Retail Investment Limits under the Canadian Crypto Asset Trading Platform (CTP) Regulatory Regime
It has been a tumultuous week in the global crypto asset markets. For all of us working in this sector, risk exposure to both crypto assets and to centralized crypto trading platforms is top of mind. These risks are important drivers of Canada's emerging regulatory regime for crypto asset trading platforms (CTPs) as securities dealers and marketplaces.
The Canadian Securities Administrators (CSA), an umbrella organization for all of the provincial and territorial securities regulatory authorities in Canada, formally introduced the CTP regulatory framework on March 29, 2021 with the publication of a Staff Notice which confirmed that internet-based CTPs that maintain custody of customer assets are considered to be dealing in securities and must register as dealers under the securities laws of each CSA jurisdiction in which they operate.
Since the CSA affirmed jurisdiction over custodial CTPs, ten Canadian domiciled CTPs have become registered as dealers with the CSA (Registered CTPs). Each Registered CTP is subject to prescribed terms and conditions (T&C) applicable to the operation of its platform as set out in a public order granted by the CSA at the time of registration (the CTP Orders)1. The T&Cs are intended to reduce investor protection risks associated with CTP operations by imposing detailed obligations on Registered CTPs relating to crypto asset custody, insurance, risk disclosure, product due diligence and other matters.
Of paramount importance is the requirement for Registered CTPs to hold at least 80% of the total value of crypto assets held by the CTP on behalf of clients with a custodian that: (i) meets the criteria for a "qualified custodian" of securities, including prudential licensing and minimum capital; (ii) has appropriate insurance to cover the loss of client assets; and (iii) has obtained a SOC 2 Type 2 report in the last 12 months (subject to the discretion of the CSA to waive such criteria).
Another key investor protection measure prescribed in the CTP Orders is the requirement for each Registered CTP to impose limits on the Canadian dollar value that retail investors resident in certain Canadian jurisdictions (the Investment Limit Jurisdictions)2 may invest in crypto assets other than "Specified Crypto Assets" on the platform. The CTP Orders designate bitcoin, Ether, Litecoin and Bitcoin Cash as "Specified Crypto Assets". Specified Crypto Assets are not subject to investment limits because they are considered to be relatively liquid. It is expected that the list of Specified Crypto Assets may change over time. In this article, crypto assets other than Specified Crypto Assets are called "Restricted Crypto Assets".
The CTP Orders reflect two different business models for investment limits that are imposed on Registered CTPs, described below.
Account Appropriateness Model & C$30,000 Limit
Seven out of the ten Registered CTPs operate under this model3. These Registered CTPs have obtained exemptive relief from the obligation that applies to registered dealers under securities laws to confirm that each trade executed with or on behalf of a client by the dealer is suitable for the client (the Suitability Obligation)4. The Suitability Obligation includes prescriptive requirements for collecting large amounts of know-your client (KYC) information, refreshing the information periodically and using it to evaluate proposed client trades and determine what portion of a client's total investible assets would be suitable for investing in various asset classes (e.g. equities, fixed income and alternatives).
Registered CTPs that have obtained relief from the Suitability Obligation have accepted T&Cs similar to those which apply to discount brokerage securities platforms regulated by the Investment Industry Regulatory Organization of Canada (IIROC) that only execute orders but do not provide advice to clients. T&Cs therefore include restrictions against making recommendations, providing advice or offering services to clients who do not demonstrate sufficient competence to conduct online activities. In addition, these CTPs must confirm that their clients have an appropriate risk tolerance to trade in crypto assets and must warn clients when their trading losses on the CTP approach a loss limit established by the CTP based on client responses to KYC questions.
Finally, Registered CTPs that are exempt from the Suitability Obligation must ensure that the maximum amount of Restricted Crypto Assets that a client resident in an Investment Limit Jurisdiction may purchase and sell on the platform in a rolling backward-looking 12 month period (calculated on a net basis and is an amount not less than $0) does not exceed a net acquisition cost of C$30,000 (the $30K Limit).
Put another way, each client resident in an Investment Limit Jurisdiction starts with C$30,000 worth of "room" in their CTP account to buy Restricted Crypto Assets on the platform. Each dollar spent on Restricted Crypto Assets on the platform reduces room in the $30K Limit by a dollar (to a minimum of zero), and each sale of Restricted Crypto Assets on the platform restores the remaining room up to a maximum of $30K. Once a client uses up all available room in the $30K Limit (i.e., has made net purchases of Restricted Crypto Assets equal to $30K in a given year), the CTP must not allow the client to purchase any additional Restricted Crypto Assets on the platform unless the client makes more room by selling some Restricted Crypto Assets on-platform.
The $30K Limit is based upon the C$30,000 cap that applies to investments made by "eligible investors"5 in reliance on the offering memorandum exemption from the prospectus requirement in Ontario and certain other CSA jurisdictions6. Interestingly, accountholders on CTPs do not need to be "eligible investors" to qualify for the $30K Limit.
Investment Tier Model
Three out of the ten Registered CTPs operate under this model. Two of these CTPs agreed to comply with the Suitability Obligation in their CTP Order7 and represented that they would "use technology to facilitate the determination of whether [a trade] is suitable for a client before accepting an instruction from that client". The third CTP8 is a member of IIROC and may rely on exemptive relief from the Suitability Obligation that is available to IIROC members operating discount brokerage platforms. These CTPs also conduct an account appropriateness assessment of each client but they are not subject to the $30K Limit.
