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:
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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;
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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;
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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;
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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;
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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;
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enhanced commitments in relation to the filing by the CTP of financial information with the CSA on a regular basis;
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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;
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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
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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:
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is not prepared to file an Undertaking (or revised form of Undertaking) in a form acceptable to CSA staff;
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files an Undertaking but does not abide by its provisions; or
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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.
