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(Kitco News) - Canada’s securities regulator has released a new set of guidelines to help fund managers understand and comply with securities law requirements for public investment funds holding crypto assets.
According to the notice published by the Canadian Securities Administrators (CSA) on Thursday, all of the recommendations provided are based on existing securities regulatory requirements and do not create any new legal requirements or modify existing ones.
“The nature of crypto assets can create unique challenges for funds that hold these assets directly, which may require specific regulatory consideration,” the CSA said. “We have identified a number of areas for which we believe greater guidance regarding CSA staff expectations may be warranted, for both existing and possible future offerings of Public Crypto Asset Funds. One or more of the identified areas may also become the subject of future policy work by the CSA.”
The first prospectus for a Canadian public crypto asset fund was issued on April 1, 2020, and resulted in the creation of a non-redeemable investment fund that invests its assets directly in Bitcoin (BTC). Following the creation of this fund, several other public crypto asset funds have been launched, including the first exchange-traded funds (ETFs) in the world that invested directly in Bitcoin and Ether.
As of April 30, 2023, there are 22 Public Crypto Asset Funds in Canada that collectively have approximately CAD $2.86 billion in net assets. This growth prompted the CSA to release its recommendations for fund managers to help get them up to speed with the latest securities law developments and guidance.
The CSA said public crypto asset funds are subject to the same regulatory framework as other publicly distributed investment funds in Canada. This framework includes a requirement that these funds have a registered investment fund manager (IFM) and portfolio manager(s), and must also compute a net asset value (NAV) on a daily basis that is calculated in accordance with National Instrument 81-106 Investment Fund Continuous Disclosure (NI 81-106).
Suitable crypto investments
The CSA said that when it comes to determining if a crypto asset is suitable for investment in a publicly distributed investment fund, the most important considerations are “the ability to determine a fair value of the crypto asset, liquidity of the crypto asset, and the classification of the crypto asset and the implications arising from its classification.”
To make this determination, the CSA said fund managers need to find “sufficient evidence of an active market for the crypto asset comprising actual and regularly occurring market transactions on an arm's length basis; the presence of a regulated futures market for that crypto asset; and publicly available indices administered by a regulated index provider for the crypto asset.”
To accurately value a crypto asset, an IFM should consider whether the market for that crypto asset has real and substantial trading volume, in large size, both in absolute terms and when compared to other markets for commodities and equities.
The CSA recommended using publicly available indices that aggregate pricing from a variety of sources to determine a spot price of a crypto asset, saying this “will help mitigate the risks of inaccurate pricing of a particular asset.”
IFMs are expected to regularly measure, monitor and manage the liquidity of the investment fund's underlying portfolio assets. The CSA said that public funds must have “effective liquidity risk management programs that include the use of stress testing and ongoing monitoring of underlying crypto asset market liquidity and encourage regular review of such programs.”
Methods recommended to help IFMs manage liquidity risks include “ongoing portfolio management and continuous liquidity assessments of the underlying crypto asset, in addition to ongoing monitoring of relationships with liquidity providers and ensuring that alternative sources of liquidity are available.”
Exchange-traded funds
Funds that are structured as ETFs or conventional mutual funds are classified as “alternative mutual funds.” These products have a greater ability to borrow cash or provide a security interest over their assets, engage in short selling, or use specified derivatives applicable to alternative mutual funds, subject to the limits set out in that rule, the CSA said.
In a review of the liquidity available for the currently listed funds, CSA staff found that these products have “not experienced any material difficulties in meeting redemption requests since their respective inceptions.”
The CSA found that most ETFs traded “very closely” to their net asset value (NAV), and funds structured as ETFs were able to meet large redemption requests without the need to borrow additional funds.
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Staking crypto assets
For funds that wish to include staking crypto asses, they can only do so for blockchains designed specifically as proof-of-stake (PoS), and only on networks where “the staked crypto assets that are used to guarantee the legitimacy of new transactions the validator adds to the blockchain.”
IFMs are required to be proficient and knowledgeable about staking crypto assets, and they must enter into written agreements with one or more third parties to stake the fund's crypto assets.
Custodians for staked assets are required to remain in possession, custody, and control of the staked crypto assets at all times, and staked assets are to be held in offline storage or cold wallets in secured facilities maintained by the crypto custodian, where applicable.
Custody guidelines
When it comes to custody, the CSA said that IFMs and custodians are required to have the necessary expertise and experience to safely custody the crypto assets; should hold the fund’s crypto assets in an offline or ‘cold wallet’; must ensure that the funds’ assets are separate from the assets of the custodian and the custodian's other clients; must use website security measures; must maintain appropriate insurance for the crypto assets in their custody; and must provide annual reports that assess the organization's security, availability, processing integrity, confidentiality, and privacy controls.
All IFMs are also required to comply with obligations under securities legislation related to Know-Your-Client/Know-Your-Partner (KYC/KYP). This includes collecting certain information from clients or business partners, taking reasonable steps to have clients confirm the accuracy of the information, and keeping the information current.
“When conducting KYC, KYP, and suitability determinations in connection with recommending Public Crypto Asset Funds to clients, registrants should be cognizant that holding crypto assets, including Public Crypto Asset Fund securities, comes with elevated levels of risk that may not be suitable for many investors,” the CSA said.
“We encourage stakeholders to review this guidance to better understand our expectations of public crypto asset funds,” said Stan Magidson, CSA Chair and Chair and CEO of the Alberta Securities Commission. “It is important for such funds to clearly understand their existing regulatory obligations given recent events in the crypto market.”
