Crypto-asset exchange platforms under the spotlight

Level playing field

In September, Quebec’s financial overseer, the Autorité des marchés financiers (AMF), successfully launched proceedings against the crypto trading platform BZ Limited and XT.com, known as XT.COM Exchange, one of the 10 largest in the world in terms of trading volume according to specialist website CoinmarketCap.

The XT.com decision, which marked the first time that Quebec succeeded in blocking the activities of an illegal crypto-asset trading platform, issued a clear message to unregistered crypto firms that they must be in compliance with securities legislation and must co-operate with regulatory authorities or face sanctions, asserted legal pundits. The ruling also reaffirms that crypto contracts, nonfungible token contracts and crypto futures meet the definition of securities as they are deemed to be investment contracts, added legal authorities.

“The decision clearly states that its objective is to protect the public,” noted Martin Bédard, a tax lawyer and cryptocurrency expert with Spiegel Sohmer in Montreal. “It’s necessary with everything we’ve seen in cryptocurrency over the last year and a half or so, with other platforms that have crashed or been revealed as fraudulent. Its objective is worthy, and I think everyone will agree that it’s absolutely right.”

The ruling also reiterates the importance of having a level playing field for all crypto players, said Laure Fouin, co-head of the digital assets and blockchain group at Osler, Hoskin & Harcourt LLP. “There are players in Canada whose operating costs are enormous because they comply with securities laws,” said Fouin. “There’s no reason why foreign players shouldn’t comply, reach the same clientele and not have the same operating costs. It’s quite fundamental in Canada that we protect our market and our investors.”   

It’s unfortunate that the crypto trading platform did not collaborate with authorities nor make any representations before the tribunal, said David Durand, a Montreal lawyer specializing in corporate, IP and technology law. “It’s a well-written decision, but I would have liked to have seen an adversarial decision,” said Durand, founder of Durand Lawyers. “Obviously had the defendants put something in, then that would have advanced the law of Quebec with respect to crypto-assets, and unfortunately we don’t have that.”

Oversight

The Canadian Securities Administrators (CSA), along with the AMF, have issued several notices over the past few years that strengthen its oversight approach towards crypto trading platforms operating in Canada by expanding existing requirements for platforms.

Crypto exchanges must register with provincial or territorial securities regulators and must abide by certain conditions, including implementing controls to protect crypto-assets and funds, limit the type of crypto-assets traded and meet the obligations to clients, including an obligation to deliver crypto-assets or cash upon a client’s request. On top of that, in February 2023, the CSA announced that crypto exchanges that operate in Canada while pursuing registration with the CSA are expected to provide an enhanced pre-registration undertaking with their principal regulator.

“Securities law has not been amended since the advent of crypto-assets, so there was no attempt at all to have a legislative discussion on what was or was not a security,” explained Fouin. “What happened was that the regulator, seeing a new product, looked at the law with which it has always worked and considered that it did indeed fall within the definition. But the way in which crypto-assets are brokered and traded is slightly different from the way in which they are traded in more traditional securities. So, the CSA, once they issued these notices, nevertheless agreed to discuss with the matter and by way of exemption, to allow crypto-asset platforms, little by little, to comply but by taking the time and following discussions with the regulators, using exemptions.”

This “imaginative and innovative” approach by regulators has a twofold purpose, added Fouin. It seeks to encourage crypto exchanges to do business in Canada while attempting to reassure investors that they are sufficiently protected. So far, 11 crypto trading platforms have been granted registration under the interim regulatory framework implemented by the CSA, and 11 more unregistered crypto exchanges currently operating in Canada are seeking registration.

But in spite of several efforts by the AMF to “formally remind” XT.com of the Canadian and Quebec securities regulatory framework applicable to crypto trading platforms, the company ignored the watchdog.

