How to Operate Fintech in Australia Without an AFSL with the Enhanced Regulatory Sandbox

Introduction

For fintech businesses and startups in Australia, navigating the regulatory landscape, particularly the financial services laws, can be complex. A significant aspect of this is often the requirement to obtain an Australian Financial Services Licence (AFSL) to legally provide financial services or deal in financial products. The AFSL licensing process can be resource-intensive, posing a considerable hurdle for new and innovative businesses in the financial services industry.

Recognising these challenges, the Australian government, through ASIC, has established the Enhanced Regulatory Sandbox (ERS). This regulatory initiative offers a valuable exemption, allowing eligible fintech businesses to test innovative financial services and products in the Australian market for a specified period without the immediate need for an AFSL or Australian Credit Licence (ACL). This article provides a practical guide on how fintech businesses can leverage the Enhanced Regulatory Sandbox to operate in Australia, offering a pathway to navigate the initial regulatory requirements and explore financial innovation.

Understanding the Enhanced Regulatory Sandbox (ERS) for Fintechs

What is the Enhanced Regulatory Sandbox?

The ERS is an Australian government initiative designed to foster financial innovation by acting as a testing ground for new financial services and credit activities. This framework allows businesses and individuals to trial their innovative solutions in real-world conditions while enjoying certain regulatory exemptions.

Notably, participants in the ERS are exempt from holding an Australian Financial Services (AFS) licence or an ACL for a limited time. This provision helps reduce the upfront regulatory burden, particularly for startups and smaller businesses. By participating in the ERS, fintech companies can validate their offerings, refine their operations, and better understand their market potential before committing to the full licensing process.

Key Benefits of the ERS for Fintech Companies

The ERS delivers several significant advantages for fintech companies seeking to innovate in the Australian financial sector:

1. Regulatory Exemptions: Fintech businesses can test new financial services or products without the immediate need for an AFS licence or ACL. This relieves them of navigating the often complex and time-consuming licensing application process upfront.
2. Cost and Resource Savings: By removing the requirement for initial licensing, the ERS enables startups and small businesses to allocate their limited resources more effectively toward developing and enhancing their offerings.
3. Extended Testing Period: The ERS provides a generous 24-month exemption period, giving businesses ample time to:
   • Test innovations in the market,
   • Gather critical feedback from consumers, and
   • Fine-tune their business models before undergoing full regulatory compliance.

These benefits make the ERS particularly appealing to startups and smaller enterprises that may struggle with regulatory resource constraints. By providing a structured and supportive environment, the ERS enables companies to focus on innovation while reducing the costs and complexities of regulatory compliance during their critical early stages.

Eligibility Criteria for the Enhanced Regulatory Sandbox

Who is an ‘Eligible Person’ for the ERS?

To access the ERS exemption, applicants must meet the eligibility requirements, which differ depending on whether the applicant is a body corporate or a natural person.

Eligibility Criteria for a Body Corporate

For a body corporate to qualify as an eligible person under the ERS, it must satisfy all of the following conditions:

• Licensing Restrictions:
  • The body corporate must not currently hold an AFSL or credit licence that authorises it to conduct the financial services, financial products, or credit activities it intends to test under the ERS.
  • It must also not act as an authorised representative of an AFS licensee or a credit representative of a credit licensee for these proposed activities.
• Previous ERS Exemptions:
  • The body corporate must not have previously been granted an ERS exemption to test the same financial service, product, or credit activity.
  • Additionally, it must not be a related body corporate of an entity that has been granted such an exemption in the past.
• Corporate Relationships:
  • It cannot be a related body corporate of an entity currently holding a relevant AFS or credit licence — or one acting as an authorised representative or credit representative for the same activities it plans to test.
• Certain Prohibited Functions:
  • The body corporate must not operate a financial market or a clearing and settlement facility.
• For Foreign Companies:
  • If the entity is a foreign company, it must be registered under Division 2 of Part 5B.2 of the Corporations Act 2001 (Cth).

Eligibility Criteria for a Natural Person

For a natural person to qualify as eligible for the ERS, they must meet the following requirements:

• Residency: The applicant must be an Australian citizen or a permanent resident.
• Licensing Restrictions:
  • The individual must not currently be authorised under an AFS or credit licence to provide the financial services, products, or credit activities they wish to test.
  • They must also not serve as an authorised representative or credit representative for the same proposed activities.
• Previous ERS Exemptions: The individual must not have been previously granted an ERS exemption to test the same financial services, products, or credit activities.

The Net Public Benefit and Innovation Tests

To qualify for the ERS exemption, applicants must also meet two critical tests underpinning the eligibility process: the Net Public Benefit Test and the Innovation Test. These requirements ensure that the ERS facilitates meaningful, innovative solutions that provide real value to the financial services sector.

