Regulation
Crypto: only for alternative funds?
The proposals would limit crypto investing to alternative mutual funds. They would also limit the crypto investments funds can make to assets traded on a recognized exchange and fungible assets – in other words, no non-fungible tokens (NFTs). The proposals would also prohibit the use of cryptoassets in securities lending, repurchase agreements and similar transactions.
The CSA wants to codify the type of requirements placed on fund managers as part of regulators’ approval of some of the world’s first crypto funds, while also incorporating policy positions set out in industry guidance.
“We believe this can facilitate the development of new products in the area while ensuring that appropriate risk mitigation measures are integrated directly into the regulatory framework for investment funds,” says the CSA notice regarding the proposals .
The proposed changes were welcomed by investor advocates, but not by the industry.
The Ontario Securities Commission’s (OSC) Investor Advisory Panel (IAP) said in its submission that it supports limiting asset types within crypto funds.
“[I]Investments in non-exchange-traded crypto assets present too much risk to make these investments suitable for wide availability to retail investors,” IAP said. “The potential benefits to investors from holding non-fungible crypto assets are limited, while the risk of harm to investors is high.”
The IAP also called on the CSA to address the risks posed by investors who accumulate exposure to cryptoassets through traditional investment funds.
“The panel is concerned about the potential concentration of cryptoassets within a traditional fund of funds structure, particularly those that use a tactical asset allocation approach and are made available to retail investors,” indicates the IAP comment.
However, many in the traditional financial sector and the crypto sector believe that the limitations sought by regulators are too restrictive and represent a worrying step in the wrong direction.
The Alternative Investment Management Association (AIMA) submission said that limiting fund holdings to cryptoassets (or crypto derivatives) that are traded on regulated exchanges effectively limits the choices to Bitcoin and Ether. Currently, no other cryptoassets are directly traded, nor any tradable derivatives, on a regulated exchange.
“We are concerned that these strict provisions will stifle market and product development and potentially drive investors to less regulated markets and products with inadequate investor protection,” AIMA said.
The Investment Industry Association of Canada (IIAC) echoed this concern.
“While we understand the CSA’s suitability concerns, we respectfully submit that investors may be better protected if they can gain exposure to cryptoassets through a regulated investment product, such as a fund. cryptoassets, rather than directly purchasing cryptoassets,” the IIAC said. .
AIMA recommended that regulators require funds to invest in assets traded on recognized crypto trading platforms. The group also warned against excluding NFTs altogether.
AIMA also spoke out against the CSA’s proposal to ban crypto-assets as collateral in securities lending transactions.
“While challenges may exist currently, it is conceivable that safeguards could be implemented over time, making the use of cryptoassets for securities lending… a viable option,” AIMA said .
Industry groups also warned that the proposed approach risks short-circuiting progress in an area where Canadian regulators once led the way.
While the U.S. Securities and Exchange Commission only approved the launch of crypto-based investment funds earlier this year, the OSC did so in 2019. That’s when Toronto-based fund manager 3iQ Corp. has sought regulator approval for one of the world’s first crypto mutuals. funds.
OSC staff initially opposed the fund, but ultimately approved it following an OSC court hearing. The hearing panel concluded that 3iQ adequately addressed the regulator’s investor protection concerns regarding allowing investment funds to hold cryptocurrencies, such as emerging liquidity issues, valuation and conservation.
Since then, a handful of other fund managers have gained approval for a variety of crypto-based mutual funds and ETFs. The terms of these initial prospectus approvals and subsequent regulatory guidance now form the basis of the CSA’s proposed rules.
These proposals contradict the CSA’s goal of allowing product development to flourish, 3iQ said.
“We believe that providing a regulated and effective product is essential for investor protection,” the company said in its submission, arguing that strict limits on regulated funds would drive investors to unregulated markets or to trading alternatives. suboptimal investment.
And restricting the use of crypto in lending transactions will limit competitiveness, the company warned.
“Outright banning lending activities is a heavy-handed approach that removes the ability of asset managers to innovate in Canada,” 3iQ said.
The company acknowledged that while strictly restricting access to crypto might be an obvious response to the high-profile frauds and failures that have besieged the industry in recent years, “moving toward providing regulated products will protect in reality better for consumers.
3iQ suggested that the availability of its early crypto funds likely prevented at least some Canadian investors from using offshore platforms, like that of FTX Trading Ltd., to gain exposure to cryptocurrencies.
“The existence of crypto-regulated products has likely reduced harm to Canadian investors by making it easier to access the asset class in a safe manner. This is why we believe that in light of the recent FTX collapse, CSAs (and the OSC) should… continue to foster innovation to protect investors,” 3iQ said.
The Canadian Blockchain Consortium’s policy and advocacy committee, meanwhile, suggested that the emerging crypto sector needed a tailored regulatory regime.
“The Canadian crypto-asset industry requires separate statutory oversight (and potentially an independent regulator) instead of integrating trading platform requirements into existing securities legislation,” argues its submission. “Without this separation, confusion over securities regulation will continue to plague industry concerns. »
Establishing a new regime to oversee the crypto sector would require legislation, however, and there is no indication that policymakers at any level are pursuing this goal.
This article appears in the May issue of Investment Executive. Subscribe to the print edition, read the digital edition Or read articles online.