The Ontario Securities Commission (“OSC”) completed a focused compliance review of the know-your-client (“KYC”), account appropriateness assessment and Client Limit (as defined below) practices of crypto asset trading platforms (“CTPs”) that are based in Ontario and registered as restricted dealers. The OSC’s findings and further guidance have been published in OSC Staff Notice 33-757 Review of Restricted Dealer Crypto Asset Trading Platforms’ Compliance with the Account Appropriateness, Investment Limits and Client Limits Requirements (the “Notice”). OSC staff (“Staff”) encourage CTPs to use the Notice as a self-assessment tool with which to strengthen their compliance with Ontario securities law.
Background
In Canada, securities legislation applies to CTPs that facilitate or propose to facilitate the trading of instruments or contracts involving crypto assets (“Crypto Contracts”), as the Canadian Securities Administrators (including the OSC) take the position that a user’s contractual right to a crypto asset may itself constitute a security and/or a derivative. Exemptive relief from the prospectus requirement has been granted to permit registered CTPs to purchase, hold, stake, deposit, withdraw and sell crypto assets for clients through Crypto Contracts. Exemptive relief from the trade-by-trade suitability determination requirements under section 13.3 of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations has also been granted to certain registered CTPs that do not provide recommendations or advice to, or that do not conduct trade-by-trade suitability determinations for, clients. As a condition of this relief, CTPs are required to perform account appropriateness assessments and apply investment limits and Client Limits.
Compliance Review
Staff reviewed six registered CTPs whose principal regulator is the OSC to evaluate the CTPs’ compliance with the terms and conditions of their exemptive relief. Four of the CTPs had obtained relief from the trade-by-trade suitability determination requirements and were conducting account appropriateness assessments. Two of the CTPs had not obtained relief from, and remained subject to, the trade-by-trade suitability determination requirements.
The terms and conditions of the CTPs’ exemptive relief included obligations relating to: (i) custody arrangements; (ii) account appropriateness assessments or suitability determinations; (iii) corporate governance structures; (iv) insurance bonding policies; and (v) conflicts of interest. While the Notice is specific to account appropriateness assessments, investment limits and Client Limits, Staff’s findings and guidance with respect to the other obligations reviewed may be found in the Registration, Inspections and Examinations Division’s Summary Report for Dealers, Advisers and Investment Fund Managers published in 2023 and 2024.
Account appropriateness assessments
CTPs that operate under the account appropriateness model are required to consider the following factors in conducting an assessment for each prospective client: (i) the client’s experience and knowledge in investing in crypto assets; (ii) the client’s financial circumstances; (iii) the client’s risk tolerance; and (iv) the crypto assets approved to be made available to a client on the platform (collectively, the “Account Appropriateness Factors”). These CTPs must perform an assessment before opening a client account, on an ongoing basis and at least every 12 months.
During the sweep, Staff found instances where CTPs took a mechanical “tick box” approach or did not update Account Appropriateness Factors in respect of their clients on an ongoing basis. This occasionally resulted in an account being opened or maintained for a client for whom it was not appropriate. The Notice encourages CTPs to:
- develop and design onboarding questions to meaningfully capture the Account Appropriateness Factors for each prospective client, and to follow up with the client where any inconsistencies are identified in the information collected;
- conduct a meaningful assessment, rather than take a mechanical “tick box” approach, that considers all of the Account Appropriateness Factors for each client at the onboarding stage and on an ongoing basis;
- update the assessment for each client at least annually or more frequently if there is a significant change in a client’s circumstances or in market conditions;
- maintain books and records that evidence any changes in a client’s information (or a confirmation that there are no changes);
- establish policies and procedures for collecting, documenting and reviewing the information necessary to conduct a meaningful assessment; and
- establish policies and procedures for handling situations where the CTP has determined that it is not appropriate for a prospective client to open an account, including preventing the client from gaming the onboarding process.
Investment limits
Subject to certain exceptions, CTPs must limit a client’s purchases of crypto assets to a maximum amount on the CTP’s platform. While a particular investment limit will depend on whether the CTP operates under the account appropriateness model or the suitability model, the investment limit cannot be less than C$0 and excludes purchases and sales of specified crypto assets. During the compliance review, Staff did not observe any instances in which CTPs failed to discharge their obligation to limit a client’s purchases of crypto assets to the maximum amount applicable on the CTP’s platform.
Client Limits
CTPs that operate under the account appropriateness model are required to establish limits to mitigate the risk of clients incurring significant realized and unrealized losses while trading in Crypto Contracts on the platform (“Client Limits”). Client Limits are intended to: (i) be an appropriate and tailored limit on the losses that a client may incur; (ii) help clients understand the losses that they have incurred to date on their investments in Crypto Contracts; and (iii) initiate meaningful action to help limit further losses that a client may incur. Client Limits are also used to help deter excessive risk-taking (e.g., the “doubling down” on existing crypto asset positions) by clients when losses are experienced.
When assigning a Client Limit for each client, CTPs are required to consider all of the Account Appropriateness Factors for the client and set a Client Limit that is appropriate in light of the client’s circumstances. During the sweep, however, Staff identified numerous instances in which CTPs assigned Client Limits that were not meaningfully tailored to the client. For example, Client Limits were determined based on consideration of only one or a few Account Appropriateness Factors or on arbitrary and dynamic factors. Staff also found instances in which CTPs did not effectively monitor Client Limits or take meaningful action once a Client Limit was met or exceeded. The Notice recommends that CTPs:
- design an onboarding process to collect sufficient information to develop an appropriate Client Limit for each client;
- consider all of the Account Appropriateness Factors to understand a client’s individual situation and assign an appropriate Client Limit during the onboarding process and on an ongoing basis;
- establish a Client Limit that is based on a dollar value that may be used in monitoring the client’s ongoing trading activity. Relying on a value or calculation that does not consider all of the Account Appropriateness Factors and that is based on elements that dynamically change does not result in a meaningful consideration of the client’s circumstances;
- ensure that the language in Client Limit notifications makes clients aware that their current trading activity is approaching their Client Limit, direct them to educational materials on the risks of excessive trading and refrain from using messaging that could be construed as advice;
- monitor Client Limits based on clients’ trading activity and take appropriate actions when a client meets or exceeds their Client Limit, including: (i) issuing timely and meaningful notifications to the client; and (ii) ensuring that any action taken is proportional to the client’s activity and that the client is aware that their activity to date is putting them at excessive risk; and
- ensure that adequate policies and procedures are in place to evaluate, monitor and apply Client Limits as required by the terms of the CTP’s exemptive relief.
What’s Next?
The Notice indicates that Staff will continue to monitor CTPs’ compliance with the terms and conditions of their exemptive relief, as well as with other fundamental registrant obligations in securities legislation, and take appropriate action where instances of non-compliance are noted.
[View source.]
