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Shut the FTX Door - Canadian Securities Regulators Tighten Grip on Crypto Asset Trading Platforms

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Technology, Media & Telecommunications Bulletin

On February 22, 2023, the Canadian Securities Administrators (the “CSA”) published a notice (the “Notice”) announcing enhanced investor protection requirements it is imposing on crypto asset trading platforms (“CTPs”).[1] This update follows on the tailwinds of the CSA’s notice on December 12, 2022, which announced its expansion of existing regulatory requirements for CTPs operating in Canada.[2]

In order to continue operating in Canada, unregistered CTPs will now have until March 24, 2023 to inform their principal regulator that they are adhering to additional pre-registration requirements and, in so doing, file a pre-registration undertaking (a “PRU”) with such regulator. It should be noted that the timeframes for compliance with the additional pre-registration requirements set out in the PRU do not appear to be set in stone, and, therefore, are likely subject to discussion and agreement with the CTPs principal regulator.

The recent, high profile melt-downs and insolvencies of CTPs around the world (including, most notably, the FTX group of companies) have spurred the CSA into action yet again in the context of crypto asset trading. Much like in the wake of the Quadriga fiasco in the early days of 2019[3], Canadian regulators are, again, reacting to the risks that unregistered (and ostensibly unregulated) CTPs pose to the investing public in Canada.

What is clear is that until regulatory amendments are made to provide a clear framework of regulations for CTPs, these CSA notices will serve to fill in the gaps and ensure that, to the limit of the Canadian regulators’ powers, they can protect the Canadian investing public from the FTXs and the Quadrigas, and assert regulatory oversight in this industry.

The Notice states that the CTPs must make the following commitments in their PRUs prior to March 24, 2023:[4]

  • that the CTP: (i) is proficient and experienced with respect to the custody of crypto assets and has appropriate policies and procedures in place to mitigate custodial risk; (ii) has or will engage a third party custodian to custody not less then 80% of the clients’ crypto assets; and (iii) will hold assets of its Canadian clients in accounts segregated from its own assets and in trust for the clients;
  • that the CTP will not pledge, re-hypothecate or otherwise use crypto assets held on behalf of Canadian clients;
  • that the CTP will be prohibited from offering margin, credit or other forms of leverage to any type of client in connection with the trading of crypto assets;
  • that the global affiliates, parent entities or controlling minds of the CTP will co-sign the PRU and will commit to: (i) not interfering with the CTP’s activities in Canada and its directors’ independent judgment; and (ii) ensuring that their activities will no undermine the CTP’s Canadian activities and its compliance with Canadian regulatory obligations;
  • that the CTP will not rely on crypto assets, including proprietary tokens issued by the CTP or an affiliate of the CTP, in determining the capital of the CTP for excess working capital purposes and in determining the capital base of the CTP;
  • that the CTP will file the financial information required of a dealer under National Instrument 31-103 with the CSA;
  • that the CTP will retain qualified Chief Compliance Officer (CCO), which CCO would meet the requirements of a CCO of a registered exempt market dealer;
  • that the CTP in prohibited from permitting clients to buy or deposit Value-Referenced Crypto Assets (commonly referred to as stablecoins) through crypto contracts without the prior written consent of the CSA; and
  • that the CTP is prohibited from facilitating the trading in crypto contracts based on proprietary tokens, except with the prior written consent of the CSA.

If CTPs are unwilling or unable to comply with these enhanced pre-registration requirements, the CSA will prohibit them from offering their services to Canadians and will impose restrictions to prevent Canadian users from accessing such CTPs products and services.

These developments are a part of a series of CSA staff notices designed to fill in gaps in the existing regulatory framework and to protect Canadians from the inherent risks of exposing their personal assets (crypto and fiat) to unregistered and unregulated CTPs.

The Notice is a further step towards the CSA’s strengthening of regulatory oversights in respect of the crypto asset trading in Canada (which is generally a good thing), but it does present a unique challenge for many CTPs. The expedited timeline and practical realities of complying with many of the requisite PRU commitments may add further burdens to the business and operations of a CTP which may be difficult to manage on top of running the business, or may simply be impossible or impractical to meet, irrespective of the timeline for filing of the PRU and compliance.

Fasken is well-positioned to assist with many of these considerations having worked extensively in the blockchain and crypto space since 2015, and having worked with some of the largest and most complex blockchain projects in Canadian history (including many CTPs).  Our national Emerging Tech group brings deep practical and full service experience within the blockchain, crypto and fintech industries. If you have any questions or want to learn more about our services, please feel free to reach out to any of the authors or subscribe to our mailing lists to receive future updates.

[3]      On January 16, 2020, the CSA published guidance on factors their staff would consider to determine whether securities legislation applies to CTPs (with the broad distinction being CTPs who did not facilitate the trading of crypto that was either a security or was subject to some kind of option or derivative might not be subject to securities legislation but would have to comply with certain requirements relating to custody of customers assets) and subsequently published guidance on how securities would apply to CTPs and explains how such CTPs should comply with existing regulatory requirements (with the introduction of the premise that CPTs that facilitate the trading of securities should seek some form of dealer registration and, in some cases, recognition as a securities exchange (or rely on an exemption) to ensure this industry is subjected to appropriate regulatory oversight)

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If you have any questions regarding, these regulatory developments, please contact the authors.

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