09 March 2023
by David Conklin (Toronto) , Owen Gaffney (Toronto), Allan Goodman (Toronto), Francesca Guolo (Toronto), Kyle Jacobson (Toronto) and Michael Partridge (Toronto)
Further to its December 12, 2022 announcement, the Canadian Securities Administrators (CSA) published Staff Notice 21-332 – Crypto Asset Trading Platforms: Pre-Registration Undertakings (“SN 21-332“) this week, which provides additional guidance regarding the CSA’s expectations for crypto asset trading platforms (CTPs) trading in securities in Canada. SN 21-332 clarifies the CSA’s expectations as set out in previous staff notices, including Staff Notice 21-329 – Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements (“SN 21-329“).
CTPs operating in Canada that facilitate the trading of Security Tokens and Crypto Contracts (as defined below) should review the requirements prescribed in SN 21-332 closely. The CSA requires that CTPs undertaking such activities apply for registration and provide a new or updated pre-registration undertaking (PRU) by March 24, 2023. Failure to do so may result in enforcement action by securities regulators.
CTP Compliance with Canadian Registration Requirements
On March 29, 2021, the CSA published SN 21-329, which set out the steps CTPs are expected to take to comply with Canadian securities legislation, including the requirement to seek restricted dealer registration on an interim basis and actively pursue full dealer registration immediately thereafter.
As defined in SN 21-329, CTPs are platforms that facilitate or propose to facilitate the trading of:
- crypto assets that are securities (“Security Tokens“); and
- instruments or contracts involving crypto assets, as indicated in Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto-Assets (“Crypto Contracts“).
The full text of SN 21-329, which sets out this process in detail, can be found here.
Following the publication of SN 21-329, on August 15, 2022, the CSA announced, that CTPs operating in Canada would now be expected to provide a PRU to their principal regulator to continue operations while their registration application is under review. By submitting a PRU, a CTP agrees to comply with terms and conditions set out in the PRU that address investor protection concerns and are consistent with conditions imposed on previously registered platforms.
The CSA introduced the PRU requirement to address:
- investor protection and risk management concerns in relation to the activities of CTPs undergoing the registration process; and
- level-playing-field concerns in relation to CTPs that had previously obtained registration as a restricted dealer or investment dealer.
Enhanced Pre-Registration Undertaking Requirements under SN 21-332
SN 21-332 was published in response to the recent slate of CTP insolvencies, including Voyager Digital, Celsius Network, FTX, and others, and is intended to introduce important new investor protection provisions into the original form of PRU.
SN 21-332 focuses on unregistered CTPs that continue to operate in Canada while they seek registration and related exemptive relief. CTPs that fail or are unwilling to submit a new or updated PRU by March 24, 2023 will be expected to off-board and restrict access for Canadian users, and may be subject to compliance or enforcement actions. CTPs will be expected to provide notice and timelines regarding the implementation of such off-boarding and access restrictions to their principal regulators and the CSA.
The new provisions of the enhanced PRU relate to the following areas, among others:
- retention of a qualified third-party custodian to hold at least 80% of the total value of crypto assets held on behalf of Canadian clients;
- segregation of crypto assets, including cash and other securities, held on behalf of Canadian clients from the CTP’s own funds;
- enhanced commitments to preclude the CTPs from pledging, re-hypothecating or otherwise using crypto assets held on behalf of Canadian clients;
- a prohibition on the CTP offering margin, credit or other forms of leverage to clients;
- commitments from controlling mind(s) and global affiliates that affect the Canadian CTP;
- restrictions on CTPs relying on crypto assets, including proprietary tokens issued by the CTP or an affiliate, in determining the capital of the CTP for excess working capital purposes and in determining the capital base of the CTP;
- regular filing by the CTP of financial information with CSA members; and
- a requirement for CTPs to retain or employ a qualified chief compliance officer.
Value-Referenced Crypto Assets
In addition to the foregoing, SN 21-332 specifically addresses the ability of CTPs to make “Value-Referenced Crypto Assets” (VRCAs) (i.e., “stablecoins”) available to their clients in Canada. SN 21-332 generally defines VRCAs as crypto assets that are 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.
SN 21-332 indicates that the CSA is continuing to assess the presence and role of stablecoins in Canadian capital markets as well as the regulatory implications and risks associated with these assets. While the CSA indicates that it believes stablecoins “may” – depending on the specific facts and circumstances – constitute securities or derivatives, SN 21-332 states that VRCAs that are pegged to or backed by assets other than fiat currency will generally be considered to be securities (and therefore may not be offered for trading in Canada in accordance with the terms of the original form of PRU). More generally, SN 21-332 outlines a number of risks that the CSA believes are associated with VRCAs that may not be properly disclosed to, or understood by, investors.
Accordingly, the enhanced PRU states that CTPs must obtain the prior written consent of the CSA to allow their clients to enter into crypto contracts to buy or deposit VRCAs, which consent may be subject to terms and conditions imposed on the CTP and the issuer of the VRCA. Pursuant to SN 21-332, the CSA expects CTPs that request such consent to conduct sufficient due diligence to ensure that applicable risks are addressed, including that, among other things:
- the VRCA is a fiat-backed crypto asset;
- distributions of the VRCA made in Canada are made in compliance with applicable Canadian securities legislation;
- the issuer of the VRCA maintains an asset reserve with a market value at least equal to the outstanding units of the VRCA;
- such reserve is comprised of highly liquid assets and is held by a qualified custodian in favour of the VRCA holders;
- the redemption rights of the VRCA holder against the issuer or the reserve of assets are clearly articulated in policies and procedures and publicly disclosed;
- the VRCA issuer maintains effective governance practices; and
- the CTP is not otherwise prohibited from allowing clients to enter into crypto contracts in respect of the VRCA.
CTPs that are trading in securities should move quickly and update their systems in accordance with these new requirements to ensure their Canadian operations are not interrupted. The CSA has warned that CTPs that do not provide a revised PRU within the prescribed 30-day window and implement the necessary changes required thereunder, may be expected to wind up existing Canadian user accounts and prohibit Canadian customers from accessing their services.
For further information on this new guidance, please contact any member of our Capital Markets or Technology Groups.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.