Securities markets around the world are grappling with new
concerns: As fintechs make cryptocurrency offerings such as Initial
Coin Offerings (ICOs), Initial Token Offerings (ITOs) or other
digital token offerings, there are various securities regulatory
issues that have been grabbing much attention. Response across the
globe has been varied - the United States and Singapore securities
regulatory authorities would like to engage in a framework that
controls, but does not restrain cryptocurrencies, Japan seems to be
geared up to introduce a stringent oversight on cryptocurrencies,
while China has gone a step further and imposed a complete ban on
cryptocurrency offerings and exchanges in its jurisdiction.
On August 24, 2017, the Canadian Securities Administrators other
than Saskatchewan, released a Notice (CSA Staff Notice 46-307
Cryptocurrency Offerings) in response to the many regulatory
issues that are likely to impact cryptocurrencies. The Notice
reveals that the Canadian securities regulators recognize
cryptocurrencies as an inevitable part of the future of the
Canadian economy, and that fintechs are actively using
cryptocurrencies to raise funds for investment.
Threshold
question: is it a "security"?
The CSA in its Notice takes an open-ended view that, if not all,
many cryptocurrencies fall within the broad definition of
"securities" under Canadian securities laws. The Notice
states that this is a question to be determined on a case-by-case
basis, depending on the various uses of the cryptocurrencies.
In assessing the applicability of securities laws, the CSA will
consider substance over form. According to the Notice, they will
apply a purposive interpretation to the law, and investor
protection will be the primary objective. The assessment conducted
by the CSA will be on a case-by-case basis following the test
applied by the Supreme Court in Pacific Coast Coin Exchange v.
Ontario Securities Commission. Regulators would consider
whether the cryptocurrency offering involves: (i) an investment of
money, (ii) in a common enterprise, (iii) with the expectation of
profit, (iv) to come significantly from the efforts of others. The
Notice urges businesses and fintechs to work hand-in-hand with
local regulatory authorities to avoid "regulatory
surprises". The Notice recognizes that Canadian securities
laws would apply if the person or company selling the securities
is conducting business from within Canada or there are Canadian
investors in the cryptocurrencies.
Regulatory issues
If a cryptocurrency is a "security", there are several securities law issues to be considered, including the following:
- any offering must be qualified by a prospectus, or fit within a prospectus exemption such as the accredited investor exemption or offering memorandum exemption
- if the offering is exempt, the cryptocurrencies will not be freely tradeable, and subsequent transfers will also need to consider the prospectus requirements or fit within an exemption
- those in the business of trading or advising in cryptocurrencies may require registration as a dealer or adviser, which would include fund managers
- a platform that facilitates trades in cryptocurrencies that are securities may be an "exchange" or a "marketplace" under Canadian securities laws
- cryptocurrencies may be derivatives, and subject to the derivatives laws adopted by the Canadian securities regulatory authorities
The Notice also provides that significant due diligence will be required regarding the exchanges on which the cryptocurrencies trade. It acknowledges that considering these exchanges are in their infancy, valuations may be difficult.
In an endeavour to assist fintechs to meet regulatory
requirements, the Notice advises them to contact their local
securities administrators and seek their assistance in determining
various requirements and applicable exemptions. The local
regulatory authorities may also approve some business owners to go
through the CSA Sandbox programme, which will expedite applications
and accord exemptions to companies that meet certain regulatory
requirements.
Industry
response
The current regulatory regime has translated into companies taking
divergent strides. Impak Finance Inc., who is offering the
cryptocurrency MPK under the offering memorandum exemption,
approached securities regulators through the CSA Regulatory Sandbox
and obtained an order,
dated August 16, 2017, granting them exemptions from the dealer
registration requirement and first-trade prospectus requirement.
Some of the highlights of the order (which is effective for 24
months), include:
- MPK issued by Impak's offering will not be listed and traded on any exchange, cryptocurrency exchange or organized market, unless the listing is in compliance with securities legislation and approved in advance by the Principal Regulator
- Impak will provide the Regulator with any report, document or information requested for the purpose of monitoring compliance with securities laws
- prospectus requirements are to apply to the first trade in MPK, unless the trade is made between a Participant and Merchant (as defined in the order)
- Impak will be required to make available Quarterly Information to its Participants
- Impak will be required to conduct know-your-client and suitability reviews and apply fair dealing policies and standards
First Block Capital Inc. manages an investment fund FBC Bitcoin
Trust that invests exclusively in bitcoin. First Block was granted
registration as an investment fund manager and an exempt market
dealer in British Columbia and Ontario, making it the first
registered investment fund manager in Canada dedicated solely to
cryptocurrency investments.
On the other hand, Kik Messenger Inc., which opened its token
(KIN) distribution event on September 12, 2017, excluded Canadians
from participating in the Token sale. Kik Messenger attributes the
exclusion to lack of direction from the securities regulators on
the applicability of securities laws. The Ontario Securities
Commission, in response stated that they actively engaged in
discussions with Kik Messenger, and provided the view that Kik
Messenger would require exemptive relief. They also stated that
they are open to any further discussions on working out flexible
measures that will ultimately result in offering appropriate
protections to Canadian investors.
The way
ahead
As a first step, fintechs will have to examine their transactions
in cryptocurrencies from a securities law perspective. This may
require working closely with regulatory authorities to acquire
suitable guidance, or make critical decisions regarding their
cryptocurrency offerings in Canada.
What remains to be seen is how other fintechs will respond and the
strategies they will adopt, in view of the current ambiguity in
securities regulations around cryptocurrencies. It appears that in
most cases the cryptocurrencies will fall under the broad
definition of "securities" and accordingly the offering
will trigger securities law implications.
However, regulatory bodies appear keen to work with individual
businesses and fintechs to avoid regulatory surprises. It will be
interesting to monitor the extent to which exemptions, concessions
and obligations will be imposed on fintechs and their
cryptocurrencies, and whether the Canadian securities regulatory
model can adapt to accommodate the new world of cryptocurrencies.
The pace at which cryptocurrencies are evolving will be a challenge
for securities regulation.
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