Securities and investment laws
Canada currently has no comprehensive framework governing the regulation of digital assets. Securities regulation has emerged as the main regulatory instrument in Canada and is primarily a matter of provincial jurisdiction. While each province and territory has its own rules and securities regulators, the securities regulatory framework is largely streamlined and harmonised across Canada, with certain provincial or regional variances. However, legislative jurisdiction in the area of derivatives is divided between the federal and provincial governments, and the harmonisation of rule-making in this area has been more challenging.2
Generally, the basic purposes of the securities laws are to provide protection from unfair, improper or fraudulent practices, foster fair and efficient capital markets, and confidence in those capital markets, and contribute to the stability of the financial system and the reduction of systemic risk.3 Securities regulation in Canada generally governs the distribution and trading of both securities and derivatives. These activities are primarily regulated through the imposition of prospectus requirements, dealer, adviser and investment fund manager registration requirements, and certain requirements imposed upon those operating exchanges, alternative trading facilities or other marketplaces that facilitate their trading, as well as related reporting and disclosure requirements.
The Canadian Securities Administrators (CSA) is an umbrella organisation of Canada's provincial and territorial securities regulators whose objective is to improve, coordinate and harmonise regulation of the Canadian capital markets. While there are no specific rules or regulations for digital assets, the CSA has published guidance in the form of a number of staff notices (the Staff Notices) with respect to virtual currencies with a view to addressing the rapidly evolving developments related to virtual currencies. The CSA and the investment industry self-regulatory organisation known as the Investment Industry Regulatory Organization of Canada (IIROC) have most recently set out the current framework and proposed approach to regulating this asset class in Staff Notice 21-329 – Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements.4 Staff Notice 21-329 provides an actionable roadmap, building on earlier guidance, including the 2019 Consultation Paper 21-402 – Proposed Framework for Crypto-Asset Trading Platforms (the Consultation Paper),5 Staff Notice 46-307 – Cryptocurrency Offerings,6 Staff Notice 46-308 – Securities Law Implications for Offerings of Tokens,7 Staff Notice 21-327 – Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets,8 and Staff Notice 51-363 – Observations on Disclosure by Crypto Assets Reporting Issuers.9i Applicability of Canadian securities laws to virtual currencies
Virtual currencies may be subject to Canadian provincial securities laws to the extent that a virtual currency is considered a security or a derivative for the purposes of those laws, such as the Securities Act (Ontario) (the Securities Act). The Securities Act defines a security to include, among other things, an investment contract. The seminal case in Canada for determining whether an investment contract exists is Pacific Coast Coin Exchange v. Ontario (Securities Commission),10 where the Supreme Court of Canada identified the four central attributes of an investment contract, namely:
- an investment of money;
- in a common enterprise;
- with the expectation of profit; and
- this profit is to be derived in significant measure from the efforts of others.
If an instrument satisfies the Pacific Coin test, it will be considered to be an investment contract and, therefore, a security under Canadian securities laws.
The application of the Pacific Coin test to virtual currencies is not always straightforward, however. Industry participants have taken the position that utility tokens, which have a specific function or utility beyond the mere expectation of profit (such as providing their holders with the ability to acquire products or services) should not be considered securities.11 This position appears to have been accepted by the CSA and IIROC in the Consultation Paper, in which it was acknowledged that proper utility tokens may not be securities. However, the CSA has also noted that most of the offerings of virtual currencies purporting to be utility tokens that its staff had reviewed involved the distribution of a security, usually in the form of an investment contract.12
The CSA and IIROC have also acknowledged that it is widely accepted that some of the well-established virtual currencies that function as a form of payment or a means of exchange on a decentralised network, such as Bitcoin, are not currently in and of themselves, securities or derivatives and have features that are analogous to commodities such as currencies and precious metals.13 In assessing whether a particular virtual currency will be considered a security subject to Canadian securities laws, the CSA will consider the substance of the virtual currency over its form.14 The CSA has outlined a number of considerations in determining whether an investment contract exists. While no single factor is determinative, the CSA has stated that the existence of some or all of the following circumstances may cause a virtual currency to be considered an investment contract:15
- the underlying blockchain technology or platform has not been fully developed;
- the token is immediately delivered to each purchaser;
- the stated purpose of the offering is to raise capital, which will be used to perform key actions that will support the value of the token or the issuer's business;
- the issuer is offering benefits to persons who promote the offering;
- the issuer's management retains a significant number of unsold tokens;
- the token is sold in a quantity far greater than any purchaser is likely to be able to use;
- the issuer suggests that the tokens will be used as a currency or have utility beyond its own platform, but neither of these things is the case at the time the statement is made;
- management represents or makes other statements suggesting that the tokens will increase in value;
- the token does not have a fixed value on the platform;
- the number of tokens issuable is finite or there is a reasonable expectation that access to new tokens will be limited in the future;
- the token is fungible;
- the tokens are distributed for a monetary price; and
- the token may be reasonably expected to trade on a trading platform or otherwise be tradable in the secondary market.
