The Canadian Securities Administrators (CSA) has granted exemptive relief to Wealthsimple making it Canada's first crypto asset platform authorized through the CSA Regulatory Sandbox initiative.
- The CSA granted Wealthsimple Digital Assets Inc. time-limited relief from certain requirements to allow it to trade crypto assets and operate a platform that facilitates the buying, selling and holding of crypto assets.
- Trading will be restricted to Bitcoin and Ether and is limited to a maximum of $30,000 per client over a 12-month period.
- Gemini Trust Company, LLC will serve as a licensed third-party custodian while multiple crypto asset trading firms will act as liquidity providers for the purchase and sale of crypto assets.
On August 7, 2020, the CSA granted time-limited relief from certain registrant obligations (including suitability relief and relief from the requirement to deliver audited financial statements), the prospectus requirement and derivatives trade data reporting requirements to allow Wealthsimple Digital Assets Inc. (WDA) to trade crypto assets and operate a platform that facilitates the buying, selling and holding of crypto assets. In the Matter of Wealthsimple Digital Assets Inc. is the first decision authorizing the operation of a crypto trading platform in Canada under the CSA Sandbox initiative and it applies in all Canadian jurisdictions other than Quebec which has issued separate exemptive relief. While the CSA has noted that the decision should not be viewed as precedent-setting, it nevertheless represents an important development for the Canadian fintech community.
Wealthsimple is an established Canadian online investment management service that, through separate affiliates, is registered in Canada as a portfolio manager and a full-service investment dealer. WDA, a wholly owned subsidiary of Wealthsimple, made an application to the CSA Regulatory Sandbox seeking exemptive relief from certain prospectus requirements and relief from delivery of financial statements and derivatives trade data requirements.
The relief was granted on a time-limited basis subject to certain conditions set out in the decision, including:
- client investment limits;
- account appropriateness; and
- reporting requirements.
The decision requires WDA to be registered as a restricted dealer, while it transitions the digital asset platform to its fully registered investment dealer firm affiliate, and to commence operations in a beta testing environment. The decision also allows WDA to operate, on an interim basis, a "closed loop" system platform to enable WDA's clients to enter into "crypto rights contracts" and to buy, sell, and hold crypto asset with WDA.
Importantly, the regulators have noted that the decision should not be understood to constitute a precedent but is "tailored for the specific facts and circumstances" of the application. The relief expires on the earlier of 24 months from the date of the decision or the date WDA transitions the platform to its IIROC registered affiliate.
The decision sets out certain conditions with respect to trading restrictions, third-party verification, platform operation and appropriateness and reporting requirements.
- Clients trading on WDA's platform enter into "crypto right contracts" and are responsible for initiating transactions that are then carried out by WDA through multiple trading firms (Liquidity Providers).
- Trading is restricted to Bitcoin and Ether using only crypto assets or Canadian dollars.
- Custody of the crypto assets is maintained by a digital asset exchange third-party custodian – Gemini Trust Company, LLC (Gemini). Gemini, a New York trust company regulated by the New York State Department of Financial Services is a "qualified custodian" for purposes of Canadian securities law.
- Importantly, WDA will not operate either as a "marketplace" or a "clearing agency" under Canadian securities law. Expanding on previous CSA guidance, the CSA noted that WDA's custody model and trading of "crypto rights contracts" constituted trading of securities and/or derivatives. Clients' control and possession over the crypto assets remains an important factor in determining the application of securities law.
- The Liquidity Providers, through which WDA carries out the buying and selling of crypto assets, are to be verified by WDA to ensure they are appropriately licensed or registered to trade crypto assets in their home jurisdictions and that they are not in default of securities legislation in the relevant Canadian jurisdiction. While the current state of the law on the trading of crypto assets in Canada may make it challenging to conduct the assessment, the decision signals some degree of acceptance of different business models and established foreign crypto trading platforms.
- WDA is also expected to verify that each Liquidity Provider has "effective policies and procedures to address concerns relating to fair price, fraud and market manipulation".
- WDA conducted due diligence on Gemini, including a review of its SOC 2 Type examination reports and did not identify "any material concerns". If a change of custodian were to take place, WDA must provide securities regulators with at least 10 days prior written notice.
- WDA will operate its platform as a closed-loop system. Clients may not transfer into their account any crypto assets purchased outside of the platform or withdraw from their account any crypto assets bought through WDA's platform. While a closed-loop system will reduce the likelihood of "fraud, money laundering, or client error in sending or receiving crypto assets to incorrect wallet addresses", it may expose clients to "insolvency risk (credit risk), fraud risk or proficiency risk" on WDA's part.
- In addition to licensing and regulatory verification, WDA must also evaluate the pricing provided by Liquidity Providers on an ongoing basis against global benchmarks to ensure clients are provided with fair and reasonable pricing.
- WDA will be compensated by the spread on trades but will not apply any account opening or maintenance fees, commissions or other charges of any kind.
- Finally, WDA will not hold crypto assets on a proprietary basis and will not take any long or short positions in crypto assets with its clients or any other party.
Appropriateness and Reporting
- WDA is expected to provide an approved form of risk disclosure statement and make educational materials available to clients on an ongoing basis.
- WDA will not provide recommendations or perform trade-by-trade suitability determinations for clients but will rather perform account and product assessments.
- Compliance with know your client requirements and, following recent amendments to Canadian federal anti-money laundering legislation involving virtual currency, Canadian federal anti-money laundering legislation is expected.
- Pre-account opening and product assessments of whether it would be "appropriate" for a prospective client to trade on the platform, on the basis of the client's experience in investing in crypto assets, using online order-execution brokerage facilities and risk tolerance are expected to be carried out by WDA.
- WDA is also required to monitor client activity on an ongoing basis to deter behaviours that indicate that trading is not appropriate for the client or that additional education is required.
- Annual unaudited financial statements must be filed by WDA. While the CSA does not provide a timeline for delivery of the audited financial statements, WDA expects to file audited final statements for the 2021 financial year end. WDA must also deliver to regulators anonymized account-level data as well as aggregate activity data.
Although the decision in In the Matter of Wealthsimple Digital Assets Inc. advises that it should not treated as a precedent, it represents an important milestone for the Canadian fintech community by expanding on earlier guidance set out in CSA staff notices and the CSA and IIROC Consultation Paper 21-402 – Proposed Framework for Crypto-Asset Trading Platforms.
The decision highlights the limitations of the current Canadian regulatory environment but offers a bridge to emerging custodial and trading solutions for crypto asset trading that are rapidly developing outside of Canada. The WDA exemptive relief provides regulators the ability to monitor and analyze anonymized trade data to build out data-driven regulatory options and, as they state, "advance the development of the Canadian regulatory framework for trading crypto assets".
The decision also highlights the importance of risk management. The conditions upon which relief was granted place a strong emphasis on internal controls to ensure fraud, money laundering, and insolvency risks are mitigated. For platforms, monitoring of the practices of counterparties and service providers, such as custodians and crypto trading firms, are key to ensuring investor protection and fair and reasonable pricing.
This article was co-authored with the assistance of Jorge Caicedo, summer student.
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