Toronto lawyer Amy ter Haar has provided her take on the Ontario Securities Commission’s (OSC’s) CSA Staff Notice 21-327: Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets.
In short, the guidance could render any cryptocurrency trading platform subject to securities laws if they allow leveraged trading or do not place customer cryptocurrencies, tokens or “cryptoassets” into discreet software wallets controlled solely by customers.
Such a move may be designed to prevent the hacking thefts of pools of customer cryptocurrencies that have occurred in part because pooling customer funds is standard practice on crypto trading platforms.
Stealing from thousands of individual wallets might make exchange-stored cryptos harder to steal.
Individual storage could also prevent crypto trading platforms from using customer cryptocurrencies to conduct large trades on their own behalf.
According to court-appointed monitors, this is what happened at the Canada-based platform Quadriga CX before it shut down and permanently lost access to $250 million CAD in customer cryptocurrencies.
Staff at the Korean crypto trading platform Upbit were also prosecuted for using customer funds to conduct $226 billion USD in wash trades on their platform.
Here is ter Haar’s take on the potentially significant new guidance from the OSC:
“In Staff Notice 21-327 (the “Notice”), the Canadian Securities Administrators (“CSA”) have taken an approach that evaluates the specific facts and circumstances of how trading of a crypto asset occurs on a platform to assess whether or not such asset is a security or derivative for the purpose of securities legislation and/or whether the platform is considered to be a ‘marketplace’ or ‘dealer’ as defined in the legislation.”
“For example, the main criterion the CSA looks at is whether there is intended to be, and whether there is, delivery of crypto assets to investors. The Notice clarifies that a consideration of all the terms and the surrounding facts and circumstances of each case will ultimately determine whether the parties intend to immediately transfer ownership, possession and control of the crypto asset to the investor. Nonetheless, it does suggest that the transaction and the platform will be subject to Canadian securities legislation if the platform takes custody of a crypto asset without the corresponding and immediate delivery of that crypto asset to the investor.”
“The operational model of many platforms involves the platform having custody of its investors’ assets including private keys and/or holding the crypto assets in its own wallet with the platform’s own private key. Since most of the trade volume in the cryptocurrency space is through these types of traditional custodial exchanges, I imagine that this Notice will influence the operations of most custodial exchanges.”
“From an operational perspective platforms will certainly want to ensure, if they haven’t already, appropriate custody controls and to provide sufficient information about the functions they perform and their fees. They’ll need to be transparent about who the legal owner of such crypto assets are and what rights the investors have in the event of the platform’s insolvency.”
“Now would be a good time for them to review and revise risk management policies and procedures and to manage and mitigate those custodial risks. Understandably, the platform will need to ensure a robust system of internal controls, including records, that ensures that an investor’s crypto assets are accurately accounted for and appropriately segregated from assets belonging to the platform. Traditional custodians that hold assets for clients may also want to engage an independent auditor to perform an audit of the custodian’s internal controls and prepare an assurance report.”
I asked ter Haar whether she thinks the guidance, not yet law, will be enforced:
“The ‘guidance’ is certainly very useful as such; it is intended to help platform operators determine whether their activities are subject to securities legislation. For example, Louis Morisset, CSA Chair and President and CEO of the Autorité des marchés financiers said ‘The evolving landscape of the industry prompts us to clarify our regulatory framework so as to better support fintech businesses seeking to offer innovative products, services and applications in Canada,’ and further ‘[a]s we continue to consider the comments and responses to the consultation we launched last year, the staff notice published today will help platform operators to determine whether their activities are subject to securities legislation.'”
“As he points out, both the CSA and the Investment Industry Regulatory Organization of Canada (IIROC) continue to review the comments and responses to Joint CSA/IIROC Consultation Paper 21-402 Proposed Framework for Crypto-Asset Trading Platforms. They anticipate publishing a summary of comments and responses along with guidance on the regulatory framework applicable to crypto-asset trading platforms that are subject to securities legislation later this year.”
“The CSA Staff Notice 21-327 certainly illuminates that most custodial platform operators operating in Canada, as well as foreign platforms that offer services to Canadian users are subject to Canadian securities legislation. Accordingly, these organizations may need to make changes to their operations or take steps to register as dealers, seek exemptive relief or otherwise comply with the applicable Canadian securities legislation.”
“The staff notice is an informative step along the path toward the forthcoming guidance on the regulatory framework applicable to crypto-asset trading platforms. Clearly, there is more to come.”
Ter Haar further stated that it is, “illuminating that the CSA will ‘consider’ most custodial platform operations…. as subject to Canadian securities legislation.”
Platforms remain entitled to case-by-case consideration, ter Haar said, and now’s a good time to consult with lawyers:
“Ultimately, whether they are, in fact, subject to Canadian securities legislation will depend on the facts of each case. Importantly, the guidance encourages platforms to consult with their legal counsel on the application of securities legislation because there is no bright-line test.”