This bulletin provides information on the current regulatory framework applicable to the investment fund industry as it relates to cryptocurrency-related activities and the actions taken by the Canadian Securities Administrators (CSA) as a follow-up to reports on CSA Staff Notice 46‑307 Cryptocurrency Offerings, published on August 24, 2017 (CSA Staff Notice). Click here (PDF) to consult the Notice and here to review Fasken's discussion on the CSA Staff Notice at the time of its publication.

Regulatory Framework

To date, no legislation has been adopted to provide a specific framework dealing and advising in cryptocurrencies. However, depending on the legal characterization of the nature of the cryptocurrencies themselves and the nature of the activities pursued by a firm, existing rules may find application. Consequently, it is important for firms to carefully review their cryptocurrency projects in order to determine if an existing regulatory framework applies.

CSA Staff has taken the view that when assessing whether or not securities laws apply to certain cryptocurrencies, substance should prevail over form and that, in many cases, when considering a cryptocurrency offering or arrangement as a whole, such cryptocurrency could be considered to be a security. CSA Staff recommend businesses consult legal professionals to complete an analysis on whether a security is involved in the cryptocurrency business opportunity they are contemplating.

If securities laws apply to the cryptocurrency-related activities firms are looking to conduct, firms may need to consider, in particular, whether any registrations are required in order to carry out the proposed activities. Additionally, firms should consider the requirements that are specific to cryptocurrencies, notably valuation and custody. For example, CSA Staff expects a custodian to have expertise that is relevant to holding cryptocurrencies, such as experience with hot and cold storage, security measures to keep cryptocurrencies protected from theft and the ability to segregate the cryptocurrencies from other holdings as needed.

Businesses with proposed cryptocurrency-related investment funds or other projects are encouraged by CSA Staff to contact their local securities regulatory authority to discuss possible approaches to complying with securities laws, in order to avoid costly regulatory surprises and delays. Any firm contemplating a cryptocurrency-related activity should consider being proactive in initiating discussions with their regulators.

Conditions Imposed on Portfolio Managers Advising on Cryptocurrencies and Cryptocurrency Investment Fund Managers

A vehicle whose primary purpose is to invest money provided by its investors in cryptocurrencies is considered by the CSA to be an "investment fund" for the purpose of applicable securities legislation. A firm acting as the investment fund manager of a cryptocurrency fund will be subject to the requirement to register as an "investment fund manager" in its jurisdiction (and potentially in other jurisdictions).

The CSA, in seeking to adequately monitor developments in this new area and to balance the demand for new investment opportunities with the need to protect investors, have imposed conditions on the registration of firms wishing to carry out cryptocurrency-related activities. Such additional obligations have been imposed on firms both as a result of proactive consultations with regulators, and from spontaneous interventions of regulators. More specifically, conditions have been put on current and new registrations of portfolio managers and investment fund managers as a consequence of their cryptocurrency-related activities.

The conditions imposed on the cryptocurrency investment fund managers include the obligation for investment fund managers to obtain the regulator's prior approval to (i) establish or act as manager of an investment fund that invests in cryptocurrencies, (ii) amend the investment objective of the investment fund, (iii) change the entity that maintains custody of the cryptocurrencies held by the investment fund, (iv) change the entity mainly responsible for the execution of trades in the cryptocurrencies for the investment fund; and (v) make a material change in their valuation policies and procedures applicable to cryptocurrencies. In addition, the cryptocurrency investment fund managers are responsible for the oversight of the functions performed by each cryptocurrency custodian and broker which have to meet certain requirements. Moreover, the agreements to be entered into with cryptocurrency custodians and brokers must include certain restrictive provisions which, in consequence, limits the firm's choice of service providers. The conditions also include certain additional reporting obligations.

The conditions imposed on the cryptocurrency portfolio managers include the obligation for the portfolio manager to obtain the regulator's prior approval to (i) manage the investment portfolio of an investment fund that invests in cryptocurrencies, (ii) amend the investment objective of the investment fund to include a cryptocurrency not previously held by such investment fund, and (iii) make a material change in their valuation policies and procedures applicable to the cryptocurrencies. Currently, the CSA have permitted investment funds to invest only in Bitcoin and Ethereum. Any manager wishing to include other cryptocurrencies in their strategies would need to convince the CSA to give its approval to such inclusion. While the criteria considered by the CSA for approving or restricting a specific cryptocurrency seem unclear, the widespread use/acceptance by the markets of a cryptocurrency seems to be one of their central considerations.

The CSA are of the view that these conditions should apply to all investment fund managers and portfolio managers involved with cryptocurrencies. We believe that such conditions may evolve as the market expands, as other cryptocurrencies become prominent and as more players initiate discussions with the CSA.

We believe it is also worth noting that the United States Securities and Exchange Commission (SEC) has recently weighed in on similar issues. In a statement made on January 18, 2018, Dalia Blass, Director, Division of Investment Management of the SEC, set out certain investor protection concerns relating to exchange-traded funds (ETFs) with exposure to cryptocurrencies. The SEC's concerns include: (a) the ability of a fund manager to accurately value the cryptocurrencies in a fund's portfolio, including in the event of a "fork" in a cryptocurrency; (b) the volatility and liquidity of the fund's portfolio, including its impact on redemptions; and (c) the ability of a fund manager to engage a custodian with sufficient capabilities to provide safe custody for cryptocurrencies.