The Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) recently published guidance on how securities legislation applies to platforms that facilitate the trading of security tokens or crypto contracts (Crypto Asset Trading Platforms or CTPs). The guidance suggests the opening of a pathway for CTPs to operate in Canada within the existing securities regulatory framework, while at the same time issuing a warning to non-compliant CTPs that enforcement action may soon follow.
Staff Notice 21-329 - Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements (Staff Notice), jointly published by the CSA and IIROC on March 29, 2021, includes:
An overview of the existing regulatory requirements applicable to CTPs;
Key risks identified by the CSA and IIROC from the operation of CTPs;
Areas where flexibility may be available in how regulatory requirements will be applied to CTPs; and
Compliance steps that a CTP needs to take, including interim steps that may allow a CTP to operate as it prepares to fully integrate into the securities regulatory framework.
Beyond indicating that CTPs operating in Canada are subject to regulation under the current securities regulatory framework, the Staff Notice notes that an existing registered firm that introduces crypto asset products and/or services will be required to report changes in its business activities to its principal regulator, and in the case of investment dealers, to IIROC.
The Staff Notice indicates that CSA members may take enforcement action against CTPs operating in Canada that do not comply with applicable Canadian securities legislation, and reminds CTPs operating from outside Canada that they are regarded as operating in Canada to the extent of their activities with Canadian clients.
Simultaneously with the release of the Staff Notice, the Ontario Securities Commission (OSC) issued a press release (Release) with an even more direct message notifying Crypto Asset Trading Platforms that they must bring their operations into compliance with Ontario securities law or face potential regulatory action. The OSC has given CTPs until April 19, 2021 to contact OSC staff to initiate compliance discussions, failing which steps will be taken to enforce applicable requirements under securities law.
The Staff Notice follows a consultation process commenced in 2019 with the publishing of Consultation Paper 21-402 Proposed Framework for Crypto-Asset Trading Platforms (Consultation Paper). Please see our March 2019 Blakes Bulletin: Now’s Your Chance: CSA Seeks Input on Regulation of Crypto Asset Trading Platforms for more information on the Consultation Paper. The Staff Notice also follows the publication in early March 2021 of CSA Staff Notice 51-363 Observations on Disclosure by Crypto Assets Reporting Issuers, in which CSA members provided guidance to reporting issuers in the crypto assets industry regarding, among other things, disclosure of risks relating to safeguarding of crypto assets, including when such issuers hold crypto assets through a CTP.
CTPS – SECURITY TOKENS AND CRYPTO CONTRACTS
CTPs are platforms that facilitate the trading of:
Crypto assets that are securities (Security Tokens), or
Instruments or contracts involving crypto assets (Crypto Contracts).
The CSA set out its views on what constitutes a Crypto Contract in CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto-Assets (CSA SN 21-327), published in January 2020. CSA SN 21-327 stated that CTPs with a custodial model—those that merely provide their users with a contractual right or claim to an underlying crypto asset, rather than immediately delivering the crypto asset to their users—will be considered to be dealing in securities or derivatives and thus will generally be subject to securities legislation.
DIFFERENTIATING DEALER PLATFORMS AND MARKETPLACE PLATFORMS
The Staff Notice distinguishes between CTPs that operate in a manner similar to a marketplace (Marketplace Platforms) and CTPs in the business of trading Security Tokens or Crypto Contracts that do not operate as a marketplace (Dealer Platforms).
The two most common characteristics of a CTP that suggest it would be a Dealer Platform are:
It only facilitates the primary distribution of Security Tokens; and
It is the counterparty to each trade made in Security Tokens or Crypto Contracts, and client orders do not otherwise interact with one another on the CTP.
On the other hand, a CTP would be a Marketplace Platform if:
It 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;
It brings together orders of Security Tokens or Crypto Contracts of multiple buyers and sellers or parties of the contracts; and
It 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.
Dealer Platforms may also be engaged in other activities not typically performed by marketplaces, such as onboarding of 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.
The Staff Notice acknowledges that some CTPs may carry out activities that have elements of both Marketplace Platforms and Dealer Platforms, and that the industry is continuing to evolve. CTPs have a variety of business models. Depending on the activities conducted by a CTP and the risks it creates, the regulatory treatment of one CTP may differ from another.