Net Public Benefit Test

This test requires applicants to prove that their proposed financial service, product, or credit activity will generate a tangible benefit to the Australian public, outweighing any potential detriment that could arise from granting the exemption.

When evaluating net public benefit, regulators such as ASIC may examine factors like:

• Addressing Market Gaps: Does the proposed service solve an existing problem for consumers or address gaps in the Australian financial market?
• Consumer Advantages: How does the service improve consumer choice, reduce costs, enhance user experience, or boost efficiency?
• Risk Management: What risks does the service pose to consumers, and what measures are in place to mitigate them?
  • Additionally, how will risks to existing clients be managed if the applicant does not secure licensing or authorisation after the exemption period?

Innovation Test

Applicants must demonstrate that their financial service, financial product, or credit activity qualifies as innovative by meeting one of two key criteria:

1. The offering is entirely new to the Australian market and has no comparable services.
2. It represents a significant adaptation or improvement of an existing service.

ASIC may assess the innovation by asking:

• Market Differentiation: Is the proposed service genuinely new or different from existing offerings?
• Comparable Services: Are there any similar services already available in the Australian market, and if so, how does the applicant’s offering stand apart?

Meeting both the Net Public Benefit and Innovation Tests is critical for obtaining the ERS exemption. These criteria ensure the sandbox is used responsibly, fostering meaningful advancements while safeguarding public interests.

Scope of the ERS: Eligible Financial Services and Products

Financial Services and Products Covered

The ERS provides an opportunity for businesses to test specific financial services and products without needing an AFSL. These services can be offered to wholesale and retail clients, though the range of eligible products varies depending on the client type.

For both wholesale and retail clients, eligible financial services include:

• Financial product advice (both personal and general):
  Providing recommendations or guidance to clients about financial products.
• Dealing in financial products:
  Engaging in activities such as issuing, varying, or disposing of a non-cash payment facility. This also includes dealing in eligible financial products (excluding their issuance) and providing crowd-funding services.
• Issuing non-cash payment facilities:
  Activities related to issuing, varying, or disposing of non-cash payment products.
• Crowd-funding service:
  Facilitating services focused on crowd-funding financial products.

In the insurance sector, entities participating in the ERS may operate either as an agent or a principal for eligible insurance products.

Eligible Financial Products

The scope of financial products for which these services can be offered depends on whether the client is a wholesale or retail client:

1. For Wholesale Clients:
   Wholesale clients can access almost all financial products, excluding derivatives and margin lending facilities.
2. For Retail Clients:
   The eligible financial products are more specific and include:
   • Deposit-taking facilities and non-cash payment products issued by Australian Prudential Regulation Authority (APRA)-regulated Authorised Deposit-taking Institutions (ADIs).
   • General insurance products issued by APRA-authorised general insurers, except consumer credit insurance products.
   • Life insurance products issued by APRA-authorised life insurers.
   • Superannuation products provided by APRA-regulated superannuation funds.
   • Interests in simple managed investment schemes, where at least 80% of investments are in readily accessible or liquid forms, such as bank deposits or marketable investments.
   • Commonwealth-issued debentures, stocks, or bonds.
   • Securities listed on approved domestic or international financial markets.
   • Fully-paid ordinary shares offered as part of a crowd-funding service.

Exposure and Client Limits under the ERS

While the ERS provides businesses with flexibility, it places limits on client exposure to reduce risk and protect consumers. These include individual retail client exposure limits and an aggregate client exposure limit.

Retail Client Exposure Limit

For certain financial products offered to retail clients, a cap of $10,000 per individual retail client applies. This means each retail client’s commitment to specific financial products cannot exceed $10,000. These products include:

• Interests in simple managed investment schemes.
• Commonwealth debentures, stocks, and bonds.
• Securities listed on approved domestic or foreign exchanges.
• Securities offered via a crowd-funding service.
• Non-cash payment facilities issued by the ERS participant.

Aggregate Client Exposure Limit

Alongside the individual limits, a $5 million aggregate client exposure cap applies across all activities under the ERS exemption. This cap includes:

• The total value of financial products covered by the services provided.
• Gross written premiums for general and life risk insurance products.
• Contributions to superannuation offerings.
• The value of credit contracts entered into through eligible credit activities.

This $5 million limit encompasses all clients (both retail and wholesale), related entities, and applies for the entire duration of the participant’s involvement in the ERS—even if the exemption has previously been used.

Breaching Exposure Limits

It is essential that ERS participants monitor these limits continuously to maintain compliance. Breaching either the individual retail exposure cap or the aggregate client exposure limit will result in automatic cessation of the ERS exemption. This underscores the importance of thorough oversight when operating under the ERS framework.

