September 8, 2017
The British Columbia Securities Commission (BCSC) has announced the first registration in Canada of an investment fund manager solely dedicated to the management of cryptocurrency investments. The BCSC news release provides further regulatory guidance in the cryptocurrency space, including insight on the additional terms and conditions that may be imposed on cryptocurrency investment funds in various Canadian jurisdictions in connection with their registration under Canadian securities legislation.
Gowling WLG Focus
The first registration of a cryptocurrency investment fund manager comes shortly after Canadian securities regulators published detailed guidance on initial coin offerings (ICOs). Due to the speed at which ICOs have gained traction, securities regulators in North America and beyond have been forced to focus on these developments and review how existing securities regulation applies to cryptocurrency exchanges, offerings and investment funds.
With heightened interest in the use of and investment in cryptocurrencies, investor appetite for broader exposure to various cryptocurrencies is growing. As investment fund managers follow this trend in the market, there has been a push to create investment funds partially or fully focused on investing in cryptocurrencies. The BCSC registration is significant in that it is the first example of a Canadian securities regulator granting registration to an investment fund that will be in the cryptocurrency business.
Cryptocurrency Investment Funds
Canadian securities regulators generally have a mandate to protect investors and the integrity of our capital markets. One of the ways this mandate is achieved is by requiring persons or companies trading in securities for a business purpose to be registered (or to rely on an exemption) and to fulfil certain compliance obligations under National Instrument 31-103 – Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).
In considering whether an organization selling tokens is trading in securities for a business purpose (and therefore must be registered or must be able to rely on a registration exemption), Canadian securities regulators will consider various factors, including whether the organization is soliciting a broad base of investors (including retail investors), whether it is using the internet (including public websites, discussion boards, etc.) to reach a large number of potential investors, whether it is attending public events (such as conferences and meetups) to advertise the sale of its tokens and whether it is raising a significant amount of capital from a large number of investors.
If an organization selling tokens is trading in securities for a business purpose and no registration exemption is available, it will have registration and compliance obligations to fulfil, including know-your-client (KYC) and suitability obligations which Canadian securities regulators acknowledge may be fulfilled through a “robust, automated, online process that incorporates investor protections”. Identity verification and collection of information sufficient to determine suitability of the investment for the purchaser will be required. Canadian securities regulators are also very concerned about cybersecurity and that organizations operating in the cryptocurrency space have strong measures in place to protect the business and its investors.
Registration Categories and Other Considerations for Investment Funds
First Block Capital Inc. was granted registration pursuant to NI 31-103 under the categories of “exempt market dealer” and “investment fund manager” in both Ontario and British Columbia, with the BCSC acting as the principal regulator. The BCSC noted in its news release that special conditions applied to the registration granted to this Bitcoin investment fund manager. These conditions were “crafted to give flexibility to allow them [First Block Capital] to operate under the present regulatory framework, and give tools to the BCSC to evaluate the identified risks of this innovative fund type.”
Canadian securities regulators are well aware of funds that are created for the purpose of providing investors with the opportunity to obtain exposure to cryptocurrencies, or baskets of cryptocurrencies. Discussions with legal counsel and with regulators will require consideration of the appropriate registration category for these entities (including dealer, adviser and/or investment fund manager registrations) – and we note that while First Block Capital did not obtain adviser registration, we expect this category of registration will become increasingly relevant as more cryptocurrencies are viewed as securities in light of the Canadian securities regulators' guidance on ICOs. Consideration of the following will also be important:
- Distribution – If a fund proposes to distribute securities to retail investors, securities regulators have warned investment funds to be cognizant of whether offering memorandum prospectus exemptions are available to distribute securities in the relevant jurisdiction, and to consider how prospectus requirements or other investment fund rules may apply.
- Due diligence – Securities regulators have noted that due diligence must be undertaken on any cryptocurrency “exchange” that a fund wishes to use in its portfolio. This due diligence would include trading volume analysis (as this may affect the fund’s ability to fund redemption requests), and procedures for identity verification, anti-money laundering, counter-terrorist financing and recordkeeping.
- Valuation – Securities regulators have asked how the fund itself will be valued, how the securities held by the fund will be valued and whether an independent audit will be conducted.
- Custody – Portfolio asset custodians must meet prescribed requirements. Securities regulators have noted that they expect custodians to have expertise that is relevant to holding cryptocurrencies.
This development is an encouraging step forward for Canadian investment funds and fintech companies that are looking to utilize Bitcoin investments. The announcement signals the BCSC’s openness to respond to the fast-paced changes in the cryptocurrency space, while maintaining its monitoring and compliance function for investor protection.
Gowling WLG has already been working with organizations in the cryptocurrency space to determine whether or not Canadian securities laws apply to their specific situation and if so, how they can conduct their business in compliance with Canadian securities laws.
We have also been engaged with securities regulators across Canada, through the CSA Regulatory Sandbox and otherwise, on issues relating to ICOs and other innovations in the fintech, securities crowdfunding and alternative finance space.
Organizations contemplating an ICO or establishing cryptocurrency investment funds or cryptocurrency marketplaces should consult with legal counsel – the following members of Gowling WLG’s Capital Markets / Crypto team would be pleased to assist:
Vancouver – Brett Kagetsu, Stefan McConnell, Denis Silva, Braden Lauer
Calgary – Gord Chmilar, Alisha Virk
Toronto – Shawn Blundell, Ian Palm, Kathleen Ritchie, Jason Saltzman, Usman Sheikh
Waterloo – Bryce Kraeker
Montreal – Naim Antaki, Michael Garellek
Gowling WLG is the only international law firm to be a partner and co-founding member of the Blockchain Research Initiative, a multi-million dollar research initiative into blockchain, led by the Tapscotts, and which includes the Government of Canada, Bank of Canada, Nasdaq, the TMX Group, IBM and many others.
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