The Canadian Securities Administration (CSA) issued “CSA Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets” on January 16, 2020. This Staff Notice carries important implications for crypto asset trading platforms to help determine whether a transaction or a trading platform falls under the purview of Canadian securities law.
CSA/IIROC Consultation Paper 21-402, March 14, 2019 (the Consultation Paper)
The Staff Notice confirms the approach set out in CSA/ Investment Industry Regulatory Organization of Canada Consultation Paper 21-402 Proposed Framework for Crypto Asset Trading Platforms that was published on March 14, 2019. This Consultation Paper stated that securities legislation applies to platforms that support the trading of crypto assets that are securities or derivatives. A security can be a tokenized security (commonly referred to as a security token in the industry) that carries rights traditionally associated with common shares, such as the right to receive a dividend and the right to vote. A derivative can be a token that provides an option to acquire an asset in the future. In addition to platforms that facilitate the trading of securities and derivatives, the Consultation Paper stated that “securities legislation may also apply to Platforms that facilitate the buying and selling of crypto assets, including crypto assets that are commodities, because the user’s contractual right to the crypto asset may itself constitute a derivative.”
CSA Staff Notice 21-327 (the Staff Notice)
The Staff Notice notes that some platform providers are of the view that securities legislation does not apply to them because they only allow transactions of crypto assets that “are not, in and of themselves, derivatives or securities.” The Staff Notice indicates that unless the platform is providing an immediate delivery of the crypto asset to its users at the time of the purchase, the platform is “merely providing users with a contractual right or claim to an underlying crypto asset, rather than immediately delivering the crypto asset to its users” and, in such cases, “these Platforms are generally subject to securities legislation.”
The CSA will consider immediate delivery of the crypto asset to have occurred if the platform immediately transfers ownership, possession and control of the crypto asset to the user and, thereafter, the user is free to use or deal with the crypto asset without any involvement with the platform or its affiliates, and the user is not exposed to “insolvency risk (credit risk), fraud risk, performance risk or proficiency risk on the part of the Platform.”
Consequently, according to the approach taken by the CSA, the only platforms not subject to securities law will fall under the very limited category in which the crypto asset being traded is neither a security nor a derivative, and the terms of the transaction result in the immediate delivery of the underlying asset to the purchaser as described above. According to the example provided by the CSA, securities law would not apply to a transaction involving the buying and selling of bitcoin if, in addition to fulfilling other conditions, the terms of the transaction require that the entire quantity of bitcoin purchased from the platform or the seller be immediately transferred to a wallet that is in complete control of the user and the transfer is immediately reflected on the bitcoin blockchain.
On the one hand, the initiative taken by the Canadian regulatory bodies to better regulate crypto trading platforms is not surprising given the two exchange scandals of the past year. The first one related to Quadriga, in which users were unable to recover more than $200 million worth of funds when Gerald Cotton (the founder of Quadriga) died mysteriously. The second one occurred in November 2019, when the British Columbia Securities Commission (BCSC) obtained a court order under the B.C. Securities Act appointing a receiver to take possession of the property of the Einstein Exchange (a Vancouver-based cryptocurrency exchange) and its affiliates, after users of the exchange complained that they could not access their funds. It should be noted that the BCSC has not authorized any crypto-asset trading platforms to operate as an exchange. It has been reported that the Einstein Exchange owed more than $16 million to its clients (around $11 million in cryptocurrencies and $5 million in cash) when it was shut down in November 2019. Moreover, ever since Facebook’s announcement of the planned public launch of Libra (a permissioned blockchain digital currency) in the first half of 2020, regulatory bodies all over the globe have begun serious efforts to regulate the industry.
However, on the other hand, the implications of the Staff Notice may be detrimental to the Canadian crypto landscape, which only maintains a small presence globally. Trading platforms that facilitate the buying and selling of crypto assets generally do not immediately transfer the crypto asset to the user’s wallet. In fact, many users prefer to leave the crypto asset on the exchange for various reasons. Some crypto users do not even have their own private wallet. Therefore, compliance with the Staff Notice’s guidance will require the trading platforms to consider their operational capabilities. Some international platforms might even reconsider offering their services to the Canadian market in light of the potentially heavy costs associated with compliance.
At this point, the Staff Notice is only guidance from the CSA and could potentially be challenged, changed or withdrawn. However, platforms will want to take note of this development as the Staff Notice suggests that CSA members intend to take enforcement actions against platforms that do not comply with the applicable securities law.
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David Shaw is a partner at Dale & Lessmann LLP, practising in its Corporate and Commercial Law Group. He would like to thank Usman Javed, an articling student at Dale & Lessmann LLP, for his assistance with this blog.