On March 29, 2021, the Canadian Securities Administrators (the “CSA”) and the Investment Industry Regulatory Organization of Canada (“IIROC”) jointly published CSA/IIROC Staff Notice 21-329 – Guidance for Crypto Asset Trading Platforms: Compliance with Regulatory Requirements (the “Notice”). The Notice introduces a novel interim regulatory approach applicable to certain crypto asset trading platforms and provides guidance on the application of securities legislation to platforms (“Crypto Asset Trading Platforms” or “CTPs”) that facilitate or propose to facilitate the trading of (i) crypto assets that are securities (“Security Tokens”) or (ii) instruments or contracts involving crypto assets (“Crypto Contracts”). Under the new guidance, CTPs that satisfy conditions described in this Insight will be subject to registration requirements under Canadian securities laws. In addition, the Ontario Securities Commission (the “OSC”) has notified CTPs that currently offer trading in derivatives or securities to persons or companies located in Ontario that they must contact OSC staff by April 19, 2021, to discuss how to bring their operations as a dealer or marketplace into compliance.

Although the new guidance is intended to provide clarity regarding the steps that crypto asset trading platforms must take to comply with applicable securities regulation and the interim steps that will allow such platforms to operate as they prepare to fully integrate into the Canadian regulatory structure, the potential for tailored requirements, exemptions, and alternative regulatory frameworks to accommodate novel businesses, suggests that pre-emptive engagement of securities regulators by crypto asset trading platforms and their legal counsel may yield benefits for all stakeholders.

This Insight discusses the registration requirements and guidance applicable to certain Crypto Asset Trading Platforms set out in the Notice as well as the novel interim regulatory approach introduced by IIROC and the CSA. Future Insights will address areas of potential flexibility in the application of the existing regulatory regime, certain core market integrity requirements that may be relevant to trading on certain CTPs, and considerations related to the clearing and settlement of trades.

Which entities are within the scope of regulatory guidance?

As a threshold matter, the guidance in the Notice applies to platforms that facilitate or propose to facilitate trading of Security Tokens or Crypto Contracts. Refer to our prior Insight, “Non-Fungible Tokens: Are You Buying Art or Trading Securities?” for a detailed discussion of whether a token is a security. Based on prior guidance from the CSA and IIROC, Crypto Contracts include: (i) contracts or instruments that are derivatives based on crypto assets, and (ii) contractual rights or claims to an underlying crypto asset.

Platforms that do not facilitate or propose to facilitate the trading of Security Tokens or Crypto Contracts are not Crypto Asset Trading Platforms and are, therefore, outside the scope of the Notice’s guidance. However, the Notice also indicated that platforms that facilitate the trading of other products or contracts structured as “traditional” derivatives that also provide exposure to crypto assets (including commodity futures contracts, contracts for difference, or swaps) are also subject to the securities regulation and may want to contact their local securities regulatory authority to discuss possible approaches to compliance.

The guidance and regulatory requirements applicable to a CTP depends on the precise nature of its operations and business model. Specifically, the Notice applies existing regulatory requirements to the following categories of Crypto Asset Trading Platforms:

1. “Marketplace Platforms”: CTPs operating in a manner similar to “marketplaces”, as such term is defined by National Instrument 21-101 – Marketplace Operation (NI 21-101);
2. “Dealer Platforms”: CTPs that are in the business of trading Security Tokens or Crypto Assets that are not marketplaces; and
3. “Hybrid Platforms”: CTPs that are carrying out activities that have elements of both Marketplace Platforms and Dealer Platforms.

A CTP is a Marketplace Platform if the following conditions are satisfied:

1. it constitutes, maintains, or provides a market or facility for bringing together multiple buyers and sellers or parties to trade in Security Tokens and/or Crypto Contracts;
2. it brings together orders of Security Tokens and/or Crypto Contracts of multiple buyers and sellers or parties of the contracts; and
3. it uses established, non-discretionary methods under which orders for Security Tokens and/or Crypto Contracts interact with each other and the buyers and sellers or parties entering the orders agree to the terms of a trade.

