On December 10, 2024, the Ontario Securities Commission (the OSC) issued Staff Notice 33-757 – Review of Restricted Dealer Crypto Asset Trading Platforms' Compliance with the Account Appropriateness, Investment Limits and Client Limits Requirements (the Staff Notice). The Staff Notice was issued after carrying out a focused compliance review (a Sweep) of the know-your-client (KYC), account appropriateness assessment and Client Limit (defined below) practices of six crypto asset trading platforms (CTPs) registered as restricted dealers in Ontario. The Staff Notice outlines the results of the Sweep and offers guidance to help CTPs meet their regulatory obligations.
The Sweep underscores the ongoing efforts of the Canadian Securities Administrators (the CSA), a conglomerate of provincial securities regulators, to enhance the regulatory framework for CTPs through discretionary securities law compliance reviews of registered and unregistered platforms. CTPs are encouraged to familiarize themselves with the recommendations and potential pitfalls highlighted in the Staff Notice to ensure they meet regulatory expectations.
Key Takeaways
Sweep Findings
The findings revealed that CTPs often used an ineffective approach in gathering client information that did not address inconsistencies within the client's account settings. Information on the following "Account Appropriateness Factors" should be adequately collected for CTPs to remain compliant:
- the client's experience and knowledge in investing in crypto assets;
- the client's financial circumstances;
- the client's risk tolerance; and
- the crypto assets.
It was also found that some CTPs failed to update client information regularly, which led to inappropriate account openings and maintenance.
The OSC found no instances of non-compliance with "Investment Limits," the maximum amount of crypto assets (other than Specified Crypto Assets)1 that a client (except clients that are residents of Alberta, British Columbia, Manitoba and Quebec, that are permitted clients or registered CTPs) may buy and/or sell on the platform in the preceding 12 months does not exceed a specified net acquisition cost.2 This indicates that CTPs adhered to the prescribed maximum amounts for crypto asset purchases on their platforms.
However, the OSC identified issues with CTPs' "Client Limits" (the appropriate limit on the losses that a client can incur based on the Account Appropriateness Factors) and noted that certain CTPs assigned limits based solely on risk tolerance or arbitrary factors, which did not adequately consider clients' ability to tolerate losses. Further, certain CTPs did not effectively monitor or act upon Client Limits and allowed clients to exceed their limits without intervention.
Guidance Provided by the OSC
To address the findings, the OSC's Staff Notice recommends several practices for account appropriateness assessments. These include, but are not limited to, the following:
- Onboarding questions should capture all relevant factors (e.g., questions related to the Account Appropriateness Factors), and follow-ups should address any inconsistencies.
- Assessments of the platform should be comprehensive and updated at least annually, or more frequently if significant changes occur.
- Policies and procedures should be established for collecting, documenting, and reviewing client information, and measures should be in place to prevent clients from gaming the onboarding process.
For Client Limits, the Staff Notice advises developing an onboarding process that collects sufficient information to set appropriate limits based on all Account Appropriateness Factors. Limits should reflect clients' circumstances and be monitored continuously. Clients should receive notifications when nearing their limits and educational materials on the risks of excessive trading. Adequate policies and procedures must be in place to evaluate, monitor, and apply the Client Limit system effectively.
The Sweep – Findings and Guidance Assessment
The Sweep was conducted for six registered CTPs whose principal regulator is the OSC, to assess their compliance with the terms and conditions of their respective exemptive relief decisions, particularly as it relates to (1) account appropriateness assessments, (2) Investment Limits, and (3) Client Limits. The findings and corresponding recommendations of the OSC are outlined below:
Account Appropriateness Assessments
During the Sweep, the OSC identified the use of a "mechanical 'tick box' approach" by CTPs to gather the Account Appropriateness Factors. Where inconsistencies resulted, CTPs would not follow up with the client to address them. Additionally, the OSC observed that certain CTPs failed to update client Account Appropriateness Factors on an ongoing basis, which resulted in subsequent assessments based on outdated information. The OSC also noted that "[these] failures sometimes resulted in accounts being opened or maintained for clients where the account was not appropriate for the client."
Given these findings, the Staff Notice recommends several practices for conducting an account appropriateness assessment. First, onboarding questions should be designed to capture the Account Appropriateness Factors for each prospective client, and follow-ups should be undertaken to address any inconsistencies in the information collected. The assessment should be meaningful and comprehensive, and it should consider Account Appropriateness Factors at both the onboarding stage and on a continuing basis. The Staff Notice further notes the importance of updating the account appropriateness assessment for each client at least annually, or more frequently if there are significant changes in the client's circumstances or market conditions. In the OSC's view, maintaining books and records that document any changes in a client's information is essential. Policies and procedures should be established for collecting, documenting, and reviewing the information required to conduct a proper assessment. Finally, there should be policies and procedures in place for handling situations where it is determined that it is not appropriate for a prospective client to open an account, including measures to prevent clients from "gaming the onboarding process."
Investment Limits
During the Sweep, the OSC found no instances where CTPs failed to comply with their obligation to limit clients' purchases of crypto assets to the prescribed maximum amounts on their platforms. As such, no guidance on Investment Limits was provided in the Staff Notice.
Client Limits
During the Sweep, the OSC identified several instances where CTPs assigned Client Limits that were not adequately tailored to individual client circumstances. For example, some firms relied solely on risk tolerance as the Account Appropriateness Factor, which would not provide a comprehensive view of the client's situation. Additionally, some Client Limits were based on "arbitrary factors and dynamic factors" such as changes in the trading price of crypto assets, fluctuations in the market value of a client's portfolio, or shifts in the market value relative to the adjusted book value of their holdings. The OSC concluded that these methods do not adequately consider the client's ability to tolerate losses and are not appropriately customized to each client's unique circumstances. Furthermore, the OSC found that some CTPs did not effectively monitor Client Limits or take meaningful action when these limits were met or exceeded, which allowed clients to continue transactions without intervention to prevent further losses.
Considering the above, the Staff Notice recommends developing an onboarding process that collects sufficient information to set an appropriate Client Limit for each client, which should consider all Account Appropriateness Factors. The Client Limit should reflect the client's circumstances and be based on a dollar value to monitor ongoing trading activity. Additionally, clients should receive notifications when their trading activity nears the Client Limit, and they should receive educational materials on the risks of excessive trading. Finally, the OSC notes that adequate policies and procedures must be in place to evaluate, monitor, and apply the Client Limit system effectively.
Looking Ahead
The OSC's continued focus on compliance and regulatory oversight of crypto asset trading will be crucial in shaping the future of CTPs in Ontario. As the regulatory landscape evolves, CTPs should remain vigilant and proactive in adhering to the guidelines and recommendations set forth in the Staff Notice and other similar guidance. By doing so, they can ensure compliance and contribute to a more secure and transparent market environment.
Footnotes
1. "Specified Crypto Assets" include, as of the date of this Comment, Bitcoin, Ether, Bitcoin Cash, Litecoin, and Value-Referenced Crypto Assets that comply with the conditions as set out in the CTP's exemptive relief decision.
2. This represents the Investment Limit under the account appropriateness model, where the CTP does not plan to provide trade-by-trade suitability determinations. For CTPs under the suitability model, the limits are C$30,000 for non-eligible crypto investors, C$100,000 for eligible crypto investors, and no limit for accredited crypto investors.
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