On January 16, 2020, the Canadian Securities Administrators issued CSA Staff Notice 21-327 (linked here). The Notice provides clarity as to the application of securities legislation (registration) requirements to entities acting as exchanges for crypto assets. However, the Notice also appears to materially expand (perhaps too far) the application of securities laws to entities dealing in crypto assets. The purpose of this blog post is to provide a summary of the key points of the Notice.
Who does the Notice impact?
Any person that facilities transactions relating to crypto assets (both digital assets and cryptocurrencies), including buying and selling crypto assets ("Platforms").
Why Issue the Notice?
Certain Platforms are operating under the view that they are not subject to securities laws because they only allow for transactions involving crypto assets which are not derivatives or securities. However, the CSA has determined that the Platforms are actually providing users with a contractual right or claim to an underlying crypto asset (rather than immediate delivery of the crypto asset to the users). In that case, CSA views the Platform as subject to securities legislation. Put another way, the CSA has concerns with cryptocurrency activities which are not carried out by securities dealers.
Is there a "test" for whether securities law applies to Platforms?
There is no bright line test in the traditional sense. The CSA has said that Platforms will not be subject to securities legislation where both of the following requirements are satisfied:
1.The underlying crypto asset itself is not a security or derivative
- Example of a crypto asset as security: a tokenized security that carries rights traditionally attached to common shares such as voting rights and rights to receive dividends
- Example of derivative as security: a token that provides an option to acquire an asset in the future
2.The contract for the purchase/sale/delivery of the crypto asset (the "Crypto Contract") results in an obligation to make immediate delivery of the crypto asset
- This will be determined by looking at
- The contractual terms respecting the crypto asset
- Whether the Platform and the user intend, at the time the contract is entered into, to make and take delivery of the crypto asset surrounding facts whether a typical commercial practice is to make delivery under the contract.
3.The Crypto Contract is settled by the immediate delivery of the crypto asset to the Platform's user according to the Platform's typical commercial practice
- This will be determined by looking at
all the facts of the scenario. However, CSA will generally consider
immediate delivery to have occurred if all of the following are
- The Platform transfers ownership, possession, and control of the crypto asset to the Platform's user, and as a result, the user is free to use the crypto asset without (i) further involvement with, or reliance on, the Platform of its affiliated entities, and (ii) the Platform or any affiliate of the Platform retaining any security interest (or other legal right) to the crypto asset)
- Following the immediate delivery of the crypto asset, the Platform's user is not exposed to insolvency risk (credit risk), fraud risk, performance risk or proficiency risk on the part of the Platform
Are there any example scenarios to watch for?
The CSA has provided some limited examples of where securities legislation will apply and where it won't:
Securities Legislation Doesn't Apply
- Platform offers services for users to buy or sell BTC and does not offer margin or leveraged training;
- Users send money to the Platform to purchase BTC at a given price;
- The terms of the transaction require that the entire amount of BTC purchased from the Platform (or counterparty) be immediately transferred to a wallet that is in the sole control of the user, and the transfer is immediately reflected on the BTC blockchain;
- There is no agreement, arrangement or understanding between the parties that would allow the transaction to be settled other than by immediate transfer of BTC;
- The Platform's typical commercial practice is to make immediate delivery in accordance with the terms of the transaction, and for the Platform (or its affiliates) not to have ownership, possession or control of the user's BTC any point following the transaction;
- The purchase/sale of BTC is not just documented by an internal ledger or book entry that debits the seller's account with the Platform and credits the crypto asset to the user's account with the Platform – rather, there is a transfer of the BTC to the user's wallet; and
- The Platform or counterparty seller retains no ownership, possession or control over the transferred BTC.
Securities Legislation Does Apply
- Terms of a contract transacted on a Platform only require the Platform to transfer crypto assets to a user-controlled wallet on request from the user; and
- The transaction is simply recorded on the books of the Platform to document the purchase and the user's entitlement to receipt the crypto asset on demand.
What can I do now?
A thorough review of the Notice, contrasted against internal Platform policies and transactional flow, is recommended. Given that the CSA's analytical framework essentially boils down to "we'll take this on a case-by-case basis," the facts on the ground matter. Platforms should, therefore, be reviewing (i) the nature of the crypto assets they are facilitating transactions in, and (ii) the policies around delivery of those crypto assets. Critically, those Platforms should be reviewing their processes around timing of delivery and whether transfers of digital assets are immediately moving to customer wallets. This concept of "immediate transfer" may ultimately not be feasible given that many Platforms intentionally have a delay in settling their cryptocurrency trades (for example, in order to comply with anti-money laundering or "know your client" laws).
Platforms would also do well to give consideration to registration pursuant to existing securities legislation. A Platform operating as an exempt market dealer (for example) would largely avoid the concerns set out in the Notice. Conversely, however, various operating cryptocurrency exchanges have voiced concerns with the CSA's legal analysis and seemingly may be taking a stance that they are not required to register as securities dealers.
What is next?
The comments here appear to originate from the aftermath of the CSA and the Investment Industry Regulatory Organization of Canada (IIROC) regulatory efforts set forth in Consultation Paper 21-402 (linked here), which was released on March 14, 2019 and had a comment period open until May 15, 2019. Many industry players took issue with the proposals put forward by the CSA and IIROC, and it is expected that those same players will raise concerns with this new guidance from the CSA. Industry commentators in the immediate aftermath of this Notice have also raised concerns that the CSA's analytical approach here is inconsistent with the very notion of providing digital goods, which are almost invariably never immediately delivered to the buyer (e.g., movies, tickets to shows, video game currency). The combined impact of this negative industry reaction could manifest itself in an exodus of Platforms outside Canada or the exclusion of Canadian customers from using these Platforms.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.