REGULATORY APPROACH TO DEALER PLATFORMS
Dealer Platforms are expected to register as dealers under applicable securities legislation. The appropriate category of registration depends on the scope of the platform’s business activities. If a Dealer Platform only facilitates distributions or the trading of Security Tokens in reliance on prospectus exemptions and does not offer margin or leverage, registration as an exempt market dealer, or in some circumstances, a restricted dealer, may be appropriate. A Dealer Platform may not offer margin or leverage for Security Tokens unless it is registered as an investment dealer and is an IIROC member.
Similarly, a Dealer Platform that trades Crypto Contracts will be expected to be registered in an appropriate dealer category, and where it trades or solicits trades for retail investors that are individuals, it will generally be expected to be registered as an investment dealer and be an IIROC member.
Registration in the exempt market dealer category would preclude a CTP from dealing with the general public. Such a CTP would be limited to transactions with accredited investors. The restricted dealer category would involve tailored restrictions limiting the activities of the dealer, based on the circumstances and the nature of the CTP’s activities and business model.
REGULATORY APPROACH TO MARKETPLACE PLATFORMS
A Marketplace Platform will operate under the oversight of the CSA and a self-regulatory entity, as defined in National Instrument 21-101 Marketplace Operation (NI 21-101). Currently, the only self-regulatory entity that fits this definition is IIROC.
The CSA anticipates that the provisions in existing rules applicable to marketplaces, such as NI 21-101, National Instrument 23-101 Trading Rules and National Instrument 23-103 Electronic Trading and Direct Electronic Access to Marketplaces, or similar provisions, would apply to Marketplace Platforms. Trading on a Marketplace Platform would be subject to market integrity requirements such as those in IIROC’s Universal Market Integrity Rules.
In some cases, it may be appropriate to regulate a Marketplace Platform as an exchange under applicable rules, including if the platform trades Security Tokens and regulates issuers of those securities, or if it regulates and disciplines its trading participants other than by merely denying them access to the platform. In such cases the platform will be expected to seek recognition or exemption from recognition as an exchange under existing rules.
A Marketplace Platform that conducts activities similar to those of a Dealer Platform would also be subject to dealer registration requirements. The CSA generally expects that a Marketplace Platform that is not an exchange would apply for registration as an investment dealer and seek IIROC membership.
INTERIM REGULATORY APPROACH
The CSA acknowledge that it will take time to obtain the dealer registrations and IIROC membership contemplated by the Staff Notice or to obtain recognition as an exchange or an exemption from recognition. The CSA also acknowledges that some CTPs may be interested in a testing environment to assess the technical merits of their platform prior to satisfying full registration requirements. Accordingly, the Staff Notice proposes an interim approach to allow some platforms to operate in a limited way by seeking registration as a restricted dealer or exempt market dealer for a limited period while they seek appropriate registrations and IIROC membership or recognition or an exemption from recognition. This interim regulatory period is generally expected to last two years.
CLEARING AND SETTLEMENT
CTPs that perform clearing functions may be required to be recognized or granted an exemption from recognition as a clearing agency or a clearing house under securities legislation. The Staff Notice suggests regulators will take a risk-based approach in considering whether to require recognition as a clearing agency or to exempt a platform from recognition subject to appropriate terms and conditions. The CSA also indicates that it will consider applications for exemptive relief from requirements that trades executed on a marketplace be reported and settled through a regulated clearing agency, having regard to the fact that there are currently no clearing agencies recognized in Canada for transactions in Security Tokens or Crypto Contracts.
The Staff Notice represents an important statement regarding the regulators’ views on how CTPs are to be regulated in Canada.
While the framework for regulation described in the Staff Notice provides helpful high-level guidance, details about the restrictions and limitations that CTPs should expect to apply to their Canadian operations are not well fleshed out in the Staff Notice. The CSA and IIROC invite each CTP to enter into discussions with them to assess how existing securities rules are intended to apply to it, and what interim registrations, exemptive relief and tailored regulation may be available to it, having regard to the CTP’s particular business model.
The Staff Notice feels like a bear hug to Canada’s emerging crypto industry. On the one hand it embraces a pathway for a CTP to comply with requirements applicable within existing categories of regulation. At the same time, it and the concurrent OSC Release warn non-compliant platforms operating in Canada that they must engage with regulators to become compliant, failing which enforcement action will be taken. In Ontario, the OSC has given CTPs trading in Ontario until April 19, 2021 to contact OSC staff to initiate compliance discussions or face potential enforcement action.