In Canada, the Canadian Securities Administrators (CSA) have made considerable progress in standardizing a regulatory framework for crypto asset trading platforms (CTPs), as reflected by the recent registration and enforcement decisions discussed below. Given the recent volatility and events in the digital asset markets, the relative certainty afforded by this framework may provide welcome stability for crypto asset businesses seeking registration and may serve as a cautionary note for those CTPs which are operating in Canada and have not yet taken steps to become registered.
CTP registration trends
On May 30, 2022, Virgo CX Inc. (VirgoCX) received regulatory approval from the CSA to operate a CTP in Canada. VirgoCX is the seventh CTP1 to become registered as a restricted dealer under the CSA's "interim" restricted dealer framework (this framework was previously discussed in our blog post on osler.com) and its registration closely mirrors the regulatory approval received by Bitvo Inc. (Bitvo) on April 25, 2022.2 While the regulatory review process and the exemptive relief granted to CTPs by the CSA has been considered "novel", tailored to the specific facts and circumstances of each filer, VirgoCX's and Bitvo's approval strongly suggests that the CSA has landed on a relatively standardized set of terms and conditions for the registration of retail-facing CTPs at this time.
As reported in our Legal Year in Review (2021): Decoding Crypto – providing regulatory clarity to cryptoasset businesses, the terms and conditions placed upon restricted dealer CTPs are intended to address what the CSA views to be the key investor protection concerns associated with crypto assets. Consistent with the other restricted dealer CTPs, the terms and conditions placed on VirgoCX's and Bitvo's registrations include:
- Custody: VirgoCX and Bitvo must hold at least 80% of client crypto assets with a qualified custodian under Canadian securities legislation at all times. Interestingly, in contrast to Bitvo and other CTPs that only use a third-party provider like Fireblocks Inc. to secure the remainder of client assets (i.e., in the CTP's "hot wallets"), VirgoCX is permitted to hold up to 5% of client crypto assets in its own proprietary hot wallets.
- Insurance: In addition to the financial institution bond required under securities legislation, VirgoCX and Bitvo have obtained third-party guarantees and/or self-insurance to address the risks that result from hot wallets (which are generally excluded from such policies).
- Account appropriateness model and recommended loss limits: To date, restricted dealer CTPs have either complied with the suitability requirement under securities legislation or received exemptive relief from this requirement. VirgoCX and Bitvo, by contrast, both received relief from this requirement, which is conditioned on conducting an "account appropriateness" assessment and recommending a loss limit based on each client's specific risk tolerance.
- Know your product (KYP): VirgoCX and Bitvo must each conduct diligence to satisfy themselves that none of the crypto assets available for purchase on their platforms are securities or derivatives, and must obtain legal advice if necessary to make this determination.
- Specified crypto assets and purchase limits: In CSA jurisdictions other than Alberta, British Columbia, Manitoba and Quebec, for crypto assets other than Bitcoin, Ether, Bitcoin Cash and Litecoin (which can be offered on an unlimited basis), VirgoCX's and Bitvo's clients are subject to an annual purchase limit of $30,000.
- Two-year transition to IIROC: As with all CTPs registered in the "interim" restricted dealer framework, VirgoCX and Bitvo are expected to transition to investment dealer registration and obtain membership with the Investment Industry Regulatory Organization of Canada (IIROC).