A particular virtual currency that meets the criteria of the Pacific Coin test or has certain characteristics described in the CSA guidance discussed in this chapter may be properly considered an investment contract and therefore a security, subject to Canadian securities laws. Regulation will also apply if the investment or contract is a 'crypto contract' as defined in Staff Notice 21-327 and as discussed below.16ii Virtual currency offerings in Canada
Canadian securities laws generally require the filing of a prospectus to qualify any 'distribution' of securities. No person or company may trade in a security where the trade constitutes a distribution unless a prospectus has been filed or the trade is made in reliance upon a prospectus exemption. Securities originally distributed under a prospectus exemption are generally subject to resale restrictions that require the issuer to have been a reporting issuer (i.e., a public company) for a specified period and, in some cases, that the securities be held for a specified period. To the extent that a virtual currency is considered a security or a derivative, the issuance or distribution to the public is subject to prospectus, qualification or similar requirements, or must be effected pursuant to applicable exemptions from prospectus or derivatives qualification requirements.
There are a number of options available for distributing securities in Canada on a prospectus-exempt basis, generally referred to as exempt distributions or private placements. Most of these are harmonised under National Instrument 45-106 – Prospectus Exemptions.17 The CSA has indicated that persons wishing to distribute virtual currencies may do so pursuant to these exemptions.18 Specifically, distributions may be completed pursuant to the accredited investor exemption, which provides a prospectus exemption for trades of securities to entities and individuals that are qualified accredited investors, subject to compliance with conventional private placement requirements.19
A number of industry participants have successfully completed virtual currency offerings in compliance with applicable securities law requirements and bespoke exemptions from those requirements. In 2017, Montreal-based Impak Finance Inc (Impak) was the first Canadian company to complete a virtual currency offering with the approval of Canadian securities regulators. Impak issued Impak Coin, a virtual currency based on the Waves blockchain platform, for gross proceeds of over C$1 million by way of private placement, in reliance on the offering memorandum exemption.20
A few months later, Token Funder Inc (Token Funder) issued its first virtual currency offering, FNDR, under the oversight of the Ontario Securities Commission (OSC). Token Funder relied upon an offering memorandum exemption and an exemption from the dealer registration requirement granted by the OSC for a period of 12 months from the date of the decision, subject to a number of conditions.21
In May 2019, ZED Network Inc (ZED) became the first company to obtain exemptive relief from the prospectus and dealer registration requirements (discussed below) under Canadian securities laws for the distribution and trading of the ZED digital remittance and foreign exchange blockchain tokens to (1) money transfer operators (MTOs) registered as money services businesses in Canada with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) (registered MTOs), and (2) MTOs appropriately registered or authorised to operate as money services businesses, or its equivalent, in accordance with the laws of foreign jurisdictions (foreign registered MTOs), as applicable.22
On 27 March 2020, the OSC granted a time-limited exemption to B2C2 OTC Ltd (B2C2) from the dealer registration and prospectus requirements that would otherwise be applicable to a trade in or distribution of an over-the-counter (OTC) derivative between B2C2 and a 'permitted counterparty' in Ontario, New Brunswick, Newfoundland and Labrador, Prince Edward Island, the Northwest Territories, Yukon and Nunavut.23
In another important decision, the OSC granted TokenGX Inc (TGX), an affiliate of Token Funder Inc., a time-limited exemption to facilitate secondary trading on a platform known as Freedom (FRX). TGX obtained registration as an exempt market dealer until 16 April 2021, subject to certain restrictive terms and conditions, enabling qualified investors in Ontario to purchase and sell certain tokens on the FRX platform.
On 7 August 2020, the OSC granted Wealth Digital Assets Inc (WDA) time-limited relief from certain registrant obligations, relief from the prospectus requirement and derivatives trade data reporting requirements to allow WDA to trade virtual currencies and operate a platform that facilitates the buying, selling and holding of virtual currencies.24 WDA is a wholly owned subsidiary of Wealthsimple Financial Corp (WFC). WFC also owns Wealthsimple Inc, a Canadian registered adviser, and Canadian ShareOwner Investments Inc (ShareOwner), a registered dealer. This decision represented the first authorisation of this kind for a virtual currency trading platform (VCTP) that facilitates trading of virtual currencies through bespoke exemptive relief.
