The outcome of Australian Securities and Investments Commission v Bit Trade Pty Ltd [2024] FCA 953 (Kraken Case), for which judgment was handed down on 23 August 2024, was somewhat unenlightening so far as it related to the application of the design and distribution (DDO) regime to credit – which is to say, rather, that it clarified nothing of note.
While there have been quite a few posts shared summarising the case and the judgment, we see the case as an opportunity missed if only alternate arguments had been raised in the Kraken Case. Before we explain the key issue that now lingers post-Kraken Case, and how it might have been clarified in other circumstances, we break down what the case was about, the submissions raised and the outcome.
The case
ASIC initiated proceedings alleging that Bit Trade breached the DDO obligations because it had not prepared a TMD for its margin extension product (Product) accessible via the Kraken Exchange. Customers could access the Product to receive margin extensions in the form of digital assets or fiat currency to make spot purchases and sales of digital assets on the Kraken Exchange. Margin extensions are arguably a form of credit or, alternately, depending on the structure, might function as a contract for difference, which is a form of derivative. ASIC elected to argue that the Product was some form of credit facility.
To win this case, ASIC only needed to establish that the Product was caught by the broader definition of a financial product in section 12AB of the Australian Securities and Investments Commission Act 2001 (Cth), which does include a credit facility as defined in regulation 2B of the Australian Securities and Investments Commission Regulations 2001 (Cth). The case was limited to this issue because, while the DDO regime is limited to retail product distribution conduct, which includes any dealing in a financial product to a retail client, the agreed facts accepted that the Product was distributed to retail clients. Accordingly, the case turned on whether the Product was a financial product.
Bit Trade’s submissions
While Bit Trade acknowledged the Product included some form of financial accommodation, Bit Trade submitted that the Product was not a credit facility and was, therefore, not a financial product for the purposes of DDO.
All Bit Trade’s submissions centred around the concept that a customer didn’t incur a ‘debt’ under the Product as required by the definition of a ‘credit facility’ in regulation 2B. The different reasons argued to support this were:
- a customer may receive a margin extension in digital assets and is required to return to Bit Trade an equivalent amount of the same digital asset. As digital assets are not money, any obligation to repay digital assets does not constitute a debt;
- a customer may receive a margin extension in foreign currency and case precedent confirms that an obligation to pay an amount in foreign currency does not create a debt;
- there was no obligation for a customer to close out a position and, therefore, there is no obligation to repay, which is a required feature of a debt; and
- any debt was notional as the debt was reflected by ledger entries only and did not give rise to an actual debt that needed to be repaid by the customer.
ASIC’s submissions
ASIC submitted that the Product did involve a ‘debt’ and that:
- Bit Trade’s interpretation of ‘debt’ was unduly narrow;
- a ‘debt’ was not limited to an obligation to pay money and equally applied to an obligation to repay digital assets; and
- if this was incorrect, the Product was nonetheless caught by the DDO requirements because the Product distributed by Bit Trade allowed for margin extensions in the form of fiat currency and customers would be required to pay these margin extensions under certain circumstances. ASIC argued that it was sufficient that customers had the option to incur an obligation to repay fiat currency under the Product and the definition of ‘retail product distribution conduct’ did not require that any customers had actually incurred any debt in fiat currency.
The judgment
The court agreed with ASIC on all points except its submission that the term ‘debt’ equally applies to an obligation to repay digital assets.
In summary, the court held that:
- where a customer was provided a margin extension in fiat currency (whether AUD or a foreign currency like USD) and was required to repay the margin extension using the same type of asset, this would amount to a ‘debt’ as the customer was required to repay using fiat currency;
- where a customer could repay using “Funds”, this did not amount to a debt as the customer had the discretion to repay using digital assets and was not necessarily required to repay using fiat currency; and
- it did not matter whether or not customers were actually provided with a margin extension in the form of fiat currency. Rather, it was sufficient that Bit Trade issued this product, and that the product included the ability to access margin extension in the form of fiat currency. In determining this, the court had regard to the definition of “retail product distribution conduct” for the purposes of DDO.
Alternate view
The arguments run by Bit Trade were very technical and narrow as they centred on the definition of ‘debt’ for the purposes of a credit facility under the definition of a “financial product” for DDO purposes.
In our view, this was a missed opportunity, as the DDO regime doesn’t readily contemplate unregulated investment credit products and this case would have provided fertile ground to assess the intent and scope of the DDO regime when it comes to these products.
This is because part of the test for whether the DDO regime applies is whether the product is provided to customers “as retail clients”. This contrasts with the test for whether a credit product is regulated as consumer credit, which is whether the credit is “provided to an individual or strata corporation for a personal, domestic or household purpose.” Notably, any credit product used for investment purposes is not caught by this test.
So, to work out if an unregulated investment credit product is caught by the DDO regime, it is necessary to work out if the product is issued to retail clients. This is problematic as the definition of “retail client” in section 761G of the Corporations Act 2001 (Cth):
- was designed for investment products (and not credit products); and
- was not modified by the drafters when the DDO regime was introduced in the ways one would expect to properly cater to credit facilities.
The outcome of this is that the definition of retail client is not readily or easily applied to credit products and, to the extent it can be applied, it creates discrepancies in how different credit products are treated under two separate regulatory regimes – the consumer credit and DDO regime. The result of this is it deprives some consumers of protections under one regime, while giving protections to people who don’t have them under the other.
On the basis of the above, we think there is a reasonable argument that the DDO regime was not intended to apply to unregulated investment credit products and we would have run this argument as an alternative to Bit Trade’s above. However, given that the Kraken Case presumed that there was retail product distribution conduct based on the agreed facts, the court did not analyse this issue at all.
It will be interesting to see if there is an opportunity to further test this thinking in the courts as, in the meantime, providers of investment credit find themselves operating in an uncertain area, without the benefit of case precedent or ASIC guidance.
In the meantime, if you are looking to launch a margin trading product for digital assets or some other unregulated investment credit product you will need to consider whether the DDO regime will apply to this product.
To help you work this out, you should ask yourself the following questions:
- What is the target market for your product?
- Will this target market include everyday consumers or only sophisticated investors?
- Should you limit your product to wholesale clients?
- If yes, what test will you rely on?
- If no, what (if any) controls should you put in place to make sure potential customers fall within the target market, understand what the product is and the risks of the product (e.g. qualifying questionnaire or test, learning modules etc)
If the DDO regime does apply, it is critical that you design the TMD and any distributor arrangements in a compliant manner that reflects the nature of the product, target market, risks and review and reporting triggers. TMD’s have certainly been a focus area for ASIC and it’s important that you get your TMD right the first time. ASIC has exercised its product intervention powers this past year or so in relation to what it believes are deficient TMD’s and there are certainly learnings that can be drawn from recent enforcement activity.
We have helped a number of clients navigate these issues and would welcome the opportunity to discuss with you.
For more information, please contact Michele Levine and Jaime Lumsden.
