The Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) published new guidance this week providing greater clarity on when securities and derivatives legislation applies to crypto-asset trading platforms (CTPs). Joint Canadian Securities Administrators/Investment Industry Regulatory Organization of Canada Staff Notice 21-329 Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements (the Notice) does not introduce new rules for CTPs but provides a path to transition into the Canadian regulatory framework for both domestic Canadian CTPs and for global CTPs that admit Canadian-resident users to trade crypto assets.
The guidance applies to CTPs that facilitate trading of crypto assets that are securities (Security Tokens), and to CTPs that facilitate trading in crypto assets that are not securities (such as Bitcoin), but which the CSA view as instruments or contracts that are subject to Canadian securities and/or derivatives regulation due to their trading processes and structures (Crypto Contracts).
Time to Check in
The release issued by the CSA in connection with the Notice directs Canadian and global CTPs that allow access to Canadian-resident users to contact the CSA now to discuss the registration process and applicable requirements, or face possible enforcement action. In a separate release (the Ontario Release), CTPs with Ontario users are specifically directed to contact staff of the Ontario Securities Commission by April 19, 2021 to bring their operations into compliance.
Importantly, the stated intention of the CSA is to strike a balance between flexibility that fosters innovation and their regulatory mandate to promote investor protection and fair and efficient capital markets. As such, while the guidance clarifies when regulation will apply and the steps that various types of CTPs will need to take, the roadmap includes an "interim approach" (including a transition period and time-limited exemptions) to allow CTPs to operate in certain circumstances as they ramp up to fully integrate into the Canadian regulatory structure.
The Notice also clarifies that:
- Canadian regulation will apply to the extent a CTP has users in one or more Canadian provinces - no greater nexus is required.
- Regulation may entail registration as a dealer, compliance with marketplace requirements, or both, based on existing frameworks that apply to the securities industry.
- The CSA may entertain bespoke exemptions to the existing frameworks, and in certain circumstances, allow for a two-year "interim period" approach before full compliance will be required.
The Notice does not introduce any new rules but clarifies how existing requirements of securities legislation may be tailored through terms and conditions and discretionary exemptive relief. The requirements will depend on how a CTP operates and what activities it undertakes, generally bifurcated into whether the CTP operates as a Dealer Platform or a Marketplace Platform, although certain CTPs may be regulated as both.
This approach is generally consistent with CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets published in early 2020. Much of the guidance is also the result of the consultation process started in 2019 with the publication of Joint CSA/IIROC Consultation Paper 21-402 Proposed Framework for Crypto Asset Trading Platforms.
The Notice states that a CTP may be considered a Dealer Platform where:
- it only facilitates the primary distribution of Security Tokens; and
- it is the counterparty to each trade and client orders do not otherwise interact with one another on the CTP.
Dealer Platforms may also be engaged in other activities or perform other functions that marketplaces typically do not undertake, including onboarding retail clients, acting as agent for clients for trades in Security Tokens or Crypto Contracts, and offering custody of assets, either directly or through a third-party provider.
The appropriate category of dealer registration will depend on the nature of the platform's activities.
- Platforms that offer margin or leverage must register as investment dealers and become members of IIROC (the relevant Canadian SRO).
- Platforms that only facilitate distributions or the trading of Security Tokens in reliance on prospectus exemptions and do not offer margin or leverage may consider registration as exempt market dealers, or in some circumstances, restricted dealers.
- Platforms that trade Crypto Contracts and trade or solicit
trades for retail investors that are individuals will generally be
expected to be registered as investment dealers
and obtain IIROC However, they will be able to
access an "interim period" process by seeking restricted
dealer registration (provided they do not offer leverage or margin
trading) while they ramp up to full investment dealer compliance.
- The interim period is generally expected to be two years.
- CTPs operating in New Brunswick, Nova Scotia, Ontario or Québec must submit applications for investment dealer registration and IIROC membership during the interim period.
- The securities regulators in Alberta, British Columbia, Manitoba and Saskatchewan will consider other regulatory approaches during the interim period, as warranted, and CTPs operating in these jurisdictions are expected to either start the process for investment dealer registration and IIROC membership during the interim period or take other steps during the interim period, in consultation with their principal regulator, to transition to an acceptable long-term regulatory framework. The specificities of this type of alternative framework are not mapped out.