The decision was subject to conditions dealing primarily with trading restrictions, third-party due diligence, platform operations and reporting requirements, including:
- trading only of Bitcoin and Ether, through 'crypto rights contracts', using virtual currencies or Canadian dollars;
- investment limits of C$30,000 over a 12-month period; and
- maintenance of custody by Gemini Trust Company, LLC, a New York trust company regulated by the New York State Department of Financial Services and a 'qualified custodian' under Canadian securities law.
WDA was also required to work 'actively and diligently with IIROC' to ensure a transition from the WDA platform to ShareOwner. Importantly, WDA will not operate as a marketplace or clearing agency.
The OSC issued a subsequent decision pertaining to WDA on 18 June 2021 (the 2021 Decision)25 that replaced the terms set out in the OSC's August 2020 decision.26 The OSC explicitly noted, however, that the conditions of the relief provided in the 2021 Decision were substantially similar to the terms to which WDA was previously subject. The 2021 Decision expands the classes of virtual currency offered by WDA and lifts investment limits for certain types of virtual currency.27 Importantly, as with the earlier relief, the OSC cautioned that the 2021 Decision does not carry precedential weight, reflecting the bespoke nature of the exemptions granted to WDA.28iii Regulatory Pathway under Staff Notice 21-329
Joint CSA/IIROC Staff Notice – 21-329 Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements does not introduce new rules for VCTPs but provides a path to transition into the Canadian regulatory framework for both domestic Canadian VCTPs and global VCTPs that admit Canadian-resident users to trade virtual currencies. The guidance applies to VCTPs that facilitate trading of virtual currencies that are securities (security tokens), and to VCTPs that facilitate trading in virtual currencies that are not securities (such as Bitcoin) but that the CSA views as instruments or contracts that are subject to Canadian securities or derivatives regulation because of their trading processes and structures (crypto contracts).
The framework outlined in Staff Notice 21-329 provides guidance related to the regulation of both 'dealer platforms' and 'marketplace platforms' (each of which is also discussed further below).
The appropriate category of dealer platform registration will depend on the nature of the platform's activities.29 For example, dealer platforms that offer margin or leverage will be required to register as investment dealers and become members of IIROC. Dealer platforms that only facilitate distributions or the trading of security tokens in reliance on prospectus exemptions and do not offer margin or leverage may consider registration as exempt market dealers, or in some circumstances, restricted dealers.30
Dealer platforms that trade crypto contracts and trade or solicit trades for retail investors that are individuals will generally be expected to be registered as investment dealers and become members of IIROC.31 However, they will be able to access a transitional 'interim period' process by seeking restricted dealer registration (provided they do not offer leverage or margin trading) while they ramp up to full investment dealer registration and compliance. The interim period is currently expected to be two years.32
There are also jurisdiction-based factors to consider. Dealer platforms operating in New Brunswick, Nova Scotia, Ontario or Quebec must submit applications for investment dealer registration and IIROC membership during the interim period. However, the securities regulators in Alberta, British Columbia, Manitoba and Saskatchewan will consider other regulatory approaches during the interim period, as warranted. Dealer platforms operating in these jurisdictions are expected to either start the process for investment dealer registration and IIROC membership during the interim period or take other steps during the interim period, in consultation with their principal regulator, to transition to an acceptable long-term regulatory framework.33 The specificities of this type of alternative framework are currently unclear.
Furthermore, dealer platforms that are in the business of trading crypto contracts that are derivatives with Quebec-resident users will be required to register as derivatives dealers under the Quebec Derivatives Act (QDA), again with time-limited relief from the IIROC membership requirement.34 Dealer platforms that also create and market derivatives must be qualified by the Autorité des marchés financiers (AMF) before derivatives are offered to the public.35
Staff Notice 21-329 sets out areas where the CSA may consider flexibility in the application of existing regulatory requirements to dealer platforms seeking registration.36 Dealer platforms are therefore encouraged to reach out to discuss their business models, the appropriate registration category and how requirements may be tailored, including through exemptive relief.37
A platform that is a 'marketplace' (a marketplace platform), discussed below, that does not offer leverage or margin and that is not an exchange may seek registration as an exempt market dealer or restricted dealer, as appropriate, for a limited period.38 Similar to the 'interim period' concept described above (also generally expected to be two years), marketplace platforms operating in New Brunswick, Nova Scotia, Ontario and Quebec are expected to start the registration or exemption process during the interim period.39 Securities regulators in Alberta, British Columbia, Manitoba and Saskatchewan will consider other regulatory approaches and may allow for other steps to be taken during the interim period to transition to an acceptable long-term regulatory framework.40iv Regulatory considerations for intermediaries
Any person or company engaging in, or holding themselves out as engaging in, the business of trading or advising in securities, and, in certain Canadian jurisdictions, in derivatives, must register as a dealer or as an adviser or, where available, conduct these activities pursuant to an exemption from the dealer or, as the case may be, adviser registration requirement under the applicable securities laws.
