Canadian regulation of cryptoassets needs a balanced, prudent approach

The recent article by Ossowski and Clement mischaracterizes the Canadian regulatory environment for cryptoassets in significant ways.

The Canadian Securities Administrators (CSA), the umbrella organization for all of Canada’s provincial and territorial securities regulators, of which the Ontario Securities Commission (OSC) is a part, has developed consistent views on the regulation of cryptoassets.

For virtually all crypto-asset trading platforms, the relationship between investors and platform operators is characterized by a critical dependence on the operators for the selection of assets to be traded, the manner in which those assets are marketed and sold, risk disclosure, and critically, the security of the custody arrangements in place . Investors only have a contractual claim to the underlying crypto assets.

We all observed the risks in Canadian-based QuadrigaCX’s failure and the revelation of the stark reality that it was a Ponzi scheme wrapped in innovation jargon, resulting in well over $100 million in losses, mostly to Canadians. This was a formative event for our development of crypto regulation.

The definition of a security in Ontario is broad and technology neutral. Canadian regulators have had plenty of precedents applying this definition to unregistered online trading platforms that offer products such as inventory arrangements, contracts for differences (CFDs), foreign exchange (foreign exchange) contracts and binary options. We look at the totality of the arrangements that platforms have with investors such as securities; despite the fact that over time Bitcoin and Ether developed in a way that allowed them to be characterized as commodities. The result is that platforms are subject to dealer registration. These crypto contracts can also be derivatives since their value depends on the value of underlying interests, in the same way that a swap is a derivative because it is based on an index or on gold. In addition, platforms have explicitly marketed crypto-derivatives, essentially over-the-counter futures contracts, which also undoubtedly fall within the jurisdiction of CSA members.

Although regulatory efforts are underway in the US, US authorities have faced challenges in providing clarity due to the shared jurisdiction between the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). In Canada, we face the challenge of coordinating multiple provincial and territorial securities regulators, but we all share unified jurisdiction over securities and derivatives.

Canadian securities regulators share the view that platforms offering these crypto-assets to Canadians must be subject to conduct and supervisory regulation tailored to how they conduct business, but with a central commitment to investor protection. They must be subject to scrutiny and continuous investigation like any other dealer. History has shown that sunshine is indeed the best disinfectant, and its absence will lead to market failure, fraud and cheating.

As partners with other financial services regulators and law enforcement agencies, we recognize the need to protect against criminal activity, particularly money laundering and terrorist financing. As market regulators, we have a shared obligation to combat market manipulation, inappropriate advertising activity and insider trading.

At the OSC, we believe that the Investment Industry Regulatory Organization of Canada (IIROC), the investment dealer self-regulatory organization that governs conduct, supervisory regulation and market surveillance, is the appropriate destination for most of these firms as they typically deal with retail investors. Direct regulation by the OSC is an interim measure on the way to IIROC membership. It is not sound public policy to exclude platforms that trade the most speculative assets from IIROC oversight, yet require it for dealers involved in capital formation for businesses that grow our economy and can support stable retirement savings.

Implicit in that op-ed is the question of how we came to have a two-tier system where large global players are unregistered while we have Canadian-based regulated firms. The answer is that global firms were established in crypto-safe havens or where there was regulatory ambiguity and initially conducted Internet-based business largely without permission from either their home countries or the jurisdictions where targeted investors resided. The fact that comprehensive US regulation has been delayed by definitional and jurisdictional issues has allowed this situation to flourish for far too long.

We had a compelling interest in regulating homegrown players who were likely to acquire an increasing share of Canadian assets. We wanted to avoid Canada being a base of operations for fraud and possible systemic risk arising from home-grown firms. As many in the now established crypto world agree, regulation is a critical key to trust and adoption. We work to ensure that the Canadian system of regulated entities deserves the confidence that comes from regulated status. Our hope continues to be that Canadians will turn to firms that have submitted to Canadian regulation.

Global players must decide whether access to Canadian investors in accordance with Canadian law is worth the compliance effort. Established firms seeking credibility will not want to be banned in Canada or subject to enforcement and other sanctions. They want to have a good status in established securities markets. We have already had successful enforcement actions against global players who feel differently.

The authors point out that attempts to block Internet access by Canadians can be circumvented by VPNs. This is true. However, if we see any encouragement of this or other actions to attract investors in Ontario after platforms agree to block access, we will treat such misconduct as tantamount to repeat infringement and seek the most severe consequences. Compliance systems are improving rapidly and we will require vigilance. The solution to the residual risk will ultimately lie in increased international regulatory cooperation.

The authors also point out variations in the treatment of some global platforms where Canadians can trade from one province and not from another. It came from our decision in Ontario to set a deadline for these platforms to embark on the path to registration. We didn’t want to give them an incentive to drag their feet. If they missed the deadline or said they didn’t want to do business in Ontario, they had to stop offering services in Ontario or face enforcement. Other provinces did not impose the same deadline, and the result was different. Preventing non-compliant firms from providing services in Canada remains a challenge, but we are making progress.

This week, CSA members have accepted pre-registration commitments from two firms, including a large global firm, to ensure basic investor protections are in place as the firms work through the registration process with us. All unregistered firms operating in Canada will be expected to provide these undertakings while their applications are being processed.

The authors erroneously attribute the differences in approach between CSA jurisdictions to the absence of a two-way passport with Ontario. That is untrue. There is not and never has been a two-way passport among CSA jurisdictions for the registration of limited dealers as trading platforms for crypto-assets, whose new businesses require tailored terms and conditions. All jurisdictions weigh in so we can benefit from the best thinking before new business models can be adopted in the Canadian marketplace. Going through this collaborative process can be challenging for both regulators and firms, but it is one that respects Canadian federalism. In this context, a two-way passport is a red herring, and the authors’ claims reflect a fundamental misunderstanding of how our regulatory regime works.

The role of securities regulators is not to pick economic winners or losers, but to create an enabling and competitive environment in which investors, innovators and entrepreneurs have the confidence to participate.

We continue to prioritize investor education to help equip investors with the appropriate knowledge of this sector so they can better understand the potential risks involved.

The Canadian securities approach to crypto assets has been principled, pragmatic and measured, aiming to protect investors and create a level playing field that facilitates competition and innovation in the crypto sector.