The evolution of the regulatory landscape is also apparent as it relates to enforcement. Continuing the trend we reported in our Legal Year in Review (2021): A dynamic year for capital markets enforcement, the period of May 2021 to June 2022 saw a marked increase in enforcement activities by Canadian securities regulators (notably by the Ontario Securities Commission (OSC)) against CTPs – in addition to other steps that further signal the new wave of enforcement we discussed. Among other things:
- a panel of the Capital Markets Tribunal (Ontario) approved a settlement agreement between the OSC and Bybit Fintech Limited (Bybit). Bybit is an international CTP that provides users with contracts involving crypto assets (in particular, crypto asset futures contracts and leveraged trading up to a 100:1 basis), which opened approximately 368 accounts for Ontario investors from December 2018 to June 2022. In the settlement, Bybit admitted that it had breached the registration and prospectus requirements of the Securities Act (Ontario) and agreed to, among other things: (a) disgorge all gross revenue (i.e., without deduction for overhead expenses) earned from those 368 accounts, being $2,468,910.00 USD; and (b) give various undertakings, including an undertaking to wind down the offending portion of its Ontario business. In its written reasons, the Tribunal noted that Bybit did not contact the OSC by the deadline described in our prior blog post on osler.com. OSC Staff tried to contact Bybit directly, and after not receiving a response, commenced enforcement proceedings;
- in another decision, a panel of the Capital Markets Tribunal (Ontario) ordered substantial monetary sanctions ($2M) and a permanent market participation ban against international entities Mek Global Limited and PhoenixFin Pte. Ltd. (collectively, KuCoin), for distributing securities without a prospectus or any exemption from the prospectus requirements in contravention of Ontario securities law. In its decision, the Tribunal reiterated that, in interpreting whether an instrument is a "security", the Tribunal must adopt a purposive (rather than formulaic) approach that is grounded in the "overarching lens" of consumer protection. The Tribunal found, among other things, that the availability of significant leverage in KuCoin's margin accounts and the encouragement to use margin through promotional coupons raised serious investor protection concerns;
- the Financial Markets Administrative Tribunal (Québec), upon request of the Autorité des marchés financiers, issued fines and orders barring two entities (and their principals) from participating in the capital markets. While not CTPs, these entities were in the business of mining crypto-assets on behalf of users, with users' ability to earn money dependent on the underlying value of those mined assets. This arrangement was found to be an "investment contract" requiring an approved prospectus or registration in accordance with the Securities Act (Quebec);
- the largest international CTP by market cap, Binance Holdings Limited and Binance Canada Capital Markets Inc. (Binance) was required to provide a public undertaking to the OSC to cease opening new Ontario accounts, cease trading in existing Ontario accounts, retain an independent compliance consultant, and provide ongoing reporting to the OSC. Binance now says it hopes to obtain regulatory approval and re-enter the market by 2024 at the latest;
- in its Business Plan for the fiscal years ending 2023-2025, the OSC announced a number of measures to "strengthen" its oversight of CTPs, including developing capabilities in CTP oversight and the hiring of additional staff to address emerging regulatory issues in this area; and
- securities regulators regularly publish notices to warn investors about specific CTPs, in particular CTPs based outside of Canada (see most recently here and here).
This increased enforcement dynamic is not uniquely Canadian. In May 2022, for example, the SEC announced a doubling of the size of its Crypto Assets and Cyber Unit in the Division of Enforcement. This comes on the heels of the landmark settlement between a large American crypto lending platform, the SEC and 32 state regulators whereby the platform agreed to pay fines totaling US$100 million for failing to register the offer and sales of its interest-bearing cryptocurrency accounts. One of the regulators' main concerns was that the platform made loans of cryptocurrency to institutional investors (referred to as rehypothecation), without adequate collateralization, while also misleading retail investors of the risks associated with the product. Clearly, the consequences of operating a CTP or other cryptoasset business without appropriate consideration for Canadian securities laws can be significant. As the examples above show, it is often better to ask for permission than beg for forgiveness.
1. A list of the CTPs currently registered to operate in Canada is available here. An eighth entity, Fidelity Clearing Canada ULC (FCC), is registered as an investment dealer and offers cryptoasset services to institutional clients, as we reported in our blog post on osler.com.
2. On June 17, 2022, FTX Trading Ltd. (a large international CTP) entered into an agreement to acquire Bitvo. The acquisition is expected to close in the third quarter of 2022, subject to regulatory approval and customary closing condition.
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