Last week, the Canadian Securities Administrators (the “CSA”) published guidance on situations when securities legislation may apply to entities that facilitate crypto-currency trading.
The CSA is an umbrella organization of securities regulators from each of the provinces and territories. The CSA’s mandate is to protect Canadian investors from unfair, improper or fraudulent practices, and to foster fair and efficient capital markets. They regularly issue guidance – written disclosures of best practices for market participants, which are non-binding but intended to summarize trends among the regulators.
The issued guidance is CSA Staff Notice 21-327, Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets (the “Guidance”). The Guidance highlights certain factors that entities facilitating trades in crypto-assets (“Crypto-Platforms”) should consider when deciding if they are subject to securities regulation. Crypto-assets include the eponymous Bitcoin (discussed by Siskinds here), as well as securities and derivatives based on cryptocurrencies. Because cryptocurrencies are not issued by any bank or government, people holding those assets generally rely on online Crypto-Platforms to trade them.
The Guidance states that Crypto-Platforms are not subject to securities legislation if each of the following apply:
- The underlying crypto-asset itself is not a security or derivative;
- The purchase or sale results in the obligation to make immediate delivery of the crypto-asset to the client; and
- The crypto-asset is actually delivered to the client.
In plain English, a Crypto-Platform has to behave more like a bank than a broker to be exempt from onerous securities laws.
The Guidance warns that substance governs over form when deciding if a Crypto-Platform facilitates simple exchanges (not heavily regulated) or engages in trading of securities and derivatives (heavily regulated). It does not matter what the Crypto-Platform says it does, if the actual practice is different:
For example, a contract or instrument would be considered a derivative or a security even though the written contract referenced an obligation to make immediate delivery, if it was not the typical commercial practice to deliver in accordance with that obligation.
The line between bank and broker relies heavily on whether the crypto-asset has been immediately delivered to the client. This is a question of whether there has been a complete transfer of “ownership, possession and control” of the crypto-asset to the client (with no further involvement of the Crypto-Platform).
Why such an emphasis on immediate delivery? As the Guidance notes, this is the point where the user would no longer “be subject to ongoing exposure to insolvency risk (credit risk), fraud risk, performance risk and proficiency risk on the part of Platform.” Securities regulators are concerned with controlling the risks of a large broker becoming insolent and evaporating client assets on a large scale.
For crypto-assets like Bitcoin, the Guidance states the immediate delivery requires “a transfer of the bitcoin to the user’s wallet.” It is not enough for a Crypto-Platform to merely record the transfer on an internal ledger. It is also not enough if the transfer only occurs on client request. It has to be immediate, automatic and full.
Owners of Crypto-Platforms should consult with experienced securities lawyers to learn more about what the Guidance says about their reporting obligations.