After examining in depth the notion of investment contracts and paying close heed to notices issued by the CSA, the tribunal held in Autorité des marchés financiers c. XT.com Exchange (XT Exchange et XT.com), 2023 QCTMF 62 that some of the products and services offered to the public by the Dubai crypto exchange XT.com are investment contracts subject to the securities regime under the Quebec Securities Act (Act).

Adjudicators Nicole Martineau and Christine Dubé further held that XT.com proceeded with the distribution of securities in breach of s. 11 of the Act, that is, without having prepared a prospectus subject to the AMF’s approval. XT exchange also created and marketed derivatives without being authorized by the AMF, in contravention of s. 82 of the Derivatives Act, held the tribunal. In the course of their activities, the crypto exchange acted as securities and derivatives dealers without being registered in any capacity whatsoever with the AMF, contrary to section 148 of the Act and s. 54 of the Derivatives Act, concluded the tribunal.

Last year the Ontario Capital Markets Tribunal came to a similar conclusion in enforcement proceedings against two foreign companies that operated unregistered crypto-asset trading platforms servicing Ontario residents.

On June 9, 2022, the Capital Markets Tribunal approved a settlement agreement with Bybit Fintech Limited after the foreign company agreed to disgorge US$2.5 million and pay a further $10,000 in costs towards the investigation led by the Ontario Securities Commission (OSC). Bybit also agreed through a legally enforceable undertaking to bring its operations into compliance with the requirements under the Ontario Securities Act. Another foreign crypto exchange platform, PhoenixFin Pte Ltd (collectively, KuCoin), was permanently banned from participating in Ontario capital markets and KuCoin was ordered to pay a $2-million administrative penalty and $96,550.35 in costs.

“Regulators have been hammering away at their interpretation of securities law and its application to crypto-assets for a few years now,” said Fouin. “And this tribunal decision is really fair to me, consistent with what has been done in the past.”

Are crypto-assets a security?

But Durand is far from certain that all classes of crypto-assets should fall under the guise of investment contracts. In a submission Durand made in 2020 to the Financial Stability Board, he argued that given the nature of crypto-assets, they do not fit the definition of a security.

“The fact that securities regulations would have scant effect in protecting users on decentralized networks makes it evident that defining crypto-assets as a security would provide ineffective regulatory enforcement in this respect,” said Durand in a position he still stands by today. He added that overreaching securities regulation on the crypto-asset regime would “likely create a system where onerous requirements are placed on users of such assets, with an end result of suppressing innovation” in financial technology and financial capital to leave Canada seeking more favourable environments.

Bédard also has concerns about the reach of the tribunal’s decision. He believes that the decision is a “little bit thin” over the “situs” of activities provided by XT.com.

The tribunal found that the exchange platform advertised itself as a global platform, and that Canadians or Quebecers with a Canadian IP address were able to reach the website and be able to trade, pointed out Bédard. “That’s pretty much the only criterion or the only factor we see in the decision as having triggered obligations under all Quebec laws,” remarked Bédard. But “there’s a difference between someone who is actively approaching the Canadian market, looking for customers in Canada, versus, in this case, Canadians who have reached that platform, which is a foreign platform.”

It could also be argued, added Bédard, that a reasonable Canadian investor who goes on the Internet and finds a crypto-assets exchange platform like XT.com would not presume that it is registered with the AMF and complies with Quebec’s securities regulatory framework. “I would assume that they comply with Dubai regulations, but not necessarily with Quebec regulations,” said Bédard.

The decision may succeed in preventing some Canadians from gaining access to such exchange platforms, but at a price, believes Bédard. “Over time, it will reduce the number of different platforms that Canadians can use, and lead to less competition,” said Bédard. “It’s not exactly ideal. So the decision may be legally correct, but I don’t think it’s exactly perfect in terms of protecting the public and investors.”

There’s also the practical matter of how the AMF is going to collect the $2-million penalty imposed by the tribunal, said legal experts. “It’s always complicated when you’re dealing with foreign jurisdictions to execute on domestic decisions,” noted Durand.