On March 14, the Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC, and together with the CSA, Regulators) jointly published Consultation Paper 21-402 Proposed Framework for Crypto-Asset Trading Platforms (Consultation Paper). Platforms that facilitate the purchase, sale or transfer of crypto assets (Platforms) may be subject to securities and/or derivatives regulation, depending on how they operate and the assets they make available for trading. The Consultation Paper discusses this threshold issue, outlines the Regulators’ understanding of the risks related to these Platforms for Canadian investors and capital markets, summarizes regulatory approaches in other jurisdictions, and then outlines the Regulators’ concept proposal for a regulatory framework for Platforms, which they give the rather awkward name of “Proposed Platform Framework.” The Proposed Platform Framework isn’t fully developed and we won’t describe it in detail. Instead, we are highlighting several issues that we think our clients might find interesting.

  • Does Securities or Derivatives Regulation Apply? As we have discussed in prior editions of the bulletin, including our June 2018 bulletin, the CSA have found that most offerings of utility tokens involve a distribution of securities. Certain other kinds of crypto-assets that function as a form of payment or means of exchange on a decentralized network, such as bitcoin, are not in themselves securities or derivatives but are more like commodities such as currencies or metals. The Consultation Paper suggests, however, that securities legislation may still apply to Platforms that offer trading of crypto assets that are commodities because the investor’s contractual right to the crypto asset may constitute a security or derivative. The Regulators outline the factors they’re considering in their analysis and are seeking feedback on this scope issue.
  • Territorial Scope: The Proposed Platform Framework will apply both to Platforms that operate in Canada and those that have Canadian participants. The CSA may consider exemptive relief for Platforms located outside Canada that are subject to similar regulation and oversight.
  • Hybrid Platforms Means Hybrid Regulation: Some existing Platforms engage in functions typically performed by marketplaces including exchanges and alternative trading systems (ATSs), dealers, custodians, and/or clearing agencies. Given the hybrid nature of the Platforms, the Regulators intend that the Proposed Platform Framework will combine elements of the existing regulatory frameworks for marketplaces (including marketplaces that trade over-the-counter derivatives) and dealers, supplemented with additional requirements tailored to additional risks presented by the Platforms.
  • Shrink to Fit Regulation: Depending on a Platform’s specific activities, some elements of the Proposed Platform Framework may not apply. For example, an entity that trades crypto assets that are securities but always trades against its participants and does not facilitate trading between buyers and sellers may be regulated as a dealer only and won’t be subject to marketplace rules. For example, exempt market dealers (EMDs) that are currently permitted under securities legislation to facilitate the sale of securities, including crypto assets, in the exempt market would be able to continue offering this service as long as they don’t fall into the definition of “marketplace”. Of course, registered firms that begin offering crypto asset products or services will be expected to report changes in their business to their principal regulator, and the proposed activities may be subject to review to assess whether there is adequate investor protection.
  • Risks, risks, risks: A substantial part of the Consultation Paper focuses on the potential risks to investors and Canadian capital markets that Platforms may present, the kinds of rules that should be adopted to address those risks, and whether the existing and/or crypto asset-specific requirements that the Regulators are contemplating will be practicable and effective. For example, the Consultation Paper seeks feedback about regulatory approaches to:
    • Custody and verification of assetse.g. what standards should a Platform adopt to mitigate risks related to safeguarding investors’ assets and how could auditors or other parties provide assurance to regulators that a Platform has adequate controls in place to protect investors’ assets?
    • Price determinatione.g. are there reliable pricing sources that could be used to determine fair prices?
    • Systems and business continuity planninge.g. what is the appropriate scope for an independent systems review (ISR) of a Platform’s information technology and related internal controls?
    • Management and disclosure of conflicts of intereste.g. are there particular conflicts of interest that Platforms may not be able to manage appropriately, given their current business models and if so, how could those models be changed to manage such conflicts appropriate?
    •  Insurancee.g. since some Platforms find it difficult to obtain insurance, are there alternative measures that address investor protection that could be considered equivalent to insurance coverage?
    • Clearing and settlemente.g. are there significant differences in risks between the traditional and decentralized models for clearing and settlement and how could those risks be mitigated?