On Feb. 22, 2023, the Canadian Securities Administrators (CSA) published Staff Notice 21-332 Crypto Asset Trading Platforms: Pre-Registration Undertakings Changes to Enhance Canadian Investor Protection (the Staff Notice) as a follow-up to the CSA’s update on Dec. 12, 2022 relating to its approach to strengthen oversight over crypto asset trading platforms (CTPs) operating in Canada.
The Staff Notice provides additional guidance on the CSA’s expectations with respect to CTPs that operate in Canada while seeking registration and related exemptive relief. All unregistered, but operating, CTPs are required to make certain commitment to the CSA through a pre-registration undertaking (PRU) that must be entered into within 30 days of the publication of the Staff Notice. CTPs will then be given a period after the signing of the PRU to implement any systems changes required to give effect to the provisions of the PRU.
While the Staff Notice primarily focuses on unregistered CTPs, the CSA also confirms that some of the guidance is relevant to currently registered CTPs and to crypto asset investment funds. It notes that registered CTPs should expect discussions with their principal regulator regarding potential changes to their registration or related relief.
The CSA’s commitment to introduce new enhanced investor protection measures comes as a direct response to the recent insolvencies involving CTPs and other market participants, including the FTX group of companies.
Summary of new expectations
Below is a summary of the new expectations for CTPs under the enhanced form of PRU:
- Enhanced commitments regarding custody and segregation of crypto assets held on behalf of Canadian clients – The PRU includes additional commitments from the CTP to hold client assets (including cash, securities and crypto assets that are not securities):
- separate and apart from its own property;
- in trust for the benefit of clients;
- in the case of cash, in a designated trust account or in an account designated for the benefit of clients with a Canadian custodian or a Canadian financial institution; and
- in the case of crypto assets, in a designated trust account or in an account designated for the benefit of clients with a custodian that comes within the definition of “Acceptable Third-party Custodian” (see definition in the Staff Notice).
- Enhanced commitments to preclude CTPs from pledging, re-hypothecating or otherwise using crypto assets held on behalf of Canadian clients – CTPs are expected to provide CSA staff with evidence of meaningful compliance systems and corporate governance controls with respect to this commitment.
- A prohibition from offering margin, credit, or other forms of leverage to any client in connection with the trading on a CTP of crypto contracts or crypto assets – While CTPs were previously permitted to offer margin, credit or other forms of leverage to “permitted clients” (as defined in National Instrument 31-103), the new prohibition applies to all clients (both retail and permitted clients).
- New commitments from controlling mind(s) and global affiliates that affect the CTP – The CSA expects all global affiliates, parent entities and/or the controlling minds of a Canadian operator of a CTP to co-sign the PRU, and will require these entities to (i) not interfere with the Canadian operator’s activities and its directors’ independent judgment; and (ii) ensure that their activities do not undermine the Canadian operator’s activities and compliance with Canadian regulatory obligations.
- Restrictions on relying on crypto assets – including proprietary tokens issued by the CTP (or an affiliate) – in determining excess working capital – For the purpose of the minimum excess working capital requirement applicable to registered firms, the CSA expects that all crypto assets held by a CTP will be excluded from the excess working capital calculation.
- Routine financial disclosures to the CSA – Under the PRU, the Canadian operator of a CTP is required to deliver financial information contemplated under section 12.12 of National Instrument 31-103 to the regulators.
- Retention of a qualified Chief Compliance Officer (CCO) during the pre-registration process – A CTP must designate an individual, that meets all applicable proficiency requirements of a CCO for a registered exempt market dealer, as its CCO. This individual is expected to perform the duties and responsibilities of such a role, including maintaining policies and procedures, monitoring and assessing compliance and having direct access to the board of directors.
Changes relating to crypto assets available on CTPs
In addition to the new expectations described above, the CSA provides guidance on their determination and treatment of “Value-Referenced Crypto Assets” or “VRCAs” (commonly referred to as stablecoins), which may constitute securities and/or derivatives. The CSA reminds registered CTPs (and those that have entered, or will be entering into, a PRU) of the standing prohibition on permitting Canadian clients to enter into crypto contracts to buy and sell any crypto asset that is itself a security and/or a derivative.
Notwithstanding the prohibition on the trading of crypto contract in respect of crypto assets that are securities and/or derivatives, the CSA acknowledges that VRCAs may be used by CTP clients for different purposes, including: for on-ramp to deposit assets with the CTP (or off-ramp); for the trading of other crypto assets; as a store of value during times of volatility in market; to avoid converting their crypto assets into fiat currency; or as a means of payment, among other purposes. Accordingly, the PRU gives the CSA jurisdictions the discretion to permit CTPs to allow their clients to enter into crypto contracts to buy or deposit VRCAs.
To obtain CSA consent, a CTP is expected to conduct sufficient due diligence and take steps to ensure that the applicable risks of the VRCA are addressed (including those set out in the Staff Notice). Among other things, the CSA clarifies that staff does not expect to provide consent in respect of an algorithmic VRCA or an VRCA that is not fully backed by an appropriate cash and/or cash-equivalent reserve.
Any CTP that wishes to offer a particular VRCA is expected to contact their principal regulator. Additionally, the CSA invites VRCA issuers that would like to distribute their crypto asset in Canada (or are seeking consent for a VRCA) to contact a member of the CSA, and to explain the steps taken to comply with applicable Canadian securities legislation and to address the risks identified by the CSA.
CSA response to CTPs that are unable or unwilling to provide a PRU
The CSA confirms that it may take compliance and/or enforcement action against any unregistered CTP that: is unable or unwilling to provide a PRU in a form acceptable to CSA staff; files a PRU but fails to implement the required systems changes to abide by the provisions of the PRU within the expected timelines; or does not make bone fide attempts to progress through the registration on a timely basis. Action may also be taken against a CTP if CSA staff becomes aware of any investor protection or other public interest concerns. The compliance and enforcement actions available to the CSA include, but are not limited to:
- the CTP being named on a CSA investor alert or investor warning list;
- the CTP being directed to implement off-boarding of clients and impose access restrictions;
- cease trading orders on the CTP and its principals and/or an order denying exemptions under securities laws; and
- other penalties or sanctions against the CTP and its principals, as determined by the securities regulators.
How BLG Digital Assets can help
BLG’s Digital Assets team helps clients to determine their regulatory status and to work closely with the regulators to obtain appropriate registrations or exemptions. We understand the digital asset business and we work with our clients to put into place a plan that balances investor protection concerns with the need for innovation while securing a feasible business model. We are also aware that domestic and global participants may be faced with different challenges and obstacles and need to plan accordingly.
For more information on the digital assets industry, reach out to any of the key contacts listed below.