Written By Andrew Bozzato, Kwang Lim, Simon Grant, Matt Flynn and Duncan Pardoe

On February 22, 2023, the Canadian Securities Administrators (CSA) released Staff Notice 21-332 (SN 21-332), which introduces enhanced pre-registration requirements that apply to unregistered crypto-asset trading platforms (CTPs) operating in Canada. SN 21-332 also clarifies the CSA's approach to regulating crypto-assets that are intended to maintain a stable value over time through pegging their value to other assets, rights, values or combinations thereof, commonly referred to as "stablecoins" or, as the CSA refers to them, "Value-Referenced Crypto Assets" (VRCAs). Collectively, these regulatory updates build on prior CSA guidance and provide important updates for CTPs and other crypto market participants in Canada.

CTP Regulatory Changes

SN 21-332 builds on the CTP guidance released by the CSA on August 15, 2022, and December 12, 2022, and on Joint Staff Notice 21-329 which we wrote about previously in our blog, New Regulatory Guidance Requires Immediate Attention from Crypto Trading Platforms. In its August 2022 guidance, the CSA announced that every CTP which continues to operate in Canada while seeking platform registration is expected to complete a pre-registration undertaking (the PRU). The PRU sets out the conditions that every CTP must satisfy to operate in Canada while awaiting the results of its CTP registration application. These conditions addressed the CSA's investor protection concerns and were consistent with the conditions then applicable to registered CTPs. Typical standard form PRU conditions have included conditions requiring a CTP to:

• adhere to various business conduct rules such as maintaining systems to manage risk and conflicts of interest, and complying with various reporting and marketplace rules;
• notify its applicable principal securities regulator:
  • of any material change affecting the CTP that may reasonably be considered material by the principal securities regulator or a CTP client;
  • of any breach or failure of the CTP’s systems of controls (such as a hack) and the steps taken to address that breach or failure;
  • if the CTP becomes subject to any bankruptcy or insolvency proceedings; and
• commit to working diligently to advance its application(s) for registration and exemptive relief, and acknowledge that if the registration process cannot be successfully completed within 12 months the CTP will cease to carry on registerable activities in Canada.

In December 2022, the CSA announced that it would be expanding the existing requirements for CTPs operating in Canada. SN 21-332 introduces new PRU conditions to address CTP insolvency risks and investor protections in connection with a CTP insolvency event (the Enhanced PRU), an unsurprising regulatory concern given the recent high profile insolvencies and liquidity events affecting crypto market participants around the world. As of February 22, 2023, standard form PRU conditions now also include:

• an obligation for the CTP to adhere to the client asset trust account reporting rules described in SN 21-332 and to keep all client assets separate from its own property by placing them in trust accounts for the benefit of the client with:
  • a Canadian custodian or Canadian financial institution for cash assets, and
  • an Acceptable Third-Party Custodian (as defined in SN 21-332) for crypto-assets;
• an obligation that any parent and global affiliate entities of the CTP (and their controlling persons) co-sign the CTP's Enhanced PRU, along with requirements that the board of directors of the Canadian CTP entity seeking registration be independent from these entities to the extent possible;
• obligations for the CTP to regularly file the financial information described in section 12.12 of National Instrument 31-103, and retain a qualified chief compliance officer as described in SN 21-332; and
• a prohibition on the CTP from:
  • pledging or otherwise using for its own purposes any crypto-assets it holds on behalf of clients;
  • extending any margin or other form of leverage to any client;
  • including any crypto-assets in the calculation of the CTP's excess working capital if those crypto-assets are not offset by a corresponding current liability; and
  • permitting any Canadian client to enter into a crypto contract to buy or sell any crypto-asset that is itself a security or derivative, except for VRCAs if the prior written consent of the CSA has been obtained.

All CTPs operating in Canada while pursuing applications for registration and related relief are now expected to provide an Enhanced PRU to their principal securities regulator by March 24, 2023. CTPs are expected to take all necessary steps to comply with the Enhanced PRU conditions within the specified timelines. If any CTP is not prepared to file an Enhanced PRU or fails to abide by any conditions of an Enhanced PRU, the CSA expects the CTP to take appropriate steps to off-board existing Canadian clients and restrict Canadian clients from accessing the CTP's products or services. If a CTP fails to take such steps, Canadian securities regulators have shown that they are ready and willing to take regulatory enforcement action against non-compliant CTPs, such as imposing penalties and sanctions.

VRCA Regulatory Changes

SN 21-332 also builds on the VRCA guidance in the CSA's December 12, 2022 news release where the CSA announced that, although it was continuing to monitor and assess the presence and role of "stablecoins" in Canadian capital markets, it was nonetheless of the view that VRCAs, or VRCA arrangements, may constitute securities and/or derivatives.

As of February 22, 2023, the CSA has now confirmed that it is of the view that VRCAs are generally considered to be securities, derivatives or both. Specifically, the CSA has stated that VRCAs which are pegged or backed by fiat currency assets (such as a reserve of currency or commercial paper denominated in that currency by the VRCA issuer) generally meet the definition of a security and/or would meet the definition of a derivative in multiple jurisdictions. The CSA also stated that VRCAs which are pegged or backed by assets other than fiat currency (such as gold or other crypto-assets) or baskets of such assets are also generally considered to be securities and/or derivatives. However, the final assessment of whether a VRCA is a security and/or derivative remains a fact-specific exercise.

As discussed above, a CTP that is not otherwise registered to trade or advise in securities and/or derivatives is not permitted to allow its Canadian clients to enter into contract to buy or sell VRCAs that are securities or derivatives unless the CTP obtains the prior written consent of the CSA and complies with any conditions of that consent. However, SN 21-322 notes that the CSA is unlikely to provide such consent in respect of a VRCA that maintains some or all of its value through an algorithm. The CSA also stated that a CTP may be unable to comply with its Enhanced PRU commitments if it allows Canadian transactions of such algorithmic VRCAs. SN 21-332 concludes by stating that the CSA's announced approach to VRCA regulation is intended to be an interim approach only, and that it may be modified as the CSA continues to assess and monitor VRCAs in Canada.

All CTPs, whether registered or unregistered, should review their policies and procedures for determining whether each crypto asset they provide exposure to or make available to clients is a security and/or derivative and consider if changes are necessary in light of this guidance.

Key Takeaways

SN 21-332 introduces new regulatory requirements for CTPs and provides clarifying guidance with respect to whether stablecoins are securities and/or derivatives. 

If you have any questions regarding SN 21-332, the process or requirements of filing an Enhanced PRU, or would like further guidance on crypto-asset regulation generally, please contact the authors or another member of the Bennett Jones Fintech group or Capital Markets group.