CSA imposes more restrictions and March 24 deadline on unregistered crypto trading platforms | Blake, Cassels & Graydon LLP

In the wake of recent major disruptions in the crypto industry, securities regulators in Canada have once again raised the bar for unregistered crypto-asset trading platforms (CTPs) operating in Canada.

In the latest in a series of announcements conveying its evolving regulatory approach to the CTP industry, the Canadian Securities Administrators (CSA) umbrella group has announced that it is improving the requirements that regulators impose on unregistered CTPs in their pre-registration undertakings (Undertakings). These enhanced requirements include stricter standards for the management, reporting and handling of client funds. The new CSA guidance sets a 30-day deadline (expiring 24 March 2023) within which unregistered CTPs are expected to provide a revised undertaking. The guidance also expands on the CSA’s previously announced position that stablecoins may constitute securities and/or derivatives under Canadian securities legislation.

This guidance is set out in CSA Staff Notice 21-332, Crypto Asset Trading Platforms: Pre-registration Firms – Changes to Improve Canadian Investor Protection (employee announcement), published on 22 February 2023.

BACKGROUND FOR THE PERSONNEL ANNOUNCEMENT

The staff announcement further clarifies CSA’s previously announced positions on commitments and stablecoins. The CSA’s objective in requiring the entities is to improve investor protection and also to level the playing field between CTPs that continue to operate in Canada without complying with applicable securities laws and CTPs that are registered and subject to a significant compliance burden.

First, in August 2022, the CSA announced that CTPs operating in Canada but not yet registered to do so must sign a pre-registration undertaking that addresses investor protection concerns. The CSA simultaneously published the commitments provided by two platforms that were not yet registered at the time. See our August 2022 Blake’s Bulletin: Obligations are now expected for crypto-asset trading platforms operating in Canada as they seek registration.

Then, in December 2022, the CSA announced that the undertakings would include extended conditions respecting custody, asset segregation and a limitation on margin lending. The CSA also announced that it will shortly communicate to unregistered platforms a deadline for when the undertakings must be delivered, and stated its view that stablecoins, or stablecoin arrangements, may constitute securities and/or derivatives. See our December 2022 issue Blake’s Bulletin: CSA Gets Tougher on Unregistered Crypto Trading Platforms and Takes Position on Stablecoins.

In addition to further clarifying the CSA’s approach to enterprises and stablecoins, the staff provides a reminder that non-compliant CTPs may become targets for enforcement.

PRE-REGISTRATION BUSINESS

CSA staff require unregistered CTPs to sign undertakings as a condition of being allowed to continue operating while the CTPs process their applications for registration and related relief. Unregistered CTPs who do not sign an undertaking meeting the newly enhanced expectations of CSA members within 30 days of publication of the staff notice (ie by 24 March 2023) and those who do not comply with an undertaking will be expected to comply CSA employees’ expectations of winding down Canadian operations or potentially facing enforcement action.

The new commitments that CSA staff are now requesting from unregistered CTPs relate to the following
areas:

• enhanced obligations in relation to custody and segregation of assets held on behalf of Canadian clients, including that cash must be held with a Canadian custodian or financial institution, and that crypto-assets must be held by an “acceptable third-party custodian”, which, in the case of a non-Canadian custodian, may require the prior approval of applicable CSA members;

• enhanced obligations to prevent the unregistered CTP from pledging, re-hypothecating or otherwise using crypto-assets held on behalf of Canadian clients, including providing evidence of meaningful compliance systems and corporate governance controls to meet this obligation;

• a ban on the part of the CTP offering margin, credit or other forms of leverage to any type of client (even sophisticated “permitted clients”) in connection with crypto trading;

• new commitments by global affiliates, parent companies and/or controlling minds to co-sign the undertaking and make certain commitments to respect the independence of the applicable CTP;

• restrictions on the CTP’s reliance on crypto-assets in determining the capital of the CTP for surplus working capital purposes and in determining the capital base of the CTP;

• enhanced obligations in relation to the submission of financial information from the CTP to the CSA on a regular basis;

• enhanced obligations in relation to the retention of a qualified chief compliance officer (CCO), who generally must meet the requirements of a CCO for an exempt market dealer, during the pre-registration process;

• a prohibition on the part of the CTP with respect to customers purchasing or depositing stablecoins (or what the CSA calls “Value-Referenced Crypto Assets”) through crypto contracts without the prior written consent of the CSA; and

• a prohibition on the part of the CTP with respect to the trading of crypto contracts based on proprietary tokens, except with the prior written consent of the CSA.

For a more detailed discussion of crypto contracts and the background to the securities approach to CTPs in Canada, see our April 2021 Blake’s Bulletin: Canadian securities regulators deliver bear hug to crypto-asset trading platforms operating in Canada.

STACK COINS OR “VALUE-REFERENCED CRYPTOS ASSETS”

The staff announcement also sets out interim guidance on whether and how CTPs can trade in stablecoins. The CSA has adopted the term “Value-Referenced Crypto Assets” (VRCAs) to discuss assets commonly called stablecoins, based on the CSA’s view that the term “stablecoin” may misleadingly imply that this type of asset will always maintain a stable value. VRCAs include stablecoins that aim to maintain a link to a fiat currency, such as Tether and USD Coin, or to other assets or values ​​(eg gold), and may be reserve-backed or algorithmic. CSA members express the view in the staff announcement that VRCAs generally meet the definition of “security” and/or “derivative,” but that the assessment of each individual asset will depend on the specific facts and circumstances.

The staff report raises a number of policy concerns related to trading in VRCAs, including a lack of transparency regarding reserves, stabilization mechanisms and governance; potential for investor confusion about risk of loss or rights associated with holding VRCAs; and management and custody of reserved assets, including bank-run style redemption risks. The staff message identifies algorithmic VRCAs as particularly risky.

In light of these concerns, the undertakings must include a prohibition against CTPs allowing their customers to enter into crypto contracts to purchase or deposit VRCAs without the CTP obtaining prior written consent from the CSA. Such consent may be subject to terms and conditions imposed on CTP and the issuer of the VRCA. CSA members will expect the CTP to conduct adequate due diligence review to ensure that risks associated with the VRCA are addressed and the VRCA meets a number of acceptability criteria. In particular, the Staff Notification casts doubt on whether VRCAs will be acceptable if they are not fiat-linked and fully reserved by highly liquid assets that are separate from the issuer’s assets and held by a qualified custodian bank, among other things. In addition, undertakings and exemption orders may explicitly prohibit trading in certain assets; for example, some registered platforms have been explicitly prohibited from trading in Tether with Canadian customers.

The staff memo notes that the outlined approach is temporary and the CSA continues to evaluate its approach to VRCAs.

COMPLIANCE AND ENFORCEMENT

The CSA continues to warn unregistered CTPs that CSA staff will consider compliance and/or enforcement action against a CTP and its principals where warranted, such as where a CTP currently operates in Canada:

• is unwilling to submit an undertaking (or revised form of undertaking) in a form acceptable to CSA staff;

• submits an undertaking but does not comply with its provisions; or

• does not make bona fide attempts to get through the registration process as quickly as possible.

Enforcement or compliance action may also be taken where other information comes to the attention of CSA staff that raises investor protection or other public interest issues.