Australia's prime minister, Kevin Rudd says asylum-seekers arriving by boat will no longer be resettled in Australia but will go to Papua New Guinea.
Mr Rudd announced the plan jointly with his PNG counterpart Peter O'Neill in Brisbane on Friday night.
Mr Rudd said the new regime to deny settlement in Australia to asylum seekers who paid people smugglers for unauthorised passage would begin immediately.
He said from now on, any asylum-seeker who arrives in Australia by boat will have no chance of being settled in Australia as a refugee.
Under the agreement, new arrivals will be sent to PNG for assessment and settled there if found to be a refugee.
Mr Rudd said to accommodate the new arrivals the offshore processing centre on Manus island will be significantly expanded to hold up to 3,000 people.
He added no cap has been placed on the number of people Australia can send to PNG.
The Manus facility currently houses 215 people in tents and shelters and living conditions are described as harsh.
Following the news, violence flared on Nauru as hundreds of asylum seekers sought to break out of the Australian detention facility there.
More than 50 asylum seekers were arrested and are held at the island's police station.
Reports also indicate hundreds have escaped the facility.
The Nauruan government said the situation was under control but several buildings had been destroyed.
Damage surveyed Friday night included large sections of new sleeping accommodation, which costs tens of millions of dollars to build, destroyed by fire.
News.com.AU had reported all staff at the centre were forced to evacuate during the riot.
Around around 300 of the 500 detainees are said to have escaped.