Recently, Canadian Securities Administrators (CSA) released CSA Staff Notice 21-332 Crypto Asset Trading Platforms: Pre-Registration Undertakings (Changes to Enhance Canadian Investor Protection) (Staff Notice).[1]
The Staff Notice presented unregistered crypto asset trading platforms (CTPs) with an ultimatum: agree to a more robust Pre-Registration Undertaking (PRU) within 30 days or cease operating in Canada. The Staff Notice specifically indicated that CTPs which remain non-compliant with the enhanced commitments called for by the Notice may be subject to compliance and/or enforcement action. The ultimatum apparently had the intended effect: the CSA announced on April 12, 2023, that certain unregistered CTPs have filed an enhanced PRU with their principal regulator following the publication of the Staff Notice.[2]
Background
In Canada, centralized CTPs are generally subject to securities laws, whether the crypto assets offered for trading on the platform are securities or commodities. Canadian securities regulators have assumed jurisdiction in this area on the basis that most CTPs do not immediately deliver a purchased crypto asset to their customer but instead provide the customer with a contractual right to that asset, which remains in the custody of the CTP (or a third party retained by the CTP for this purpose). This contractual right constitutes a security and/or a derivative.
Depending on their business model and service offerings, CTPs are regulated as dealers or marketplaces, and are expected to become members of the New Self Regulatory Organization (SRO, formerly the Investment Industry Regulatory Organization of Canada). However, in order to foster innovation, the CSA has provided CTPs with a grace period during which they may continue to carry on business without being fully regulated in this manner, so long as they:
- Register as a restricted dealer;
- Submit an application for registration as an investment dealer and for SRO membership (or, in the case of an exchange, start the process for recognition as an exchange); and
- Enter into a PRU with their principal regulator which sets out business conduct and risk management obligations which protect investors and preserve market integrity.[3]
Additional PRU terms and conditions required by the Staff Notice
The Staff Notice followed on the heels of the collapse of the FTX platform and several other high-profile CTPs. It seeks to enhance investor protection and mitigate CTP solvency risk by bolstering the related terms of PRUs. In particular, the Staff Notice requires that unregistered CTPs provide the following additional PRU commitments, among others:
- Enhanced commitments regarding custody and segregation of Canadian customer assets. Unregistered CTPs are required to hold Canadian customer cash and crypto assets separate and apart from their own property, and in trust for the customer.
- Prohibition on pledging or re-hypothecating Canadian customer crypto assets.
- Prohibition on providing margin or other forms of trading leverage to any customers, in order to mitigate CTP solvency risk.
- Exclusion of all crypto assets held by the CTP in assessing whether the CTP meets minimum excess working capital requirements. The rationale for this exclusion is that crypto assets are speculative and their value is highly volatile.
- The filing of regular financial information, including annual audited financial statements.
- Requirement to retain a Chief Compliance Officer (CCO) prior to registration. The CCO shall maintain policies and procedures for assessing CTP compliance with securities laws, and shall monitor and assess compliance and report directly to the CTP’s Board.
- Prohibition on allowing customers to trade in Value-Referenced Crypto Assets (VRCAs, otherwise known as “stablecoins”) without prior consent. This prohibition accounts for the fact that VRCAs carry significant risks “related to the stabilization mechanism associated with the maintenance of the peg to their reference value, the management and custodianship of their reserve of assets and their governance.”
Conclusion
As alluded to above, the CSA recently announced that some unregistered CTPs have agreed to enhanced PRUs containing these terms and conditions. These terms and conditions are intended to protect Canadian investors from the solvency and other issues faced by several major CTPs in 2022.
To unregistered CTPs which have not yet given an enhanced PRU to their principal regulator, the Staff Notice delivers a clear and unequivocal message: come into compliance immediately by providing (and abiding by) such a PRU, or cease operating in Canada. CTPs which refuse to heed this message face the threat of regulatory enforcement action.
For additional information, please contact the Litigation and Dispute Resolution group at Dentons.
[1] https://www.osc.ca/sites/default/files/2023-02/csa_20230222_21-332_crypto-trading-platforms-pre-reg-undertakings.pdf.
[2] https://www.securities-administrators.ca/news/canadian-securities-regulators-provide-update-on-pre-registration-undertakings-for-crypto-asset-trading-platforms/.
[3] Joint CSA/IIROC Staff Notice 21-329 Guidance for Crypto Asset Trading Platforms: Compliance with Regulatory Requirements; CSA News Release, “Canadian securities regulators expect commitments from crypto trading platforms pursuing registration,” (https://www.securities-administrators.ca/news/canadian-securities-regulators-expect-commitments-from-crypto-trading-platforms-pursuing-registration/).