Addressing concerns that no centralized marketplace is involved when a digital ledger is used to record “trades” agreed to between parties, IIROC and the CSA indicated that, if the orders of multiple buyers and sellers or parties are brought together on a third-party facility, and the interaction of those orders results in a trade, that facility acts as a marketplace and noted that, in many circumstances, the individual trades on a CTP are not recorded on the digital ledger other than in situations where the customer delivers crypto assets to the CRP or takes delivery of crypto assets from the CTP. Accordingly, CTPs and their counsel should have a detailed understanding of the operational and settlement mechanics applicable to the business.

The two most common characteristics of a CTP that suggest it is a Dealer Platform and not a Marketplace Platform are that: (i) it only facilitates the primary distribution of Security Tokens, and (ii) it is the counterparty to each trade in Security Tokens and/or Crypto Contracts and client orders do not otherwise interact with one another on the CTP, although CTPs that are Dealer Platforms may also engage in other activities or perform functions that marketplaces typically do not undertake, such as onboarding of retail clients onto the CTP, acting as agent for clients for trades in Security Tokens or Crypto Contracts, and offering custody of assets, either directly or through or a third-party provider.

Regardless of the categories described above, capital market participants should be aware that, depending on the business model used and activities conducted by a CTP, as well as the risks created, the regulatory treatment of individual CTPs may differ across platforms. This case-by-case approach requires CTPs and their counsel to carefully articulate unique aspects of, and risks associated with, existing and future business models with a view to navigating applicable registration requirements and identifying areas where regulatory relief may be sought and obtained.

Rules and guidance applicable to “Dealer Platforms”

As noted above, guidance and regulatory requirements applicable to a CTP depends on the precise nature of its operations and business model. Key takeaways for Crypto Asset Trading Platforms that are Dealer Platforms include:

• the appropriate category of dealer registration for a Dealer Platform will depend on the nature of its activities;
• Dealer Platforms may not offer margin or leverage for Security Tokens unless they are registered as an investment dealer and are IIROC members;
• Dealer Platforms that trade Crypto Contracts are expected to be registered in an appropriate dealer category and, where they trade or solicit trades for retail investors that are individuals, will generally be expected to be registered as investment dealers and be IIROC members (subject to the interim approach described below);
• if a Dealer Platform only facilitates distributions or the trading of a Security Token in reliance on prospectus exemptions and does not offer margin or leverage, registration as an exempt market dealer or restricted dealer may be appropriate, although this would not preclude the Dealer Platform from seeking registration as an investment dealer;
• existing registered firms introducing crypto asset products and/or services are required to report changes in their business activities to their principal regulator and, in the case of investment dealers, to IIROC; and
• if a Dealer Platform starts conducting marketplace activities that cause it to be considered a Marketplace Platform, the regulatory framework applicable to Marketplace Platforms will also apply.

Interim approach and application process for CTPs that are Dealer Platforms

To foster innovation and provide flexibility, as an interim measure, a Dealer Platform that trades Crypto Contracts may operate by seeking registration as a restricted dealer, provided it does not offer leverage or margin trading and it takes steps during the interim period to transition to a long-term regulatory framework. Under this interim approach, Dealer Platforms that trade Crypto Contracts will be subject to terms and conditions tailored to their business model and that address key risks to clients. CTPs should note that this interim approach may involve certain limitations on a Dealer Platform’s activities, to be determined by the specific facts and circumstances of the Dealer Platform.

Dealer Platforms operating in Ontario, Quebec, New Brunswick, and Nova Scotia that trade Crypto Contracts are expected to submit applications for investment dealer registration and IIROC membership during the interim period and transition to investment dealer registration and obtain IIROC membership by the end of the interim period, which is generally expected to last two years. In Quebec, Dealer Platforms in the business of trading Crypto Contracts that are derivatives will be required to seek registration as a derivatives dealer. In addition, the securities regulators in Alberta, British Columbia, Manitoba and Saskatchewan will consider other regulatory approaches during the interim period.