A person or entity that directs the business, operations and affairs of an 'investment fund' must comply with the investment fund manager registration requirements or obtain an exemption from the requirements. Registration requirements are generally harmonised under National Instrument 31-103 – Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103),41 which sets out requirements for dealers and advisers dealing with capital, proficiency, insurance, financial reporting, know your client, investor suitability, client disclosure, safekeeping of assets, record-keeping, account activity reporting, complaint handling and other compliance matters.
In Canada, the requirement to register as a dealer or adviser is triggered where a person or company conducts a trading or advising activity with respect to securities or derivatives for a business purpose.42 The mere holding out, directly or indirectly, as being willing to engage in the business of trading in securities may trigger the requirement to register as a dealer; however, a number of factors must be considered when determining whether registration is required, including whether a business:
- engages in activities similar to a registrant;
- intermediates trades or acts as a market maker;
- carries on an activity with repetition, regularity or continuity;
- expects to be remunerated or compensated; and
- directly or indirectly solicits.43
In the context of virtual currency distributions, the CSA has noted the following additional factors in determining whether a company may be considered to be trading in securities for a business purpose:44
- soliciting of a broad range of investors, including retail investors;
- using the internet to reach a large number of potential investors;
- attending public events to actively advertise the sale of a virtual currency; and
- raising a significant amount of capital from a large number of investors.
Dealer platforms may also be engaged in other activities or functions that may be subject to the dealer registration requirement or be indicative of registrable activity, such as onboarding retail clients, acting as agent for clients for trades in security tokens, or crypto contracts, and offering custody of assets, either directly or through a third-party provider.45
Where dealer registration is triggered, the CSA has stated that persons or companies subject to registration must collect know your client information and perform suitability assessments to ensure that purchases of virtual currencies are suitable, including with respect to investment needs and objectives, financial circumstances and risk tolerance.46
The creation and marketing of products subject to registration are also subject to derivatives-related regulatory requirements, including in relation to qualification, registration and trade data reporting in a number of Canadian jurisdictions, including specifically Quebec, where the rules in relation to OTC and exchange-traded derivatives are more fully developed.47
The CSA has also issued proposals to establish a harmonised framework of registration and business conduct requirements for OTC derivatives market participants.48 The proposals expressly define a commodity to include virtual currencies.v Exchanges and other platforms
As marketplaces, exchanges are regulated pursuant to their applicable provincial securities statutes, as well as National Instrument 21-101 – Marketplace Operation (NI 21-101),49 National Instrument 23-101 – Trading Rules (NI 23-101)50 and their related companion policies.
NI 21-101 defines a marketplace as a facility that brings together buyers and sellers of securities, brings together the orders for securities of multiple buyers and sellers, and uses established non-discretionary methods under which the orders interact with each other.51
An exchange is a marketplace that may:
- list the securities of issuers;
- provide a guarantee of a two-sided market for a security on a continuous or reasonably continuous basis;
- set requirements governing the conduct of marketplace participants; or
- discipline marketplace participants.52
To operate as an exchange in Canada, a person or company must first apply for recognition as an exchange or for an exemption from the recognition requirement.53 As another type of marketplace, alternative trading systems, which provide automated trading systems that match buyer and seller orders, are also regulated under NI 21-101 and NI 23-101. It follows that a VCTP that facilitates the purchase, transfer or exchange of virtual currencies that are considered securities or derivatives may be subject to recognition requirements as securities or derivatives exchanges or marketplaces, as discussed in further detail below.
The applicable requirements will depend on how the VCTP operates and what activities it undertakes. Generally, VCTPs are divided into two categories: dealer platforms and marketplace platforms, although certain VCTPs may be regulated as both.54Dealer platforms
A VCTP may be considered a dealer platform where:55
- it only facilitates the primary distribution of security tokens; and
- it is the counterparty to each trade and client orders do not otherwise interact with one another on the VCTP.
A VCTP is considered a marketplace platform if it:56
- constitutes, maintains or provides a market or facility for bringing together multiple buyers and sellers or parties to trade in security tokens or crypto contracts;
- brings together orders of security tokens or crypto contracts of multiple buyers and sellers or parties of the contracts; and
- uses established, non-discretionary methods under which orders for security tokens or crypto contracts interact with each other and the buyers and sellers or parties entering the orders agree to the terms of a trade.