The Notice reminds market participants that Dealer Platforms that are in the business of trading Crypto Contracts that are derivatives with Québec-resident users will be required to register as derivatives dealers under the Québec Derivatives Act (QDA), again with time-limited relief from the IIROC membership requirement. Dealer Platforms that also create and market derivatives must be qualified by the Autorité des marchés financiers (AMF) before derivatives are offered to the public.
The Notice further sets out areas where the CSA may consider flexibility in the application of existing regulatory requirements to Dealer Platforms seeking registration. Platforms are therefore encouraged to reach out to discuss their business models, the appropriate registration category and how requirements may be tailored.
A CTP is considered a Marketplace Platform if it:
- constitutes, maintains or provides a market or facility for bringing together multiple buyers and sellers or parties to trade in Security Tokens and/or Crypto Contracts;
- brings together orders of Security Tokens and/or Crypto Contracts of multiple buyers and sellers or parties of the contracts; and
- uses established, non-discretionary methods under which orders for Security Tokens and/or Crypto Contracts interact with each other and the buyers and sellers or parties entering the orders agree to the terms of a trade.
CTPs that are marketplaces will be expected to operate in a similar manner to alternative trading systems (ATS) and be subject to similar marketplace rules, including National Instrument 21-101 Marketplace Operation, National Instrument 23-101 Trading Rules and National Instrument 23-103 Electronic Trading and Direct Electronic Access to Marketplaces. In addition, trading activity on a Marketplace Platform may be subject to market integrity requirements. However, the CSA anticipate tailoring these requirements to accommodate the novel aspects of CTPs. The Notice also outlines certain core market integrity requirements considered relevant to trading on Marketplace Platforms, and areas where flexibility in the application of existing regulatory requirements may be provided.
Where a Marketplace Platform performs dealer functions, it would also be subject to the appropriate dealer requirements and, depending on the circumstances and the CTP's business model, these dealer activities may have to be conducted through a separate entity or business unit which would need to meet the applicable regulatory requirements or be separated through ethical walls.
Finally, a Marketplace Platform that trades Security Tokens and regulates issuers of those securities, or if it regulates and disciplines its trading participants other than by merely denying them access to the platform, may be carrying on business as an exchange and would be expected to seek recognition or, if appropriate, an exemption from recognition as an exchange.
A Marketplace Platform that does not offer leverage or margin and that is not an exchange may seek registration as an exempt market dealer or restricted dealer, as appropriate, for a limited period of time. Similar to the "interim period" concept described above (also generally expected to be two years), Marketplace Platforms operating in New Brunswick, Nova Scotia, Ontario and Québec are expected to start the registration or exemption process during the interim period. Securities regulators in Alberta, British Columbia, Manitoba and Saskatchewan will consider other regulatory approaches and may allow for other steps to be taken during the interim period to transition to an acceptable long-term regulatory framework.
Application process and other considerations
The Notice also provides information relating to the expected application process, additional considerations in the context of clearing and settlement and prospectus exemptions and trade reporting. The CSA also caution that as the industry is still developing and a wide variety of CTP models are emerging, the regulatory treatment of one CTP may differ from another.
Existing Canadian registered firms introducing crypto asset products and/or services are reminded to report changes in their business activities to their principal regulator and, in the case of investment dealers, to IIROC. The proposed changes to activities may be subject to review to assess, among other requirements, whether there is adequate investor protection.
The CSA signal their openness to engage in continued dialogue with CTPs and stakeholders on specific compliance issues and provide additional flexibility to address emerging technology and operational models. The CSA also remind CTPs operating from outside Canada that have Canadian clients that they are expected to contact the CSA to discuss the registration process and comply with Canadian securities legislation. CSA members may take new enforcement actions or continue existing actions against CTPs that do not comply with Canadian securities legislation. The Ontario Release states that "[p]latforms must contact OSC staff by April 19, 2021, to discuss how to bring their operations as a dealer or marketplace into compliance. If a platform currently trading in derivatives or securities in Ontario does not do so by this date, steps will be taken to enforce applicable requirements under securities law. Platforms located outside of Ontario that allow Ontarians access are regarded as operating in Ontario for the purpose of securities regulation". CTPs with users in other Canadian jurisdictions should consider engaging with other Canadian regulators as part of this process.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.