By John Filar Atwood
The Canadian Securities Administrators (CSA) and the Investment Industry Regulatory Organization of Canada (IIROC) are seeking public input on the appropriate way to regulate Canadian platforms that trade crypto-assets. The regulators offered a proposed regulatory framework, but are seeking feedback on core issues such as how to address custody and verification of assets, price determination, market surveillance, and clearing and settlement.
The CSA and IIROC noted in a news release that crypto-asset trading platforms may be subject to securities and/or derivatives regulation depending on how they operate and the assets they make available for trading. They are concerned that the exiting regulatory system may not fully address the novel features and potential risks of crypto-assets. Where securities legislation applies to the platforms, the CSA and IIROC said that they are considering a tailored regulatory framework to address the novel features and risks.
The consultation paper seeks input on a number of areas that will assist in determining appropriate requirements for platforms. The CSA and IIROC noted that they will continue to engage with international regulators about their approaches to crypto-asset trading platforms, and will consider input on a variety of existing regulatory approaches.
The CSA, through its regulatory sandbox, is in discussions with several platforms that are seeking guidance on the requirements that apply to them. Platform operators and their advisers told the CSA that they would welcome a regulatory framework as they try to build consumer confidence and expand their businesses. At the moment, there are no platforms recognized as an exchange or otherwise authorized to operate as a marketplace or dealer in Canada.
The CSA and IIROC acknowledged that some well-established crypto assets that function as a form of payment or means of exchange on a decentralized network, such as Bitcoin, are not currently in and of themselves securities or derivatives. Rather, they have certain features that are analogous to existing commodities such as currencies and precious metals.
Application of securities laws. Securities legislation may still apply to platforms that offer trading of crypto-assets that are commodities, the CSA said, because the investor’s contractual right to the crypto-asset may constitute a security or derivative. The regulators are evaluating the specific facts of how trading occurs on platforms to assess whether or not a security or derivative may be involved.
To make this determination, they are considering, among other things: (1) whether the platform is structured so that there is intended to be and is delivery of crypto-assets to investors; (2) if there is delivery, when that occurs, and whether it is to an investor’s wallet over which the platform does not have control or custody; (3) whether investors’ crypto assets are pooled together with those of other investors and with the assets of the platform; (4) whether the platform or a related party holds or controls the investors’ assets; (5) if the platform holds or stores assets for its participants, how the platform makes use of those assets; and (6) whether the investor can trade, or rollover positions held by the platform.
Proposed framework. The proposed framework will apply to platforms that are subject to securities legislation and that may not fit within the existing regulatory framework. It will apply both to platforms that operate in Canada and to those that have Canadian participants.
The framework is based on the existing regulatory framework applicable to marketplaces and incorporates relevant requirements for dealers facilitating trading or dealing in securities. A platform that brings together orders of buyers and sellers of securities and uses non-discretionary methods for these orders to interact is a marketplace.
As a marketplace, a platform will be subject to requirements set out in NI 21-101, National Instrument 23-101 Trading Rules (together with NI 21-101, the “Marketplace Rules”), and National Instrument 23-103 Electronic Trading and Direct Access to Marketplaces.
In addition to marketplace functions, the platform may also perform dealer functions such as providing custody of crypto-assets and permitting direct access to trading by retail investors. The framework will include requirements that address the risks relating to these additional functions.
The CSA noted that some entities will not fall within the definition of a marketplace. For example, an entity that is trading 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 therefore not be subject to the Marketplace Rules and the proposed framework.
Firms that are currently registered in the category of exempt market dealer and are permitted under securities legislation to facilitate the sale of securities, including crypto-assets, in reliance on available prospectus exemptions in National Instrument 45-106 Prospectus Exemptions, can continue to offer this service as long as they do not fall within the definition of “marketplace.”
Registered firms introducing crypto-asset products and/or services are required to report changes in their business activities to their principal regulator and the proposed activities may be subject to review to assess whether there is adequate investor protection.
Investment dealers. Like the Marketplace Rules, the framework contemplates platforms both becoming registered as investment dealers and becoming IIROC dealer and marketplace members. IIROC currently oversees all investment dealers as well as trading activity on debt and equity marketplaces in Canada, and has a comprehensive body of rules governing the business, financial and trading conduct of IIROC members.
IIROC also has established programs to assess compliance with both IIROC’s rules applicable to dealers, and the universal market integrity rules that govern trading on a marketplace. IIROC also has experience with dealers and marketplaces that trade a variety of securities and has developed tailored compliance programs and applied tailored rules for marketplaces.
Derivatives. The CSA plans to consult on the appropriate regulatory framework to apply to marketplaces that trade over-the-counter derivatives, including platforms that offer derivatives with exposure to a crypto-asset. In the interim, if a platform is trading or dealing in crypto-assets that may be classified as derivatives, to the extent that the platform has similar functions to those contemplated in the consultation paper, it may be appropriate to apply requirements to those platforms that are similar to the requirements contemplated by the framework. However, the CSA expects that the requirements may need to be tailored to reflect the requirements that currently apply to derivatives or are otherwise appropriate to apply to those products and marketplaces.