Regulatory developments in crypto from CSA to OSFI

The Canadian landscape for cryptoassets continues to mature against the backdrop of evolving securities and banking regulatory requirements, among other considerations.

In this quarterly update, we consider two developments from the third quarter of 2022:

• the Canadian Securities Administrators (CSA) renewed its push for crypto trading platforms operating in Canada to comply with applicable securities laws by announcing its expectation for unregistered crypto trading platforms to provide a pre-registration undertaking; and
• the Office of the Superintendent of Financial Institutions (OSFI) issued an advisory setting out OSFI’s interim approach for the regulatory capital and liquidity treatment of cryptoasset exposures held by federally regulated financial institutions.

Securities regulations for CTPs

On March 29, 2021, staff of the CSA and the Investment Industry Regulatory Organization of Canada (IIROC) jointly published Staff Notice 21-329 – Guidance for Crypto-Asset Trading Platforms: Compliance with Regulatory Requirements, in which they provided guidance on the application of securities laws to crypto trading platforms that facilitate or propose to facilitate the trading of security tokens (cryptoassets that are securities) or crypto contracts (instruments involving cryptoassets where users have a contractual right to a cryptoasset).

Since the introduction of Staff Notice 21-329, nine crypto trading platforms have registered as a restricted dealer or investment dealer and been granted exemptive relief under the interim approach described in Staff Notice 21-329, and many other crypto trading platforms have initiated dialogue with their respective Canadian principal securities regulators to bring their operations into compliance with securities laws.

Pre-registration undertakings requirement

On August 15, 2022, the CSA announced that it expects crypto trading platforms that are in the process of seeking registration and associated exemptive relief but are continuing to operate in Canada to provide a pre-registration undertaking to their principal regulator while their applications are being reviewed. In August, CSA members accepted pre-registration undertakings from Crypto.com and Coinsquare Capital Markets Ltd.

The new pre-registration requirement levels the playing field between crypto trading platforms that have been granted exemptive relief and those platforms that are seeking exemptive relief or registration. The terms and conditions of the pre-registration undertakings are largely similar to, and consistent with, the terms and conditions of the exemptive relief granted to registered crypto trading platforms under the interim approach in Staff Notice 21-329. However, there are two items in the pre-registration undertakings which may be of interest to crypto trading platforms.

Margin and other forms of leverage

None of the nine crypto trading platforms that have been granted exemptive relief extend margin or other forms of leverage to their clients. Moreover, Staff Notice 21-329 requires that platforms not offer leverage or margin trading to their clients under the interim approach.

Despite that, the pre-registration undertakings to Crypto.com and Coinsquare Capital Markets Ltd. permit them to offer margin, credit and other forms of leverage, albeit only to a subset of their clients that are considered “permitted clients” (generally institutional or ultra-high net worth clients). Before we read too much into this development, we should also note that following the acceptance of the pre-registration undertakings of Crypto.com and Coinsquare Capital Markets Ltd., the Alberta Securities Commission released Blanket Order 24-506, which, among other items, required crypto trading platforms that rely on the Blanket Order to not offer to their clients trading on margin or leverage. As such, industry participants will likely seek greater clarity from members of the CSA regarding their position on this topic.

Crypto lending and staking services

The pre-registration undertakings of Crypto.com and Coinsquare Capital Markets Ltd. required both platforms to seek consent from their principal regulator and the securities regulatory authority of the other jurisdictions in which they intend to offer crypto lending and/or staking services prior to the provision of such services. This may suggest that members of the CSA consider such services to fall within their purview. Accordingly, crypto trading platforms that seek to offer crypto lending and/or staking services may want to consider consulting with the relevant securities regulators before offering such services.

Looking forward

The new developments impacting the regulation of crypto trading platforms and their service offerings reflect a continuing engagement between platforms and the regulators to further develop the securities regulatory framework to accommodate new service offerings by platforms, while addressing, innovation, client service and investor protection considerations. We will continue to monitor this area with interest as new developments are introduced.

OSFI advisory on cryptoassets

On August 18, 2022, OSFI issued an advisory (the Advisory) providing an interim approach for cryptoassets held by federally regulated financial institutions (FRFIs). The scope of the Advisory is limited to the capital and liquidity treatment of a FRFI’s exposures to cryptoassets and helps ensure that FRFIs adopt sound risk management policies and practices concerning their cryptoasset holdings in order to safeguard the resiliency and stability of the Canadian financial system.

Defining cryptoassets

The Advisory defines cryptoassets as digital assets that depend primarily on cryptography and distributed ledger or similar technology. The Advisory categorizes cryptoassets into two groups:

1. Group 1 cryptoassets must meet certain prescribed criteria, which include, among other things, that such cryptoassets are digital representations of traditional assets and have a legal opinion confirming (a) that all rights, obligations and interests arising from the cryptoasset are clearly defined, legally enforceable and consistent with the rights, obligations and interests associated with comparable traditional assets; and (b) settlement finality of the cryptoasset.
2. Group 2 cryptoassets are defined broadly to include all residual cryptoassets that are not Group 1 cryptoassets.

Based on the categorizations set out in the Advisory, we note that popular cryptoassets such as Bitcoin and Ether would be characterized as Group 2 cryptoassets, since they are not digital representations of traditional assets.

Cryptoasset exposures and their treatment

The categorization of cryptoassets as Group 1 or Group 2 is important because it impacts the capital treatment received by the FRFI relating to the cryptoasset exposures associated with such cryptoasset.

Group 1 cryptoassets generally receive similar treatment as comparable traditional assets, whereas Group 2 cryptoassets are subject to a more conservative treatment. Examples include Group 2 cryptoassets’ ineligibility to count towards certain FRFI capital and collateralization requirements (subject to 100% haircut) and unfavourable liquidity treatment because Group 2 cryptoassets do not contribute any liquidity value.

Looking forward

While the Advisory sets out capital and liquidity treatment of FRFI exposures to cryptoassets, it is important to note that the Advisory does not address the fundamental issue of whether a FRFI is permitted under the Bank Act, Insurance Companies Act or Trust and Loan Companies Act to issue any particular cryptoasset, or to acquire or hold a controlling or substantial investment in entities that issue cryptoassets. However, OSFI notes that it is committed to updating the interim arrangements outlined in the Advisory to reflect ongoing developments in four key areas:

1. the Department of Finance legislative review focused on the digitization of money and maintaining financial sector stability and security;
2. responses to OSFI’s consultation questions in connection with the Advisory;
3. the Basel Committee on Banking Supervision’s final guidance on the prudential treatment of cryptoasset exposures; and
4. ongoing developments in the cryptoasset market.

As such, we can expect to see further guidance on the treatment of cryptoassets by OSFI in the future.

Conclusion

With the development of distributed ledger technologies and rapidly expanding use cases of such technologies, the related regulatory frameworks in securities laws and banking, among others, are also being further developed and refined. Regulators are taking a thoughtful approach and balancing the need to remain vigilant regarding the risks associated with these technologies, while at the same time promoting innovation.