CSA sets rules for crypto funds

In the wake of the U.S. Securities and Exchange Commission’s (SEC) recent landmark decision approving spot Bitcoin funds in the U.S. market, Canadian securities regulators are seeking to formalize new rules for investment funds that hold cryptoassets.

The Canadian Securities Administrators (CSA) are proposing the first set of regulatory requirements for funds that invest in crypto, which would clarify the types of cryptoassets that funds are allowed to hold, impose restrictions on these holdings, and introduce new custody requirements, among other things.

Specifically, the regulators are proposing to limit direct crypto holdings to alternative funds and closed-end funds. Under the rules, conventional mutual funds could hold crypto only by investing in alt funds that hold crypto.

The rules would also limit the sorts of crypto that funds can invest in to assets listed for trading on regulated exchanges. Funds would not be allowed to hold non-fungible assets, such as NFTs, as these kinds of assets carry added liquidity and valuation risks, “and the current regulatory framework may not have the parameters needed to mitigate these risks,” the CSA said.

Additionally, the CSA is seeking to prohibit the use of crypto as collateral in transactions, such as securities lending, repo and reverse repo transactions.

“While we believe that the market characteristics of most cryptoassets make them impractical for these types of transactions in an investment fund, we think it is important to remove any regulatory ambiguity,” the regulators said in their notice.

The rules would also set custody requirements for funds’ crypto holdings, including requirements for “cold wallet” storage, insurance and audit requirements.

The regulators are also proposing guidance to support these new requirements.

According to a notice setting out the regulators’ proposals, the new rules would largely codify existing crypto funds’ practices, and the terms of exemptive relief that regulators have granted in this space so far.

The CSA said its proposals will give investment fund managers “greater regulatory clarity concerning investments in cryptoassets.”

“We think this can facilitate new product development in the space while also ensuring that appropriate risk mitigation measures are built directly into the investment fund regulatory framework,” the regulators said.

The proposals are also intended to formalize investor protections and curb risk in an area that the CSA characterized as largely speculative.

Investing in crypto through investment funds is “higher risk and may not be suitable for most retail investors,” the regulators warned. “Generally speaking, investing in cryptoassets is a speculative activity, and the value and liquidity of cryptoassets are highly volatile,” they said.

The CSA noted that these proposals represent the second phase of its project to introduce a regulatory framework for crypto funds.

The publication of regulatory guidance in July 2023 marked the first phase of that effort. Longer term, after the initial set of requirements for crypto funds is adopted, the regulators intend to consult on a “broader and more comprehensive regulatory framework” for crypto funds in phase three, they said.

“We recognize the current regulatory framework for public investment funds needs to be adapted to address the unique aspects and risks of cryptoassets,” said Stan Magidson, chair of the CSA and chair and CEO of the Alberta Securities Commission, in a release.

“Formalizing these fundamental requirements will provide fund managers with greater clarity while we continue to assess whether a more comprehensive regime is required,” he said.

The CSA’s latest proposals are out for a 90-day comment period, ending April 17.