In a detailed joint notice (the "Notice") the Canadian Securities Administrators ("CSA") and the Investment Industry Regulatory Organization of Canada ("IIROC") yesterday published a summary of their expectations of unregistered Crypto Asset Trading Platforms ("CTPs") that allow trading of "crypto assets that are securities" ("tokens") or "contracts involving crypto assets" ("crypto asset contracts")1.
The Notice codifies and elaborates on positions that securities regulators in Canada have held for some years2.
In a separate notice (the "OSC Notice") published concurrently with the CSA Notice, the Ontario Securities Commission ("OSC") has announced that CTPs with Ontario clients or that otherwise operate in the province must contact OSC staff by April 19, 2021 to discuss how to bring their operations as a dealer or marketplace into compliance. Failure to do so by this date, the OSC warns, will result in a referral to the OSC's enforcement branch.
The main points of the CSA Notice are as follows:
- Securities regulators in Canada believe that tokens and crypto asset contracts can often be characterized as securities or derivatives using the broad language in the statutory definition of the term "security".
- This characterization that tokens and crypto asset contracts are securities means that CTPs are to be regulated either as dealers or as marketplaces under existing Canadian securities laws.
- In the Notice, the securities regulators make it clear that they now expect CTPs operating within Canada or operating outside Canada but with Canadian clients to assess their platforms and take steps to fashion their "own interim regulatory approach"3 to promptly bring themselves into compliance with securities law. This interim solution will probably involve a restricted registration of some kind before full investment dealer status is achieved4.
- CTPs need to consider in light of their business model and with the help of legal advisors whether they should be regulated as a dealer or a marketplace. If orders do not interact with each other on the CTP but there is instead one counterparty (the dealer) for every client trade, dealer registration is likely appropriate.
- The CTP must then seek a path, which in the case of dealer platforms can be no longer than two years, to achieve investment dealer registration and IIROC membership. During the interim period, a CTP can, by agreement with regulators, operate on some kind of limited basis as, for example, a restricted dealer or an exempt market dealer5. CTPs that trade tokens and do not offer credit can apply depending on their circumstances as exempt market dealers, restricted dealers or even as investment dealers from the outset.
- If margin or leverage is employed by a CTP operating as a dealer, IIROC membership will have to be sought6. For platforms that trade crypto asset contracts, derivative dealer registration should be considered for businesses with customers in Quebec. During the interim period for these platforms, restricted dealer registration must be sought or a customized exemption applied for.
- Platforms that use crypto asset contracts rather than tokens will often be creating contracts as part of the platform operations. This aspect of the platform business model may require additional relief from prospectus filing obligations and over the counter trade reporting requirements.7
- A CTP has to be regulated as a marketplace rather than a dealer if the CTP operates a market or facility for bringing together multiple buyers and sellers or parties to trade in tokens or crypto asset contracts. In those circumstances, the CTP will generally be required to obtain IIROC membership and most likely will wind up being regulated under the national marketplace instrument, NI 21-101, as an "alternative trading system"8.
- Marketplaces are subject to various instruments that do not apply to dealers including rules that govern trading on marketplaces such as requirements intended to promote market integrity like those in the Universal Market Integrity Rules administered by IIROC. Marketplaces also present a need for associated clearing and settlement arrangements which have their own regulatory requirements.
- It is also recognized in the Notice that some marketplace platforms may share characteristics of a dealer and characteristics of a marketplace platform and, if that is so, the nature of the regulatory discussion will be more complex and possibly longer. Ultimately a CTP exhibiting hybrid characteristics may require a customized suite of exemptions from rules that the CTP cannot structurally satisfy.
- Similarly, IIROC requirements may not fit with all the models of CTPs and the Notice recognizes that some accommodation of IIROC rules to the business model will have to be discussed with the IIROC membership applicant.
- The Notice recognizes that CTPs reflect a range of business models and on the surface welcomes innovation. Yet the orientation is to understand the various forms of innovative models on which CTPs operate with a view to bringing them within securities regulation, not relieving them from securities regulation. The CSA's avowed openness to innovation should probably not be equated to a willingness to entertain a completely different regulatory approach for CTPs as compared to current dealers and marketplaces. This is because the CSA and IIROC continue to be focused on the risks presented by these platforms and devote an entire appendix to the Notice to a discussion of these matters.
- The OSC Notice contains another noteworthy manifestation of this wariness. It states that the OSC is aware of CTPs seeking to become reporting issuers through an initial public offering or through reverse take-overs, changes of business or similar transactions. The OSC cautions that there are potential public interest concerns with a CTP that is required to be registered, but that is not, becoming a reporting issuer. CTPs and their representatives are asked in the OSC Notice to contact their local securities regulator if they intend to become reporting issuers through an initial public offering or other transaction.
- In summary, though the Notice provides a helpful compilation of guidance on the subject, the most novel aspect is that the securities regulators expect every CTP to present itself in short order to regulators to develop a plan and a path to becoming registered within two years and to present a plan for regulated operations in the interim. This represents, if anything, a hardening of the position that has been developed through public pronouncements and regulatory action over the past few years that strongly encourages compliance by CTPs with securities regulatory requirements.
1 The CSA had previously taken the view that crypto asset contracts would generally be subject to securities regulation where a platform is merely providing its users with a contractual right or claim to an underlying crypto asset, rather than immediately delivering the crypto asset to its users. See CSA Staff Notice 21-327, pg. 1-2.
2 See, for example:
3 "The guidance in this Notice is intended to provide clarity regarding the steps that a CTP needs to take to comply with securities legislation, including interim steps that will allow a CTP to operate as they prepare to fully integrate into the Canadian regulatory structure." See Notice, pg. 2.
4 The Notice also indicates that CSA members are taking a divergent approach to regulating crypto intermediation with regulators in Ontario, Quebec, Nova Scotia and New Brunswick indicating the registration process will involve IIROC during an interim transition period while regulators in Alberta, British Columbia, Manitoba and Saskatchewan will consider other regulatory approaches during the interim period.
5 "If the Dealer Platform only facilitates distributions or the trading of tokens in reliance on prospectus exemptions and does not offer margin or leverage, registration as an exempt market dealer, or in some circumstances, restricted dealer may be appropriate, although this would not preclude the Dealer Platform from seeking registration as an investment dealer." See Notice, pg. 3.
6 "Dealer Platforms may not offer margin or leverage for tokens unless they are registered as an investment dealer and are IIROC members." See Notice, pg. 3.
7 See Notice, pg. 6.
8 In more unusual circumstances, recognition as an "exchange", a more regulated form of marketplace, may be appropriate.
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