Financial regulators all over the world are making noises about regulating initial coin and token offerings, crypto-currency investment funds and crypto-currency exchanges, although they are generally not going any further at present with ICOs and ITOs. This is now happening in Canada.

The Canadian Securities Administrators have floated their theory about why Canadian law entitles them to regulate "cryptocurrency offerings" in CSA Staff Notice 46-307. Cryptocurrency offerings can provide new opportunities for HNW investors to access a broader range of investments and for businesses to raise capital.

The CSA, which presumably chose its name in the hope that the uninitiated would believe that the 'A' stood for 'authority,' has seized upon "investor protection" as the best pretext for intervention in the ICO/ITO area. It has detected danger for HNW investors in volatile prices, valuation, custody and liquidity. It has also found fault with ICOs' lack of 'transparency,' which might be a sign that its member-regulators would like to know more about the progress of every ICO in real time.

Many of these cryptocurrency offerings involve sales of securities and the CSA views this as a good justification for regulation, saying that securities laws will apply if Canadian investors are involved. It says the same for derivatives. Even here, however, the regulatory club couches its pronouncements in the most ambiguous language, stopping short of "laying down the law" and instead merely saying that it wants to help financial technology (fintech) businesses "understand what obligations may apply." The CSA thinks that a platform that facilitates trades in coins/tokens that are securities "may be a marketplace" and therefore might be obliged to comply with "marketplace requirements" (it leaves this term unexplained) or ask a regulator for an exemption from them.

Nevertheless, the administrative body does make two hard-and-fast pronouncements.

• Someone (it does not say who) may only sell securities after someone else (also unidentified) receives a receipt from a securities regulator for a comprehensive disclosure document (a prospectus) or pursuant to a private placement that relies on a "prospectus exemption."
• Businesses and individuals who trade in or give advice about securities must be registered or rely on an exemption from registration.

Cryptocurrency exchanges

Online exchanges that allow investors to buy and sell cryptocurrencies operate all over the world, in many cases without government supervision or regulation. In this area, several jurisdictions including the Isle of Man have taken steps to impose a measure of regulatory authority on them, especially in the areas of anti-money laundering control and recordkeeping.

On this topic, once again, the CSA lapses into tentative language: "A cryptocurrency exchange that offers cryptocurrencies that are securities must determine whether it is a marketplace [that is] required to comply with the rules governing exchanges or alternative trading systems." To date, no cryptocurrency exchange has "been recognised" (a term that the CSA does not explain and never uses again) in any jurisdiction of Canada or, indeed, exempted from recognition.

ICOs/ITOs

The regulatory body seems to be on firmer ground when stating that the resale of coins/tokens that are securities will be subject to the restrictions they place on secondary trading. Once again, however, it is tentative in its vague warning that any cryptocurrency exchange that allows coins/tokens that are securities issued as part of an ICO/ITO to trade on it "may" also place the business that issues the coins/tokens on the wrong side of Canada's securities laws.

Start-up businesses generally use ICOs/ITOs to raise capital from investors (often HNW/retail investors) on the Internet. An ICO/ITO is typically open for a set period, during which investors can visit a website to purchase coins/tokens in exchange for fiat currency or a cryptocurrency such as Bitcoin or Ether. The structures of ICOs/ITOs are as different from one another as the colours of the rainbow. Anyone with Internet access can create or invest in an ICO/ITO; in many cases, he can do so anonymously.

Coin and token offerings

ICOs/ITOs are generally used by start-up businesses to raise capital from HNW and other investors through the Internet. An ICO/ITO is typically open for a set period, during which investors can visit a website to purchase coins/tokens in exchange for fiat currency or a cryptocurrency such as Bitcoin or Ether. The structures of ICOs/ITOs are as different from one another as the colours of the rainbow and anyone with Internet access can create or invest in one. In many cases, he can do so anonymously.

The regulatory body has consulted its lawyers and believes that anything the courts classify as an "investment contract" is subject to Canadian securities laws. The leading case is the Supreme Court of Canada's decision in Pacific Coast Coin Exchange v Ontario (Securities Commission), [1978] 2 SCR 112, plus the various judicial and administrative decisions that flowed from it.

This case law requires an assessment of the economic realities of a transaction and a purposive interpretation with the objective of "investor protection" in mind. When determining whether or not an "investment contract" exists, the business in question should ask itself whether the ICO/ITO involves the following.

• an investment of money...
• in a common enterprise...
• with the expectation of profit...
• to come significantly from the efforts of others.

If it does, it passes the test. Many fintech businesses publish so-called white papers for their ICOs and ITOs, and these contain the details that the reader might want to know. White papers are a form of disclosure document for investors, but they are not prospecti or offering memoranda.

The CSA also threatens any ICO businesses that fail to "play ball" with its desire to regulate them with a reminder that investors in ICOs might sue them for failing to comply with securities laws, although it does not gauge their chances of success. If one of them wins, he will have a right to withdraw from the transaction and might be awarded damages.

Cryptocurrency investment funds

These funds are set up to invest in Bitcoin and other cryptocurrencies. They provide HNW investors with "exposure" to cryptocurrencies, or baskets thereof.

Again, the CSA lapses into the most tentative of language, "encouraging" but not commanding new fintech businesses that want to establish cryptocurrency investment funds to "consider" the following, among other things.

• Retail investors. Only some provinces of Canada allow "investment funds" (the CSA seems to be implying that cryptocurrency investment funds are the same as the investment funds that are already on the statute books) to distribute securities to investors without prospecti. If the courts decide that crypto-coins are securities, this might be a source of trouble for ICOs and crypto investment funds.
• Cryptocurrency exchanges. The CSA believes that the investment fund in question ought to "consider" doing "due diligence" on any cryptocurrency exchange that it uses to purchase or sell cryptocurrencies for its portfolio.
• Registration. This, according to the regulatory body, is something that "businesses must consider."
• Valuation. How will cryptocurrencies in the investment fund's portfolio be valued?
• Custody. If the investment fund in question falls under the securities laws of this-or-that Canadian province, it might have to ensure that all its portfolio assets are held by one custodial bank, which itself is regulated.

When the cat's away, the sandbox must stay

Regulators all over the world have always found it hard to understand the world of IT in general and 'fintech' operations in particular. The temperament of a regulator is very different from that of an IT expert and regulatory databases often work suboptimally. Financial regulators, therefore, are not well suited to keeping track of IT developments. Such developments are growing more and more important with every passing year.

With this in mind, the regulators of the UK have developed a strategy to square their desire to regulate everything that seems worth regulating (an ever-expanding field) with their inability to understand IT and the new concepts it helps to create. The strategy offers 'fintech' start-ups a cheaper route to market – one that involves less onerous (and therefore less expensive) regulation than the rules dictate. In return, each co-operative start-up must involve the regulators in its most intimate operations, providing them with much-needed information about the new areas of fintech that they want to regulate. It also promises to provide them with an army of pliant people who, as they move from one fintech firm to another in future, might provide them with free intelligence about their employers.

The UK, for an unknown reason, has given its initiative the eccentric name of "the regulatory sandbox." This is little more than a considerable relaxation of rules in exchange for much-needed information about the latest technology and the financial (or pseudo-financial) uses to which it can be put.

The CSA, too, has such an initiative in place and is encouraging crypto firms to take part, even if they do not require regulation under current law. As we have seen, it is doing so by a combination of all the indistinct threats it can imagine and the offer of cheaper set-up costs.