Conditions and Ongoing Obligations for ERS Participants

Disclosure, Conduct, and Consumer Protection Requirements

Businesses operating under the ERS exemption must comply with strict disclosure and conduct obligations designed to protect consumers. Key requirements include notifying all clients, clearly and prominently, that the business operates without an AFSL or ACL. This notification must explicitly state that the business is neither an authorised representative nor a credit representative, meaning some standard protections tied to licensed entities may not apply. Additionally, clients must be informed in writing about significant business events, such as changes to services or the cessation of operations. Any such events must also be promptly reported to ASIC.

For retail clients, there are further mandatory disclosures. Businesses must provide:

• Their name and contact details,
• Information about remuneration,
• Details of any associations that could influence the services provided, and
• Comprehensive information about dispute resolution systems, including the contact details for the Australian Financial Complaints Authority (AFCA).

Apart from these disclosures, businesses must comply with specific conduct requirements in line with obligations imposed on AFS licensees. These include:

• Providing Statements of Advice (SOA) for personal advice given to retail clients,
• Adhering to client money handling obligations, and
• Meeting financial product disclosure requirements.

Dispute Resolution, Compensation, and Reporting Obligations

Robust dispute resolution and compensation arrangements are critical ongoing responsibilities for ERS participants. Businesses must implement internal dispute resolution (IDR) procedures that meet the same high standards required of AFS licensees. Alongside these internal mechanisms, ERS participants must be members of the AFCA, ensuring they can manage external complaints from retail clients. Notably, these procedures must address complaints related to the financial services provided.

To further safeguard clients, businesses must also maintain adequate compensation arrangements. This typically includes holding professional indemnity (PI) insurance with a minimum coverage of $1 million per claim and in aggregate. These arrangements protect retail clients who may suffer losses arising from breaches of the Corporations Act, National Credit Act 2009 (Cth), or the ERS exemption conditions. Businesses are required to uphold these provisions—including AFCA membership and PI insurance—for at least 12 months following the end of the ERS exemption period.

Finally, after completing their ERS exemption testing period, businesses must submit a report to ASIC within two months. This report should outline key testing-phase details, such as:

• Client demographics,
• Complaints received,
• Issues encountered, and
• Revenue and expense information.

Applying for the ERS Exemption: The Notification Process

Preparing and Lodging Your Notification with ASIC

To access the ERS exemption, businesses must notify ASIC by lodging the appropriate notification form. The specific form depends on whether you are testing financial services or credit activities:

• For testing eligible financial services, use the ‘Notification to use the ERS exemption to test eligible financial services’ form.
• For testing eligible credit activities, submit the ‘Notification to use the ERS exemption to test eligible credit activities’ form.

These forms require detailed information to enable ASIC to assess your eligibility and proposed activities. As part of the process, you must provide:

• Probity, fitness, and propriety details: Information about yourself, your officers, controllers, and significant decision-makers, ensuring they meet the standards set by ASIC.
• Net Public Benefit Test explanation: A clear statement demonstrating how your proposed financial service or credit activity will provide a net benefit to the Australian public, with public benefits exceeding any potential drawbacks of the exemption.
• Innovation Test justification: Evidence showing that your proposed financial service or credit activity is innovative—either something new to the Australian market or a substantial improvement of existing services.

It is essential to certify that all information in your notification is accurate, complete, and correct. Providing false or misleading information to ASIC is a serious offence and could result in the rejection of your application.

ASIC Assessment and Exemption Commencement

Once you submit your notification, ASIC has 30 calendar days to assess whether you satisfy the eligibility criteria as well as the requirements of the Net Public Benefit Test and the Innovation Test. During this period, ASIC primarily relies on the information you provide in your notification form and may not request additional documentation.

Once the assessment is complete, ASIC will notify you in writing within the 30-day time frame indicating whether you are permitted to rely on the ERS exemption. If ASIC does not respond by the end of the 30-day period, the ERS exemption will automatically take effect on the 31st day after the form was lodged.

To promote transparency, ASIC maintains a public register listing businesses currently utilising or that have previously used the ERS exemption to test their financial services or credit activities.

Conclusion

The ERS offers a significant advantage for fintech businesses in Australia by providing a pathway to test innovative financial services and products without the immediate need for an AFSL or ACL. This initiative by ASIC reduces the regulatory burden, allowing businesses to explore and validate their offerings within a 24-month exemption period. By leveraging the ERS, fintech companies can save valuable time and resources typically spent on the often complex and resource-intensive AFS licensing process and ongoing compliance, enabling them to focus on innovation and market validation.

If you are considering leveraging this exemption to test your fintech innovation, contact our team at AFSL House today. Our unparalleled expertise in regulatory frameworks and AFS licensing can provide you with the specialised knowledge and support needed to successfully utilise the Enhanced Regulatory Sandbox and achieve your business objectives in the Australian market.

Frequently Asked Questions