In the aftermath of recent major disruptions in the crypto
industry, securities regulators in Canada have again raised the bar
for unregistered crypto asset trading platforms (CTPs) operating in
Canada.
In the latest of a series of announcements conveying its evolving
regulatory approach to the CTP industry, the Canadian Securities
Administrators (CSA) umbrella group has given notice that it is
enhancing the requirements that regulators impose on unregistered
CTPs in their preregistration undertakings (Undertakings). These
enhanced requirements include stricter standards of governance,
reporting and handling of customer assets. The new CSA guidance
sets a 30-day deadline (expiring March 24, 2023) by which
unregistered CTPs are expected to provide a revised Undertaking.
The guidance also expands on the CSA's previously announced
position that stablecoins may constitute securities and/or
derivatives under Canadian securities legislation.
This guidance is set out in CSA Staff Notice 21-332, Crypto Asset Trading Platforms:
Pre-Registration Undertakings – Changes to Enhance Canadian
Investor Protection (the Staff Notice), published on
February 22, 2023.
BACKGROUND TO THE STAFF NOTICE
The Staff Notice further clarifies the CSA's previously
announced positions on Undertakings and stablecoins. The CSA's
goals in requiring the Undertakings are to enhance investor
protection and also to level the playing field between CTPs that
continue to operate in Canada without complying with applicable
securities laws and CTPs that are registered and are subject to a
significant compliance burden.
First, in August 2022, the CSA announced that CTPs that operate in
Canada but are not yet registered to do so must sign a
preregistration undertaking that addresses investor protection
concerns. The CSA concurrently published the Undertakings delivered
by two platforms that were not yet registered at that time. See our
August 2022 Blakes Bulletin: Undertakings Now Expected for
Crypto Asset Trading Platforms Operating in Canada While Seeking
Registration.
Then, in December 2022, the CSA announced that Undertakings should
include expanded terms respecting custody, asset segregation and a
restriction on margin lending. The CSA also announced it would
shortly communicate to unregistered platforms a deadline by which
Undertakings must be delivered, and stated its view that
stablecoins, or stablecoin arrangements, may constitute securities
and/or derivatives. See our December 2022 Blakes Bulletin: CSA Gets Tougher on
Unregistered Crypto Trading Platforms and Takes Position on
Stablecoins.
In addition to further clarifying the CSA's approach to
Undertakings and stablecoins, the Staff Notice sets out a reminder
that non-compliant CTPs may become targets of enforcement.
PREREGISTRATION UNDERTAKINGS
CSA staff are requiring that unregistered CTPs sign Undertakings
as a precondition to being permitted to continue to operate while
the CTPs pursue their applications for registration and related
relief. Unregistered CTPs that do not sign an Undertaking that
meets the newly enhanced expectations of CSA members within 30 days
of the publication of the Staff Notice (i.e., by March 24, 2023),
and those that do not comply with an Undertaking, will be expected
to comply with CSA staff expectations regarding winding down
Canadian operations or potentially face enforcement action.
The new commitments CSA staff are now requesting from unregistered
CTPs relate to the following
areas:
- enhanced commitments in relation to the custody and segregation of assets held on behalf of Canadian clients, including that cash must be held with a Canadian custodian or financial institution and that crypto assets must be held by an "Acceptable Third-party Custodian," which, in the case of a non-Canadian custodian, may require preapproval by applicable CSA members;
- enhanced commitments to preclude the unregistered CTP from pledging, rehypothecating or otherwise using crypto assets held on behalf of Canadian clients, including providing evidence of meaningful compliance systems and corporate governance controls to meet this commitment;
- a prohibition on the part of the CTP offering margin, credit or other forms of leverage to any type of client (even sophisticated "permitted clients") in connection with the trading of crypto;
- new commitments from global affiliates, parent companies and/or controlling minds to co-sign the Undertaking and make certain commitments to respect the applicable CTP's independence;
- restrictions on the CTP relying on crypto assets in determining the capital of the CTP for excess working capital purposes and in determining the capital base of the CTP;
- enhanced commitments in relation to the filing by the CTP of financial information with the CSA on a regular basis;
- enhanced commitments in relation to the retention of a qualified chief compliance officer (CCO), who generally must meet the requirements for the CCO of an exempt market dealer, during the pre-registration process;
- a prohibition on the part of the CTP in respect of clients buying or depositing stablecoins (or what the CSA is calling "Value-Referenced Crypto Assets") through crypto contracts without the prior written consent of the CSA; and
- a prohibition on the part of the CTP in respect of trades in crypto contracts based on proprietary tokens, except with the prior written consent of the CSA.
For a more detailed discussion of crypto contracts and the background to the securities regulatory approach to CTPs in Canada, see our April 2021 Blakes Bulletin: Canadian Securities Regulators Deliver Bear Hug to Crypto Asset Trading Platforms Operating in Canada.
STABLECOINS OR "VALUE-REFERENCED CRYPTO ASSETS"
The Staff Notice also sets out interim guidance regarding
whether and how CTPs can trade in stablecoins. The CSA has adopted
the term "Value-Referenced Crypto Assets" (VRCAs) to
discuss assets commonly called stablecoins, based on the CSA's
view that the term "stablecoin" may misleadingly imply
that this type of asset will always maintain a stable value. VRCAs
include stablecoins that aim to maintain a peg to a fiat currency,
such as Tether and USD Coin, or to other assets or values (e.g.,
gold), and can be reserve-backed or algorithmic. CSA members
express the view in the Staff Notice that VRCAs generally meet the
definition of "security" and/or "derivative,"
but that the assessment of each particular asset will depend on the
specific facts and circumstances.
The Staff Notice raises a number of policy concerns relating to
trading in VRCAs, including lack of transparency regarding
reserves, stabilization mechanisms and governance; potential for
investor confusion about risks of loss or rights associated with
holding VRCAs; and management and custody of reserved assets,
including "bank-run"-style redemption risks. The Staff
Notice identifies algorithmic VRCAs as being particularly
risky.
In light of these concerns, Undertakings must include a prohibition
on CTPs allowing their clients entering into crypto contracts to
buy or deposit VRCAs without the CTP obtaining the prior written
consent of the CSA. Such consent may be subject to terms and
conditions imposed on the CTP and the issuer of the VRCA. CSA
members will expect the CTP to conduct sufficient due diligence
review to ensure that risks relating to the VRCA are addressed and
the VRCA meets a number of acceptability criteria. In particular,
the Staff Notice casts doubt on whether VRCAs will be acceptable if
they are not fiat-linked and fully reserved by highly liquid assets
that are segregated from the issuer's assets and held by a
qualified custodian, among other things. In addition, Undertakings
and exemptive relief orders may explicitly prohibit trading in
certain assets; for example, certain registered platforms have been
explicitly prohibited from trading in Tether with Canadian
clients.
The Staff Notice notes that the outlined approach is interim in
nature and the CSA is continuing to consider its approach to
VRCAs.
COMPLIANCE AND ENFORCEMENT
The CSA continues to warn unregistered CTPs that CSA staff will consider compliance and/or enforcement action against a CTP and its principals where warranted, such as where a CTP currently operating in Canada:
- is not prepared to file an Undertaking (or revised form of Undertaking) in a form acceptable to CSA staff;
- files an Undertaking but does not abide by its provisions; or
- does not make bona fide attempts to progress through the registration process as quickly as possible.
Enforcement or compliance action may also be taken where other information comes to the attention of CSA staff that raises investor protection or other public interest concerns.
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