Incoming Deadline Looms for Crypto Asset Trading Platforms to Comply With New Requirements

The Canadian Securities Administrators (“CSA”) has reacted to recent high-profile insolvencies occurring in the cryptocurrency market by announcing its intention to increase and strengthen its oversight of cryptocurrency asset trading platforms (“CTPs”) that operate in Canada or that are accessible to Canadians.

On February 22, 2023, the CSA published Staff Notice 21-332 Crypto Asset Trading Platforms: Pre-Registration Undertakings – Changes to Enhance Canadian Investor Protection (the “Notice”). In order to continue operating in Canada, CTPs that are applying for registration will need to file an enhanced pre-registration undertaking (“PRU”) with the CSA by March 24, 2023. The Notice also provides additional guidance to CTPs that are already registered, in particular around the trading of stablecoins.

Background

On August 15, 2022, the CSA first announced that it expected unregistered CTPs accessible to Canadians to deliver a PRU to their principal regulator while pursuing registration, regardless of where the CTP is physically located.

On December 12, 2022, the CSA announced that a deadline would be soon set for unregistered CTPs to deliver the PRU to their principal regulator while they pursued registration or they would have to cease operating. The CSA announced that if a PRU was not received by the deadline, the CSA would consider all regulatory options available to bring the CTP in compliance with applicable Canadian securities laws, including enforcement action.

The CSA also further expanded the existing undertakings for unregistered CTPs to include:

• requirements to hold Canadian clients’ assets with an appropriate custodian (i.e., if they are regulated by a financial regulator in Canada, the U.S. or a similar jurisdiction);
• requirement to segregate client assets from the platform’s business assets; and
• a prohibition on offering margin or leverage for any Canadian client.

In this announcement, the CSA also stated that it is of the view that stablecoins may constitute securities and/or derivatives. Although the CSA did not take a definitive position on this issue in this announcement, the CSA did state that CTPs are “prohibited from permitting Canadian clients to trade, or obtain exposure to, any crypto asset that is itself a security and/or a derivative.” The CSA also stated that it expects CTPs to have established policies and procedures that determine whether the crypto assets that they provide exposure to are securities and/or derivatives.

New Provisions in CSA Staff Notice 21-332

The CSA has now published the Notice outlining that all CTPs are expected to submit PRUs to their principal regulator by March 24, 2023. CTPs that are unwilling or unable to comply with the Notice are expected to off-board Canadian users from accessing their CTP’s products or services. CTPs currently operating in Canada that would like to continue to do so must comply with the Notice by the deadline.

In furtherance of the previous announcements, the CSA is now requesting the following additional commitments from unregistered CTPs:

• client assets must be held separately from CTP assets in a designated trust account, in trust for the client;
• CTPs are prohibited from re-hypothecating, pledging or otherwise using assets held on behalf of Canadian clients;
• CTPs are prohibited from offering margin, credit or other forms of leverage to any type of client in connection with the trading of crypto contracts or crypto assets on their platform;
• the PRU must be signed by the Canadian legal entity as well as any global affiliates and/or parent companies and controlling minds which will undertake not to interfere with the activities of the Canadian legal entity and ensure that their activities will not interfere with the ability of the Canadian entity to comply with its regulatory obligations;
• the PRU must include, “to the extent possible” a provision that the Canadian entity’s board of directors be independent from its parent entities, global affiliates and controlling minds;
• a CTP must exclude all crypto assets from its calculation of minimum excess working capital calculation. This may have adverse effects for CTPs which hold their reserves in crypto assets rather than fiat;
• the CTP must follow enhanced commitments in relation to the filing of financial information with the CSA on a regular basis;
• while the PRU is in effect during the pre-registration period, the CTP must retain a qualified Chief Compliance Officer (“CCO”) that meets the proficiency requirements applicable to exempt market dealers under securities legislation; and
• the CCO must be responsible for maintaining a compliance system and have direct access to the board of directors of the CTP.

Restrictions on Crypto Assets and Stablecoins (a.k.a. Value-Referenced Crypto Assets)

In the Notice, the CSA states that both registered CTPs and those giving PRUs are required to have policies and procedures to assess whether any crypto asset available on the platform is a security and/or derivative. If any such crypto asset is determined to be a security and/or derivative, then the CTP must promptly stop permitting clients to buy the asset.

The CSA further reiterates that the term “stablecoin” may be a misnomer as these assets can be volatile. As a result, the CSA has used the term Value-Referenced Crypto Assets (“VRCAs”) to describe these assets, which may also constitute securities or derivatives. The CSA describes VRCAs as “a crypto asset that is designed to maintain a stable value over time by referencing the value of a fiat currency or any other value or right, or combination thereof.” The CSA’s position is that a VRCA backed by a fiat currency reserve likely constitutes “evidence of indebtedness” as per the definition of “security” in most CSA jurisdictions, or it falls within another head of the definition of “security.”

The CSA acknowledged in the Notice that VRCAs do have utility for deposits, trading of other crypto assets, as a store of value, and as a means of payment. As such, the CSA does not advocate for the full ban on the offering of VRCAs by registered CTPs, but rather prohibits CTPs from offering VRCAs without the written consent of the CSA.

When seeking such consent, CTPs must ensure that:

• the VRCA is backed by fiat and not algorithmic stablecoins;
• any issuances of the VRCA are made in compliance with the applicable securities laws (i.e., complying with private placement exemptions from prospectus requirements);
• the issuer’s fiat reserve (a) has market value equal to at least the value of all of the outstanding units of the fiat-backed VRCA; (b) consists of liquid assets such as cash or cash equivalents; (c) is held by a qualified custodian; (d) is held separately from the issuer’s assets; and (e) is subject to publicly available monthly annual audits by an independent auditor;
• the redemption rights are clearly stated in publicly disclosed policies and procedures;
• issuers maintain a plan for recovery or wind-down in the case of failure;
• issuers maintain governance practices;
• accurate information about the VRCA is accessible in plain and non-technical language; and
• the CTP is not otherwise prohibited from offering the VRCA.
  

In the Notice, the CSA encourages both registered CTPs and those who are filing PRUs to get approval for fiat-backed VRCAs if they would like to offer or continue to offer them in Canada.

Non-Compliance with CSA Staff Notice 21-332

The CSA explicitly states in the Notice that nothing should be interpreted as limiting any enforcement powers that the CSA may take against any CTP. If CTPs refuse to file a PRU or breach the terms of a PRU once filed, the CSA may consider any compliance and/or enforcement action against the CTP and its principals. The CSA may also name the CTP on a warning list, direct the CTP to withdraw from operations in Canada, impose a cease trade order or deny exemptions under applicable Canadian securities laws. 

The speedy timeline and numerous measures required for CTPs to enhance their PRUs in order to comply with CSA expectations highlights the elevated levels of risk that Canadian regulators see from investing in crypto assets, and the seriousness with which they will look at firms that do not comply with these expectations when offering crypto assets to Canadian investors.

If you have any questions on how this may impact your business, please contact a member of the Aird & Berlis LLP Capital Markets Group.