A Dealer Platform that only facilitates distributions or trading of Security Tokens in reliance on prospectus exemptions and does not offer margin or leverage should submit an application for registration as an exempt market dealer or as an investment dealer. A Dealer Platform that will trade Crypto Contracts may be registered on an interim basis in the category of restricted dealer (with limitations on activities). In Quebec, a Dealer platform that trades Crypto Contracts that are derivatives should submit to the AMF, at the same time and in addition to the registration application as a derivatives dealer, an application for a time0limited exemption from the requirement to obtain IIROC membership and other obligations of derivatives dealers that may not be relevant.

Any applications for discretionary exemptive relief from regulatory requirements should be prepared in consultation with legal counsel and accompany the registration application and include how key risks are addressed. Dealer Platforms that trade Crypto Contracts should be aware that they: (i) may need discretionary exemptive relief in the applicable jurisdictions from the prospectus requirement to facilitate the distribution of Crypto Contracts since they will be subject to the prospectus requirement in most CSA jurisdictions, and (ii) may need discretionary relief from the over-the-counter trade reporting requirements in the applicable CSA jurisdictions on the basis that they provide alternative reporting, if they are unable to comply with existing requirements.

Rules and guidance applicable to “Marketplace Platforms”

In contrast to the considerations for CTPs that are Dealer Platforms, discussed above, key take-aways for Crypto Asset Trading Platforms that are Marketplace Platforms include:

• Marketplace Platforms are in the business of trading in securities and/or derivatives and, unless they are regulated as an exchange, should seek registration;
• Marketplace Platforms will operate under the oversight of the CSA and a self-regulatory entity (IIROC is the only entity that satisfies the definition set out in NI 21-101), similar to the manner in which alternative trading systems are currently regulated;
• the concepts described in the provisions applicable to marketplaces in NI 21-101, National Instrument 23-101 – Trading Rules, and National Instrument 23-103 – Electronic Trading and Direct Electronic Access to Marketplaces are generally relevant, and will be applied to Marketplace Platforms;
• trading activity on a Marketplace Platform will be subject to market integrity requirements such as those in IIROC’s Universal Market Integrity Rules or provisions consistent with same;
• where a Marketplace Platform also conducts activities similar to those performed by Dealer Platforms, it would also be subject to the appropriate dealer requirements and, depending on the circumstances and the CTP’s business model, such dealer activities may need to be conducted through a separate entity or business unit which would need to meet the applicable regulatory requirements or be separated through ethical walls;
• IIROC and/or the CSA may, on application by a CTP, consider discretionary exemptions from existing applicable rules where a Marketplace Platform that also has dealer functions demonstrates that it can comply with the policy intent of the existing regulatory requirements in alternative ways or where its operational model is such that compliance with the specific requirement is impractical but the risks can be appropriately managed in another way; and
• in some cases it may be appropriate to regulate a Marketplace Platform as an exchange and, in such cases, the CTP will be expected to oversee its issuers’ continuing compliance with the listing requirements of the Marketplace Platform and regulate the operations and standards of practice and business conduct of its members and their representatives.

Interim approach and application process for CTPs that are Dealer Platforms

In circumstances where: (i) a Marketplace Platform wishes to conduct a pilot to nest a novel business idea or proposed new market, or (ii) the time it takes to prepare for and obtain registration and IIROC membership may delay operations or impact the development of a Marketplace Platform’s business, provided that a Marketplace Platform is not offering leverage or margin and is not an exchange, it can seek registration as an exempt market dealer or restricted dealer, as appropriate, for a limited period of time. However, if a Marketplace Platform performs exchange functions, it may require recognition as an exchange or an exemption during the interim period, which is generally expected to last two years.

