On January 18, 2024, the Canadian Securities Administrators (CSA) published a notice and request for comment regarding proposed amendments (Proposed Amendments) and changes to regulations concerning investment funds that invest in crypto assets (Public Crypto Asset Funds). These proposals aim to provide clarity and regulatory guidance on various operational aspects of these investments.

The proposed amendments and changes intend to clarify regulations related to Public Crypto Asset Funds. They cover criteria for the types of crypto assets these funds can invest in, restrictions on investing in crypto assets and requirements for custody of these assets.

Background

The CSA recognizes the need for adapting existing regulations to accommodate the unique characteristics of crypto assets as investment products for publicly distributed funds. This is part of a broader project aimed at providing investor protection, regulatory clarity and facilitating product development in this space.

Phases

The project is divided into three phases:

• Phase 1: Provided guidance and information to stakeholders regarding expectations and developments related to Public Crypto Asset Funds.
• Phase 2: Involves the proposed amendments and changes to existing regulations, with a focus on codifying existing practices and granting exemptive relief for these products.
• Phase 3: Will involve broader public consultation for a more comprehensive regulatory framework for funds investing in crypto assets.

Proposed amendments to NI 81-102

The proposed changes include:

• Expanding the definition of "alternative mutual fund" to include those investing in crypto assets.
• Restricting the direct investment in crypto assets to alternative mutual funds and non-redeemable investment funds, with certain criteria for eligible assets.
• Prohibiting the use of crypto assets in securities lending, repurchase transactions or reverse transactions.
• Clarifying that money market funds cannot invest in crypto assets.
• Introducing provisions related to the custody of crypto assets, including requirements for offline storage and insurance.
• Allowing crypto assets as subscription proceeds for mutual funds, under specific conditions.

Proposed changes to 81-102 Companion Policy (81-102CP)

The proposed changes to 81-102CP (CP Changes) are intended to provide guidance and clarification on several aspects, such as:

• Defining "crypto assets" for investment funds regulation.
• Clarifying that funds can acquire crypto assets from sources other than recognized exchanges.
• Expanding on the standard of care required for crypto custodians.
• Providing details on the assurance reports required for custodians holding crypto assets.

Transition/coming into force

The Proposed Amendments are expected to come into force approximately 90 days after final publication, depending on comments and regulatory requirements.

Request for comments

The CSA is seeking feedback on various aspects of the proposal, including the definition of crypto assets, restrictions on crypto asset types, custody requirements and any other considerations related to investment funds dealing with crypto assets.

Specific questions in the request for comment set out by the CSA are as follows:

Guidance on “crypto asset”

1. The CSA are seeking feedback as to whether the guidance in the CP Changes provides sufficient clarity in understanding the type of assets that will be considered crypto assets for the purpose of NI 81-102.

Restrictions on investing in crypto assets

2. The Proposed Amendments contemplate restricting publicly distributed investment funds to only holding fungible crypto assets. The CSA are seeking feedback on whether this is a reasonable restriction in light of the risks that are generally associated with holding non-fungible crypto assets in an investment context. If not, the CSA has asked commenters to be specific as to why they think the scope of permitted crypto assets should be expanded to include non-fungible crypto assets and what investor protection measures are appropriate for Public Crypto Asset Funds to hold these types of assets.
3. The Proposed Amendments also contemplate restricting publicly distributed investment funds to holding crypto assets that trade on, or are reference assets for specified derivatives that trade on, a “recognized exchange”. This reflects market integrity concerns with certain crypto asset markets and is intended to limit funds to holding those crypto assets for which spot prices can be derived through regulated sources that reflect institutional support and promote price discovery, which is not dissimilar to how more traditional fund portfolio assets trade. The CSA are seeking feedback as to whether this is a reasonable qualifying criterion. If not, the CSA has requested feedback on what criteria may be more appropriate for determining when a crypto asset should be deemed an appropriate investment for an investment fund directed at retail investors.

Custody

4. The Proposed Amendments include a requirement that custodians or sub-custodians that hold crypto assets on behalf of an investment fund obtain an annual assurance report prepared by a public accountant that assesses the design and effectiveness of various internal controls and policies concerning their obligations to custody crypto assets. The CP Changes clarify that obtaining a SOC-2 Type 2 will be considered to comply with the requirement, without prescribing that specific report. The CSA are seeking feedback regarding other assurance reports that may be comparable to a SOC-2 Type 2 that the CSA should also consider sufficient for complying with this requirement. The CSA are also seeking feedback regarding the appropriate scope of any reporting to be provided under this requirement.

Broader Consultation

5. The CSA are seeking comments on other issues or considerations relating to investment funds that invest in crypto assets that the CSA should also be considering. This feedback will help inform the broader consultations for the third phase of the Project.

The deadline for comments is April 17, 2024. The full text of the notice and request for comment can be found at: https://www.osc.ca/sites/default/files/2024-01/csa_20240118_81-102_rfc_crypto-assets.pdf

The proposed changes aim to strike a balance between fostering innovation in crypto asset investment products and ensuring investor protection through clear and appropriate regulations.

For more information, please contact Diana Nakka or any member of the Securities and Corporate Finance key contacts in Canada.