The Canadian Securities Administrators (CSA), a council of the regulatory bodies of Canada’s provinces and territories, published on Thursday Staff Notice 21-327 Guidance on the Application of Securities Legislation to Entities Facilitating the Trading of Crypto Assets. The legal interpretation, which comes after a consultation paper proposed a framework for crypto asset trading platforms in March, is supposed to help operators identify situations where Canadian securities laws may or may not apply to their activities.
Canadian regulators have issued new guidance determining when current securities legislation applies to operations conducted by cryptocurrency exchanges. According to the clarifications in the document, many domestic and foreign entities serving Canadian users, for example those that provide custodial services, will have to abide by the country’s securities laws and act like securities dealers.
CSA Tries to Explain When Cryptos Are Securities
The CSA explains that in certain cases crypto assets clearly represent securities. A tokenized security, for instance, carries rights that are traditionally attached to common shares such as voting rights and rights to receive dividends, the organization notes. A crypto asset can also be a derivative, the CSA remarks, like when a token provides an option to acquire an asset in the future. The regulator points out:
Securities legislation may apply to platforms that facilitate the buying and selling of crypto assets that are commodities, because the user’s contractual right to the crypto asset may itself constitute a derivative, a security or both.
The agency notes that the relevant determination will depend on the specifics, including “the obligations and intention to provide immediate delivery of the crypto asset.” Trading platforms would not be subject to securities legislation if “the underlying crypto asset itself is not a security or derivative”, or when the contract for the purchase, sale or delivery results in an obligation to make immediate delivery of the asset to the user.
In an attempt to define what constitutes ‘immediate delivery,’ however, the CSA admits there is no “bright-line test” to determine whether a contract or an instrument results in an obligation to make and take immediate delivery of a crypto asset. At the same time, a crypto transaction may be subject to securities laws if it does not clearly result in such an obligation.
The CSA staff will examine the terms of the contractual arrangements between crypto exchanges and their users as well as their typical commercial practices to establish if they create an obligation for immediate transfer of ownership, possession and control of crypto assets. The organization which coordinates the regulation of capital markets across Canada also details:
As part of this analysis, we will consider whether the platform and the user intend, at the time the contract or instrument is entered into, to make and take delivery of the crypto asset on which the contract or instrument is based.
Custodial Platforms to Operate as Securities Dealers
Then there’s the question of how to establish not only whether but also when exactly a crypto asset has been delivered. According to the guide, an immediate delivery occurs when ownership, possession and control is immediately transferred by the exchange and the user is afterwards free to deal with the asset without further participation of the platform. Also, the exchange must not retain any security interest or other legal right to the asset and the user should not be exposed to any risks related to the platform in the future.
Relations with exchanges, domestic and foreign, providing custodial services will be subject to securities regulations as there’s no obligation for immediate delivery of the assets to a user-controlled wallet. Clients remain reliant on the platform and exposed to insolvency, fraud, and other risks on its part. This means that following the new guidance, many of the hundreds of crypto exchanges operating globally will have to apply and be licensed as securities dealers to work in Canada, if they maintain their current business models, the Globe and Mail noted in an article.
The notice issued by the CSA contains many abstract statements such as “focus on substance over form”, “typical commercial practice”, and “intention to make and take immediate delivery.” This highlights how difficult it is to produce clear definitions and apply the traditional set of terms and rules to the trading and exchange of cryptocurrencies and other crypto-related activities. The regulator acknowledges that “new fintech businesses may not fit neatly into the existing framework” and invites such companies to join its regulatory sandbox. Participants in the initiative will enjoy a faster application process for exemptive relief from Canada’s securities law requirements, the CSA promises.