Marketplace Platforms operating in Ontario, Quebec, New Brunswick, and Nova Scotia are expected to start the process for registration as an investment dealer and IIROC membership (or the process for recognition or exemption from recognition as an exchange) during the interim period. Securities regulators in Alberta, British Columbia, Manitoba, and Saskatchewan will consider other regulatory approaches during the interim period.

A Marketplace Platform that wishes to pursue the interim approach should make applicable to applicable securities regulatory authorities for registration as an exempt market dealer or restricted dealer. Such applicants must satisfy regulators that it appropriately manages the risks relating to trading, which determination will be based on the sufficiency of existing rules and processes to monitor trading and the availability of resources. In addition, Marketplace Platforms seeking to employ surveillance solutions during the interim period would need to ensure they have the requisite capabilities to do so, having regard to the marketplace they will operate and the restrictions or limitations that will be applied during the interim period.

Marketplace Platforms should note that regulators are likely to impose limitations on the types of activities that may be undertaken during the interim period, as a measure to mitigate the risks presented by the CTP’s operational model. Such constraints could include limits on: (i) the number and types of products traded, (ii) the types or number of participants, or (iii) the amount invested by any particular participant. Key considerations in assessing the appropriateness of any limitations, include: (x) whether the Marketplace Platform provides any advice to participants, (y) whether the Marketplace Platform trades on a proprietary basis, and (z) whether there is any differentiation between client types (for example, relating to the sophistication or experience of the participant).

If it is not pursuing the interim approach described above, CSA and IIROC indicated that they would generally expect a Marketplace Platform that is not an exchange to apply for registration as an investment dealer and seek IIROC membership. The Marketplace Platform should include with its application information similar to that currently included in an information statement applicable to an alternative trading system. Similarly, a Marketplace Platform that is an exchange would apply for recognition as an exchange and would submit an application describing how it meets applicable criteria for recognition.

Additional considerations and take-aways for businesses and investors

Although the guidance set out in the Notice purports to merely clarify existing legal requirements rather than impose new rules, the clarification provided and the novel interim approach proposed by the CSA and IIROC represent landmark changes in the evolving regulatory landscape applicable to Crypto Asset Trading Platforms and will have a material impact on the business models, operations, and development of those businesses in Canada. In addition, the April 19, 2021 deadline for CTPs that currently offer trading in derivatives or securities in Ontario to contact OSC staff to discuss compliance underscores the importance of CTPs to the Canadian capital markets and the speed by which companies must consult with advisors and adapt to regulatory considerations.

Notably, the Notice indicated there are areas of potential flexibility within the existing regulatory requirements provided that key risks are addressed in an manner appropriate in the circumstances. Accordingly, CTPs should assess the risks associated with their business models and evaluate strategies for addressing such risks in a manner that may benefit from regulatory relief where available. In conducting such assessment, CTPs should consider how requests for relief may be viewed as consistent with the stated goal of the approach outlined by IIROC and the CSA, which is to ensure a balance between flexibility, in order to foster innovation in the Canadian capital markets, and meeting the regulatory mandate of promoting investor protection and fair and efficient capital markets.

While this Insight provides an overview of the registration requirements and guidance applicable to certain Crypto Asset Trading Platforms and the novel interim regulatory approach introduced by IIROC and the CSA, future Insights will address areas of potential flexibility in the application of the existing regulatory regime, certain core market integrity requirements that may be relevant to trading on certain CTPs, and considerations related to the clearing and settlement of trades.

For more information or advice with respect to Canadian registration requirements or the dealer application process, the novel interim approach proposed by the CSA and IIROC, blockchain and distributed ledger technology, cryptocurrencies or other crypto assets, initial coin offerings, initial token offerings, or the evolving regulatory landscape relating to such matters, contact Michael C. DeCosimo or Suraj Rammohan.