Registered CTPs which operate under the Investment Tier model must ensure that the maximum amount of Restricted Crypto Assets that a client resident in an Investment Limit Jurisdiction may purchase and sell on the CTP (calculated on a net basis and is an amount not less than $0) in the preceding 12 months:
- in the case of a client that is not an Eligible Crypto Investor, does not exceed a net acquisition cost of C$30,000;
- in the case of a client that is an Eligible Crypto Investor, but is not an Accredited Crypto Investor; does not exceed a net acquisition cost of C$100,0009; and
- in the case of an Accredited Crypto Investor, is not limited.
Although the amount of Restricted Crypto Assets which may be sold to an Accredited Crypto Investor is unlimited, the suitability of each trade must be considered within the context of the account appropriateness assessment conducted by the CTP.
The categories for "Eligible Crypto Investor" and "Accredited Crypto Investor" are based on the "Eligible Investor" and "Accredited Investor" categories prescribed in private placement exemptions from the prospectus requirement under applicable securities laws, except that individuals are permitted to include the value of crypto assets in their calculation of net "financial assets" for the purpose of qualifying as Accredited Crypto Investors.
Specifically, an "Eligible Crypto Investor" means a person: (i) whose net assets (including crypto assets), alone or with a spouse, exceed C$400,000; or (ii) whose net income exceeded C$75,000 in the two most recent years and expects to exceed that income level in the current year; or (iii) whose net income, alone or with a spouse, exceeded C$125,000 in the two most recent years and expects to exceed that income level in the current year.
"Accredited Crypto Investor" means an individual: (i) who, alone or with a spouse, beneficially owns financial assets and crypto assets, if not included in financial assets, having an aggregate realizable value that, before taxes but net of any related liabilities, exceeds C$1,000,000; or (ii) whose net income before taxes exceeded C$200,000 in each of the two most recent years and who reasonably expects to exceed that net income level in the current year; or (iii) whose net income before taxes combined with that of a spouse exceeded C$300,000 in the two most recent years and expects to exceed that income level in the current calendar year, or (iv) who, alone or with a spouse, beneficially owns net assets (including crypto assets) of at least C$5,000,000.
The "Accredited Crypto Investor" category also includes most categories of "accredited investor" that are prescribed in the "accredited investor" exemption from the prospectus requirement under Canadian securities laws. In addition, the "Eligible Crypto Investor" category includes anyone who qualifies as an Accredited Crypto Investor.
Investment Limits apply to the Investor's Holdings on a Platform, not the Investor's Holdings across Platforms
The investment limits have not been imposed to restrict how much crypto a Canadian resident in the Investment Limit Jurisdictions can buy and hold. The CSA has not attempted to restrict the number of crypto asset trading accounts that one investor can open. Consequently, an investor can open accounts on numerous CTPs and max out their $30K Limit on all of them.
In addition, the CSA has only exerted jurisdiction over CTPs that maintain custody of crypto assets traded by clients of the platform, on the basis that the relationship between a custodial CTP and its users is itself a security and/or derivative. The CSA has not attempted to restrict Canadians from holding crypto assets in self custody or accessing trading opportunities on decentralized exchanges. The CSA has not attempted to regulate over-the-counter trading desks that immediately deliver crypto assets to digital wallets controlled by their clients.
The $30K Limit applies to the investor on each platform of which the investor is a client, and is therefore consistent with the CSA's focus on regulating market intermediaries, as opposed to crypto assets themselves. The $30K Limit limits the exposure of retail investors to the KYP process which each Registered CTP uses to select Restricted Crypto Assets for trading on their platform. Ontario Securities Commission (OSC) Chair Grant Vingoe explains this approach as follows: "For virtually all crypto asset trading platforms, the relationship between investors and platform operators is marked by a critical dependency on the operators for the selection of assets to trade, the manner in which those assets are marketed and sold, risk disclosure, and critically, the safety of the custodial arrangements that are in effect."10 .
1. The Ontario Securities Commission (OSC) maintains a web page for Registered crypto asset trading platforms which includes links to the CTP Orders.
2. The investment limits do not apply in the provinces of Alberta, British Columbia, Manitoba and Quebec. This may reflect different perceptions among Canadian regulators of the relative risk of Specified Crypto Assets and Restricted Crypto Assets.
4. The Suitability Obligation is set out in Section 13.3 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations.
5. An eligible investor has net assets of at least $400,000, net pre-tax income that exceeds $75,000 in the 2 most recent calendar years and reasonably expects to exceed that level in the current year, or net pre-tax income together with a spouse that exceeds $125,000 in the 2 most recent calendar years and reasonably expects to exceed that level in the current year.
6. $30,000 is the amount that an "eligible investor" may invest in exempt market securities distributed under the offering memorandum exemption in Ontario and many other Canadian Jurisdictions under Section 2.9 of National Instrument 45-106 Prospectus Exemptions (the Offering Memorandum Exemption).
9. C$100,000 is the investment cap applicable to an eligible investor who receives advice from a registered dealer or adviser when relying on the Offering Memorandum Exemption.
10. Grant Vingoe, "Canadian crypto-asset regulation needs a balanced, prudential approach", The Hub (August 29, 2022)
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