In a Canadian first, crypto-asset trading platform Coinsquare Capital Markets Ltd. (“Coinsquare”) was admitted as a member of IIROC effective October 12, 2022.
The Investment Industry Regulatory Organization of Canada (IIROC) is a Canadian self-regulatory organization that oversees all investment dealers operating in Canada.[1] Membership in IIROC is mandatory under all provincial and territorial securities regulations, and confers IIROC with the ability to sanction members who have breached IIROC rules.
Coinsquare has come a long way on the regulatory path. It was only a few years ago that Coinsquare Ltd., the parent company of Coinsquare Capital Markets Ltd., admitted it engaged in misconduct such as manipulating the market by inflating trading volumes and making misleading statements to conceal its misconduct. Coinsquare Ltd. entered into a settlement agreement with the OSC on July 16, 2020 to resolve the dispute[2]. Among other conditions, the settlement agreement required Coinsquare Ltd. to engage in substantial corporate governance improvements including: (1) establishing an independent board of directors; (2) creating a whistleblower program; and (3) resubmitting its subsidiary’s application for IIROC membership.[3]
IIROC membership imposes many obligations on Coinsquare. Coinsquare will require robust investor protection controls, such as “Know Your Client” (KYC) verification, which require the firm to investigate a client’s risk tolerance, financial situation and investment knowledge. Coinsquare will also have to follow market integrity obligations. This prohibits entities from engaging in certain activities (such as frontrunning client trades) and requires trade surveillance to detect market abuses (such as price manipulation).
IIROC granted two forms of relief to Coinsquare to account for the peculiarities of cryptocurrency.
First, Coinsquare is not currently required to maintain FIB insurance for certain assets[4] (the “Insurance Exemption”). However, Coinsquare is obligated to obtain such insurance for losses of crypto assets “once one becomes available” to it.[5] In the interim, Coinsquare must self-insure by setting aside a trust account for client assets that are not held at Coinsquare. This trust account must be equal to or greater than IIROC’s minimum FIB insurance coverage requirement.
Second, Coinsquare is exempted from certain custody controls[6] (the “Custody Exemption”) including deducting 100% of the market value of crypto assets held in a non-“acceptable securities location”.[7] Two third-party custodians – Coinbase Custody Trust, LLC and Tetra Trust Company – are approved to provide custody services if they obtain annual SOC 2, Type 2[8] security reports and stay in good standing with their respective regulators.
The Insurance Exemption and Custody Exemption signify IIROC’s willingness to be flexible with crypto-asset trading platforms. The unique features of cryptocurrency make traditional insurance and custody requirements untenable. For insurance, the onset of “crypto winter” and risk of hacks have left insurers with little appetite for covering crypto assets. This may have led IIROC to provide flexibility from a traditional insurance requirement. For custody, the materialized risks of self-custody (such as the Quadriga collapse) may have made third-party custody solutions more attractive (even with jurisdictional risk).
[1] Effective January 1, 2023, IIROC will amalgamate with the Mutual Fund Dealers Association of Canada (MFDA) to form a single SRO with the temporary name “New Self-Regulatory Organization of Canada”. For now, it is still known as IIROC.
[2] The settlement agreement involved Coinsquare Ltd. and its former employees Cole Diamond, Virgile Rostand and Felix Mazer.
[3] Undertaking of Coinsquare Ltd. and Coinsquare Capital Markets Ltd. to the OSC dated July 16, 2020 at para 2.
[4] IIROC Rule 4456 (Financial institution bond). Financial Institution Bonds are used to protect entities against losses from fraud, theft, embezzlement and other criminal acts.
[5] IIROC New Member Notice dated October 12, 2022 at Appendix “A”.
[6] IIROC Rule 4342 (Hold securities in an acceptable securities location).
[7] IIROC New Member Notice dated October 12, 2022 at Appendix “A”. “Acceptable securities location” is defined at IIROC Form 1 (General Notes and Definitions) and means an entity considered suitable to hold securities on behalf of a member without capital penalty.
[8] SOC 2 is an auditing procedure that evaluates the efficacy of a firm’s security compliance. Completion of these examinations is considered a mark of the highest security compliance.