likely to experience significant price volatility and deep negative returns in periods of asset price decline.”

In its PDSs, Holon has disclosed the risk that assets in the Funds could face a total loss of value.  However, ASIC does not consider that the PDS with its risk factors matches the target market. This includes investors with a potentially medium, high or very high risk and return profile who are intending to use the fund as a satellite component (up to 25%) of their investment portfolio; and those intending to use the fund as a solution/standalone component (75-100%) of their investment portfolio.

Two difficulties arise here. The first, is that this is arguably a finer line of judgment ASIC is exercising than in previous interim stop orders. It has stated that crypto assets – even the relatively well understood stalwart’s bitcoin and ether – are ‘very risky and speculative’ such that even investors with a ‘medium risk… and return profile’ are not suitable to make concentrated investments in the asset. Different views will be taken on where ASIC is drawing the line here, and whether the asset class is a victim of its own notoriety, though the ASIC house view on crypto assets in and of themselves is sharp and the level of disclosure required for investors is significant and very clear. This is interesting when you consider that the second most held product type is cryptocurrency (44%), compared to Australian shares (73%): ASIC Report 735 Retail Investor Research.

The second difficulty is that crypto assets themselves are vastly different and behave differently. For cryptocurrencies, many view them as quasi-financial products in and of themselves. Senator Bragg’s The Digital Assets (Market Regulation) Bill 2022 would have them classified as such, along with non-fungible tokens and other crypto products unrelated to financial services. The merits of that legislation is a separate topic, but what is worth noting is that crypto assets do not come with disclosure documents. There are no ‘issuers’ per se, save for developers (who are rarely concerned with legal disclosure documents). Unlike derivatives, equities, bonds and other financial products, there is not the same level of information to test for fund managers. All of which makes the job of the issuer of the PDS and TMD that much harder.

Takeaways

ASIC has surveillances underway to check whether product issuers and distributors are complying with DDO. While all product issuers should be rechecking their TMDs to see that they align with the disclosure documents, those whose TMDs are connected to crypto should have a much closer look. Unfortunately, the bar seems to be set extremely high for them.

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Authored by:

Matthew Bode, Partner
Taylor Green, Associate
Jessica Barge, Legal Project Coordinator
Monty Frankish, Paralegal

[1] Corporations Act 2001 (Cth) s 1023D(1).

[2] Ibid s 1023G(2).