Grant Vingoe: Canadian crypto-asset regulation needs a balanced, prudential approach

Protecting investors and facilitating innovation in the crypto sector are key
A sign advertises a Bitcoin automated teller machine, ATM, at a shop in Halifax on Wednesday, February 4, 2020. Andrew Vaughan/The Canadian Press.

The recent article by Ossowski and Clement1Canada’s shaky rules on cryptocurrencies have their root in Ontario mischaracterizes the Canadian regulatory environment for crypto assets 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 viewpoints on crypto asset regulation.

For virtually all crypto asset trading platforms, the relationship between investors and platform operators is marked by a critical dependency on the operators for the selection of assets to trade, the manner in which those assets are marketed and sold, risk disclosure, and critically, the safety of the custodial arrangements that are in effect. Investors have only 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 the jargon of innovation, resulting in well over $100 million in losses, predominantly to Canadians.2QuadrigaCX: A Review by Staff of the Ontario Securities Commission 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 ample precedents applying that definition to unregistered online trading platforms offering products such as commodity warehousing schemes, contracts for differences (CFDs), foreign exchange (forex) contracts, and binary options. We view the totality of the arrangements that platforms have with investors as securities; notwithstanding that over time, Bitcoin and Ether evolved in a manner that allowed them to be characterized as commodities. The result is that platforms are subject to dealer registration. These crypto contracts may also be derivatives since their value is dependent 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. Additionally, platforms have explicitly marketed crypto derivatives, essentially off-exchange futures contracts, which also fall unquestionably within the jurisdiction of CSA members.

Although regulatory efforts are underway in the U.S., American authorities have faced challenges in providing clarity because of the divided jurisdiction between the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). In Canada, we have 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 need to be subject to conduct and prudential regulation, adapted to how they conduct business but with a central commitment to investor protection. They need to be subject to scrutiny and ongoing examination like any other dealer. History has shown that sunshine is indeed the best disinfectant and its absence will lead to market failures, fraud, and cheating.

As partners with other financial services regulators and law enforcement bodies, we recognize that it is necessary to protect against criminal activity, notably money laundering and terrorist financing. As market regulators, we have a shared commitment to combating market manipulation, improper promotional activity, and insider trading.

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

Implicit in the 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 conducted internet-based business initially largely without permission from either their home countries or the jurisdictions where targeted investors resided. The fact that the comprehensive U.S. regulation has been delayed by definitional and jurisdictional questions has allowed this situation to flourish for far too long.

We had a compelling interest in regulating home-grown players who were likely to garner an increasing proportion 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 are working to ensure that the Canadian system of regulated entities deserves the confidence that follows from regulated status. Our hope continues to be that Canadians will turn to firms that have submitted to Canadian regulation.

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

“The role of securities regulators is not to choose economic winners or losers but to create an enabling and competitive environment”

The authors point out that efforts 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 Ontario investors after platforms agree to block access, we will treat such misconduct as equivalent to recidivist violations and seek the most serious consequences. Compliance systems are improving rapidly, and we will demand vigilance. The solution for 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 transact from one province and not another. That arose from our decision in Ontario to set a deadline for these platforms to embark on the road 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 didn’t impose the same deadline, and the result was different. It remains a challenge to bar non-compliant firms from offering services in Canada, but we are making progress.

This week CSA members have accepted pre-registration undertakings from two firms, including a large global firm, to help ensure that fundamental investor protections are in place while 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 incorrectly attribute the differences in approach among CSA jurisdictions to the absence of a two-way passport with Ontario. That is false. There isn’t and never has been a two-way passport among CSA jurisdictions for the registration of restricted dealers such as crypto asset trading platforms, whose novel businesses require tailored terms and conditions. All jurisdictions weigh in so that we can benefit from the best thinking before new business models can be employed in the Canadian marketplace. It can be challenging for regulators and firms alike to go through this collaborative process, 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 operates.

The role of securities regulators is not to choose 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 regulatory approach to crypto assets has been principled, pragmatic, and measured, with a view to protecting investors and creating a level playing field that facilitates competition and innovation in the crypto sector.

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