On October 29, 2019, a panel of the Ontario Securities Commission ("OSC") issued a decision (the "Decision") that will allow The Bitcoin Fund (the "Fund"), managed by 3iQ Corp. ("3iQ"), a Canadian investment fund manager, to be the first publicly traded bitcoin investment fund.
3iQ has created the proposed Fund as a non-redeemable investment fund that would invest substantially all of its assets in bitcoin. In October 2018, 3iQ filed a non-offering prospectus with the OSC with the intention of converting and refiling as an offering prospectus to raise proceeds once all regulatory concerns were resolved. However, staff at the OSC's Investment Funds & Structured Products branch ("IFSP") formally recommended against the Director issuing a receipt for that prospectus and in February 2019, the Director IFSP issued a decision refusing to issue a receipt for the Fund's preliminary prospectus. The basis for this refusal was that bitcoin was an illiquid asset as defined in National Instrument 81-102 - Investment Funds ("NI 81-102") and that issuing a receipt for the Fund's prospectus would not be in the public's interest due to (i) market integrity concerns regarding the trading of bitcoin; (ii) the security and safekeeping of the Fund's bitcoin; and (iii) limitations in respect of the Fund's ability to file audited financial statements.
After receiving the Director's decision, 3iQ and the Fund filed an application for a hearing and review.
In the OSC's October 29, 2019 Decision, the Commissioner began by emphasizing the role of securities regulators. Notably he stressed that it is not the role of securities regulators to approve or disapprove of the merits of securities being offered to the public. The Commissioner recognized that bitcoin is both a novel and risky asset and that markets for novel assets look and feel different from those prevalent in more mature markets. As a result, some novel asset classes and securities products fail and others succeed and become gold or the next great technology. The Commissioner noted that "[s]ecurity regulators are not mandated to try and pick winners and losers".
The Commissioner went on to address the concerns raised by staff at the IFSP. He first addressed the staff's submission that bitcoin is an illiquid asset, as defined in NI 81-102 and disagreed, stating that:
The evidence shows that substantial volumes of bitcoin trade daily on market facilities, many of which are regulated. These market facilities provide a liquid market for promoting price discovery for valuing the Fund's assets and for disposing of bitcoin to satisfy redemption requests.
The Commissioner then considered evidence regarding market integrity concerns. In considering the evidence he acknowledged that:
While there is evidence of market manipulation and the associated risks, there is also sufficient evidence of a real market in bitcoin, with real trading...staff has not proven that true price discovery in the bitcoin market is prevented by insufficient 'true trading' or price manipulation, at least on the regulated exchanges.
Further, the Commissioner did not accept the IFSP staff's submissions that the Fund's safeguards for its bitcoin did not comply with the custodial requirements under NI 81-102. He noted that the general safeguarding of assets is an "operational risk" that is highlighted in the Fund's prospectus and pointed to the following facts regarding the Fund's proposed custodian Cidel Trust Company ("Cidel"), and qualified sub-custodian Gemini Trust Company ("Gemini"):
- Cidel is a regulated Canadian trust company;
- Cidel is an experienced custodian;
- Gemini is regulated by New York State and is subject to a regulatory regime specific to crypto-assets. Every two years, New York State conducts an examination to determine the safety of the conduct of Gemini's business;
- Gemini has a legal obligation under New York law to establish and maintain an effective cybersecurity program and a written business continuity and disaster recovery plan;
- Gemini is a qualified custodian under NI 81-102;
- Gemini has over $100 million in assets (which could be used to satisfy any settlement or judgment in favor of the Fund, even without insurance); and
- Gemini will have insurance for the Fund's bitcoin to the extent it is held in hot wallets, for the brief periods when the bitcoin is sold to satisfy redemption requests. Otherwise, the Fund's bitcoin will be held offline in cold storage.
Lastly, the Commissioner accepted 3iQ's evidence that a "a qualified and reputable auditor says it can conduct the audit, even without a System and Organization Controls for Service Organizations (SOC 2) type 2 report, and still comply with generally accepted auditing standards."
When considering all of the evidence relating to whether the issuance of a receipt for a final prospectus for the Fund was not contrary to the public interest the Commissioner stated that:
Denying investors the opportunity to invest in bitcoin through a public fund would not promote fair and efficient capital markets and confidence in capital markets. Instead, it would suggest that investors should acquire bitcoin through unregulated vehicles, and capital market participants should be encouraged to create those vehicles.
The OSC's Decision to set aside its original decision and approve the issuance of a receipt for the Fund's prospectus is a signal to the marketplace that regulators in Canada are becoming increasingly supportive of innovative asset classes such as bitcoin.
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