Marketplace platforms will be expected to operate on a basis that is similar to alternative trading systems (ATS) and also be subject to marketplace rules, including NI 21-101, NI 23-101 and National Instrument 23-103 – Electronic Trading and Direct Electronic Access to Marketplaces.57 In addition, trading activity on a marketplace platform may be subject to market integrity requirements.58 However, the CSA anticipates tailoring these requirements to accommodate the novel aspects of VCTPs based on certain core market integrity requirements considered relevant to trading on marketplace platforms.59
Where a marketplace platform performs dealer functions, it would also be subject to the appropriate dealer requirements and, depending on the circumstances and the VCTP's business model, these dealer activities may have to be conducted through a separate entity or business unit, which would need to meet the applicable regulatory requirements or be separated by ethical walls.60
Finally, a marketplace platform that trades security tokens and regulates issuers of those securities, or regulates and disciplines its trading participants other than by merely denying them access to the platform, may be carrying on business as an exchange and would be expected to seek recognition or, if appropriate, an exemption from recognition as an exchange.61vi Asset management and investment funds
Both retail and institutional demand for economic exposure to virtual currencies has surged in Canada and investment funds have become a popular new vehicle for obtaining this exposure. Persons operating or administering collective investment structures that hold or invest in virtual currencies may also be subject to investment fund manager registration requirements in addition to dealer, adviser and prospectus or private placements requirements. The structures themselves may also be subject to reporting and conduct requirements that apply to investment funds.
Canada has been at the forefront of global activity related to exchange-traded funds (ETFs) dealing in virtual currencies. The rise of virtual currency-based ETFs in Canada was triggered by the OSC's decision to issue a receipt for the final non-offering prospectus of a non-redeemable investment fund (3iQ Fund) filed by 3iQ Corp,62 discussed in greater detail below. In 2021, Purpose Investments received approval from the OSC to launch the world's first direct custody Bitcoin and Ether ETF platforms.63 Similarly to physically backed gold products, these ETFs are backed by physically settled Bitcoin and Ether holdings, which exposes investors to less risk than the alternative method of using self-custody and a digital wallet.64
Staff Notice 51-363 provides greater clarification regarding when investment fund requirements apply to issuers in the business of investing in virtual currency.65 Even in circumstances where an issuer does not meet the technical definition of an 'investment fund', it may still be subject to applicable regulations if investing in virtual currencies is material to the issuer's business and the issuer does not have other substantial operations.66 Securities regulators decide on a case-by-case basis whether to issue receipts for prospectuses to help ensure that proper procedures required for investment funds are followed. In prior cases, the OSC has mandated certain investment concentration restrictions and requirements to use a custodian as described in Part 6 of National Instrument 81-102 – Investment Funds (NI 81-102).67 The discretion to receipt a prospectus is pursuant to the OSC's public interest powers.
In September 2017, First Block Capital Inc became the first registered investment fund manager (IFM) in Canada for a fund dedicated solely to investments in virtual currencies.68 The British Columbia Securities Commission (BCSC) granted First Block Capital registration as an IFM and exempt market dealer to operate a Bitcoin investment fund, subject to certain bespoke exemptions from the applicable regime.69
In October 2018, 3iQ filed a non-offering preliminary prospectus on behalf of the Bitcoin Fund (3iQ Fund), a non-redeemable investment fund established as a trust under the laws of the province of Ontario, in its capacity as investment fund manager of the Fund.70 In February 2019, the Director, Investment Funds and Structured Products (the Director) of the OSC decided that it would be contrary to the public interest to issue a receipt for the 3iQ Fund's preliminary prospectus.
Following a contentious process before an OSC panel, 3iQ was ultimately issued a receipt by the OSC related to its preliminary prospectus in November 2019. Concerns about market manipulation and valuation were assuaged by 3iQ Fund's investment in Bitcoin instead of an unrestricted basket of virtual currencies; its pursuit of a buy-and-hold strategy; and the restriction to trade Bitcoin only on regulated markets. The panel also found sufficient evidence of trading in Bitcoin, including on regulated exchanges, for it to be considered a liquid asset. The decision also signalled that the underlying regulatory objectives may ultimately be better served by encouraging market participants to enter through the 'front door' of the market and engaging regulatory oversight from the outset, rather than through transactions such as reverse takeovers. Importantly, the 3iQ decision challenges the recent trend of expansive interpretation of the 'public interest' under securities legislation, offering a more restricted interpretation.