On January 16, 2020, the Canadian Securities Administrators (the CSA) published Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets. The Staff Notice provides guidance on factors the CSA considers when determining whether Canadian securities legislation applies to entities that facilitate transactions relating to crypto assets (Platforms).
The Staff Notice is generally consistent with the approach suggested by the CSA and the Investment Industry Regulatory Organization of Canada (IIROC) in Consultation Paper 21-402 — Proposed Framework for Crypto‑Asset Trading Platforms. The Consultation Paper stated that if crypto assets, which are securities or derivatives, including contracts or instruments that are derivatives based on crypto assets, are traded on a Platform, the Platform is subject to Canadian securities legislation. We summarize the CSA guidance below.
When does securities legislation NOT apply?
According to the CSA, Platforms are not generally subject to Canadian securities legislation if each of the following apply:
- the underlying crypto asset itself is not a security or derivative; and
- the contract or instrument for the purchase, sale or delivery of a crypto asset:
- results in an obligation to make immediate delivery of the crypto asset; and
- is settled by the immediate delivery of the crypto asset to the Platform’s user according to the Platform’s typical commercial practice.
The CSA generally considers delivery a part of the Platform’s typical commercial practice if it occurs in each instance, except where it is prevented by an event outside the Platform’s reasonable control.
When is there an obligation to make immediate delivery of a crypto asset?
The CSA states that there is no bright-line test when considering this question, and that it will review the contractual arrangements between the parties, including whether both parties intend to make and take delivery of the crypto asset, in determining whether an immediate delivery obligation exists.
The CSA generally considers there to be an obligation to immediately deliver if the contract creates an obligation on the Platform to immediately transfer the crypto asset to the user and, as a result, delivery occurs. A contract that creates an obligation to make immediate delivery is still considered a security or derivative if it is not the typical commercial practice to make delivery.
When has a crypto asset been immediately delivered?
The CSA notes that this determination is fact specific and depends on the economic realities of the relationship as a whole, which includes evidence relating to the intention of the parties.
The CSA generally considers immediate delivery to have occurred if:
- the Platform immediately transfers ownership, possession and control of the crypto asset to the Platform’s user and, as a result, the user is free to use or otherwise deal with, the crypto asset without
- further involvement with, or reliance on, the Platform or its affiliates; and
- the Platform or any affiliate retaining any security interest or any other legal right to the crypto asset; and
- following the immediate delivery of the crypto asset, the Platform’s user is not exposed to insolvency risk (credit risk), fraud risk, performance risk or proficiency risk on the part of the Platform.
Example of where securities legislation DOES NOT apply:
The CSA suggests that Canadian securities legislation does not apply to a Platform with each of the following characteristics:
- the Platform offers services for users to buy or sell Bitcoin and does not offer margin or leveraged trading;
- users send money to the Platform to purchase Bitcoin at a given price;
- the terms of the transaction require that the entire quantity of Bitcoin purchased from the Platform or counterparty seller be immediately transferred to a wallet that is in the sole control of the user, and the transfer is immediately reflected on the Bitcoin blockchain;
- there is no agreement, arrangement or understanding between the parties that allows the transaction to be settled other than by immediate transfer of Bitcoin;
- the Platform’s typical commercial practice is to make immediate delivery in accordance with the terms of the transaction, and for the Platform or its affiliates not to have ownership, possession or control of the user’s Bitcoin at any point following the transaction;
- the sale or purchase of Bitcoin is not merely evidenced by an internal ledger or book entry that debits the seller’s account with the Platform and credits the crypto assets to the user’s account with the Platform, but rather, there is a transfer of the Bitcoin to the user’s wallet; and
- the Platform or counterparty seller retains no ownership, possession or control over the transferred Bitcoin.
Example of where securities legislation DOES apply:
If the terms and conditions of a contract or instrument transacted on a Platform only require the Platform to transfer crypto assets to the user-controlled wallet on request, the contract or instrument described is subject to Canadian securities legislation because:
- the contract or instrument does not create an obligation to make immediate delivery of the crypto assets to the user; and
- the typical commercial practice of the Platform is not to deliver, since users that do not make a request to transfer crypto assets do not receive full ownership, possession and control over the crypto assets that they transacted in.
The CSA is of the view that a mere book entry does not constitute delivery because of the subsequent reliance of the user on the Platform in order to receive the crypto asset once requested.
The Staff Notice suggests that Canadian securities legislation applies to Platforms that facilitate the trading of crypto assets that are commodities, such as Bitcoin, if immediate delivery does not occur.
What does this mean for you?
The Staff Notice suggests that CSA members intend to take enforcement action or continue existing enforcement action against Platforms that do not comply with Canadian securities legislation. Platforms should consult with their legal counsel on the application of, and their compliance with, Canada securities legislation.
If you have any questions about the Staff Notice, please contact one of the authors of this bulletin or any other member of BLG’s Cryptocurrency and Blockchain Group. Our Cryptocurrency and Blockchain Group leverages BLG’s expertise in legal areas, such as investment management, corporate finance, derivatives and fintech, to provide advisory and transactional support right from the start.