On Feb. 22, 2023, the Canadian Securities Administrators (CSA) published Staff Notice 21-332 - Crypto Asset Trading Platforms: Pre-Registration Undertakings (the "Notice") confirming that unregistered cryptocurrency asset trading platforms (CTPs) are expected to submit their pre-registration undertaking (PRU) (including enhanced terms and conditions) by March 24, 2023. The CSA also outlined new commitments unregistered CTPs are expected to respect while they pursue registration. This article is Part II in a series and provides more details on these new commitments.
For more information on the deadline and on the CSA requirement that CTPs not allow their clients to enter into crypto contracts to buy or deposit stablecoins (referred to as Value-Referenced Crypto Assets (VRCAs)), you can read Part I here.
The Notice makes it clear that if you are operating as an unregistered CTP in Canada while pursuing applications for registration and related relief, you must deliver a PRU based on the template set out by CSA staff to your principal regulator on or before March 24, 2023; and implement such systems changes as may be necessary to give effect to the provisions of the PRU within timeframes set out in the PRU.
Enhanced pre-registration undertakings
The CSA are now requesting additional commitments from unregistered CTPs relating to the following areas:
A. Enhanced commitments in relation to the custody and segregation of crypto assets held on behalf of Canadian clients
The enhanced PRU now requires CTPs to hold assets, including cash, securities, and crypto assets that are not securities, of a Canadian client:
- separate and apart from its own property;
- in trust for the benefit of the client;
- in the case of cash, in a designated trust account or in an account designated for the benefit of clients with a Canadian custodian or Canadian financial institution; and
- in the case of crypto assets, in a designated trust account or in an account designated for the benefit of clients with a custodian that comes within the definition of "Acceptable Third-party Custodian".
Steps also need to be taken by the CTP to allow CSA staff to obtain information about the status of Canadian client accounts directly from the custodian(s) and without going through the CTP.
B. Enhanced commitments to preclude the unregistered CTP from pledging, re-hypothecating or otherwise using crypto assets held on behalf of Canadian clients
The enhanced PRU will maintain the already existing commitment that the CTP hold crypto assets in trust for the benefit of clients separate and apart from its own assets (and from the assets of any custodial service provider) and not pledge, re-hypothecate, or otherwise use clients' crypto assets. Additionally, the CSA will be asking for evidence of meaningful compliance systems and corporate governance controls to provide assurance that the CTP complies with this provision.
C. A prohibition on the part of the CTP offering margin, credit or other forms of leverage to any type of client in connection with the trading of crypto contracts or crypto assets on the CTP's platform
The enhanced PRU includes a commitment that the CTP not offer or provide margin, credit, or other forms of leverage to any client, including both retail and "permitted clients". Previously, permitted clients were going to be an exception to this prohibition.
D. New commitments from controlling mind(s) and global affiliates that affect the CTP entity seeking registration and relief
Parent entities of CTPs and/or their controlling minds will be expected to co-sign the enhanced PRU. They will also be required to undertake to not interfere with the CTP's activities and its directors' independent judgement and ensure that their own activities do not undermine the CTP's activities and its compliance with Canadian regulatory obligations. To the extent possible, the CSA will be expecting that the CTP's board of directors be independent from that of its global affiliates, its parent entities and/or their controlling minds.
E. Restrictions on the part of the CTP relying on crypto assets, including proprietary tokens issued by the CTP or an affiliate of the CTP, in determining the capital of the CTP for excess working capital purposes and in determining the capital base of the CTP
For the purpose of the minimum excess working capital requirement applicable to registered firms, the CSA will expect a 100% reduction on all crypto assets which are not offset by a corresponding current liability, such as crypto assets held for the clients as collateral to guarantee obligations under crypto contracts. This will result in the exclusion of all the crypto assets held by the CTPs from the excess working capital calculation.
F. Enhanced commitments in relation to the filing by the CTP of financial information with the CSA on a regular basis
The enhanced PRU will require the CTP to deliver the information required under section 12.12 [Delivering financial information – dealer] of National Instrument 31-103.
G. Enhanced commitments in relation to the retention of a qualified Chief Compliance Officer (CCO) during the pre-registration process
The enhanced PRU will require that the CTP designate an individual as its CCO who meets the requirements of a CCO for a registered exempt market dealer. The CCO will be responsible for maintaining policies and procedures for assessing compliance with securities legislation by the CTP and individuals acting on behalf of the CTP, monitoring and assessing such compliance, and directly accessing the board of directors or individuals acting in such capacity for the CTP at such times as the CCO may consider necessary or advisable in view of the CCO's responsibilities.
H. A prohibition on the part of the CTP in respect of clients buying or depositing Value-Referenced Crypto Assets (VRCAs, and commonly referred to as stablecoins) through crypto contracts without the prior written consent of the CSA
If a CTP intends to request written consent to enter into such crypto contracts from the CSA, it should be aware that the CSA will expect the CTP to conduct sufficient due diligence to ensure that the risks of VRCAs are addressed, including, among other things, that:
- the VRCA is a fiat-backed crypto asset;
- where distributions of the fiat-backed crypto asset are made in Canada, such distributions are made in compliance with applicable Canadian securities legislation; and
- the issuer of the fiat-backed crypto asset maintains a reserve of assets with a market value at least equal to the value of outstanding units of the fiat-backed crypto asset at the end of each day, and that the reserve of assets is comprised of highly liquid assets, such as cash or cash equivalents and is held by a qualified custodian in favour of the fiat-backed crypto asset holders.
I. A prohibition on the part of the CTP in respect of trades in crypto contracts based on proprietary tokens, except with the prior written consent of the CSA
The CSA will also require written consent prior to a CTP trading in crypto contracts based on proprietary tokens. The CSA has not provided a detailed set of requirements for what would be needed to satisfy the CSA regarding these types of trades.
Providing the enhanced PRU
If an unregistered CTP is unable or unwilling to meet the requirements within the required timelines, the CSA expects the CTP to take appropriate action to identify and off-board existing Canadian users and impose restrictions to prevent Canadian users from accessing its products or services. In such cases, the CSA expects the unregistered CTP to provide notice and timelines to its principal regulator and other members of the CSA for the implementation of such steps and restrictions.
Should you have any questions or require assistance in connection with the matters covered by this article, please feel free to reach out to a member of our Capital Markets or Blockchain & Smart Contracts groups.
 The CSA have circulated on a confidential basis to a number of unregistered CTPs that have filed applications for registration and related relief (and that otherwise meet certain eligibility criteria) a template form of PRU21-3. The PRU option is generally not available to unregistered CTPs that have been operating in Canada but did not contact CSA staff by certain deadlines.
 The Notice provides a detailed definition of an "Acceptable Third-party Custodian" and includes Canadian custodians and Canadian financial institutions that meet certain requirements, and other entities if the CTP has also obtained approval from its principal regulator.
 The CSA prefers the term Value-Referenced Crypto Asset or VRCA because the term "stablecoin" may be misleading in that these types of assets can experience volatility and may not be able to maintain their "peg" on trading platforms.