Canadian cryptocurrency-focused investment funds have so far remained in regulators’ good books, but new guidance from the Canadian Securities Administrators (CSA) highlights areas where fund managers need to exercise caution – including when it comes to valuation and liquidity practices.
The CSA published a notice on Thursday outlining regulators’ experience with cryptocurrency-focused funds and setting out additional guidance for fund managers in the fledgling sector.
According to the notice, since the Ontario Securities Commission began approving some of the world’s first cryptocurrency-focused mutual funds and ETFs in early 2020, the sector has grown to 22 funds with approximately $2.9 billion in assets under management ( as of April 30).
Regulators reviewed these funds in response to the recent turmoil in the cryptocurrency sector and found no real problems with managers fulfilling redemption requests or ensuring sound custody arrangements.
CSA’s review of cryptocurrency ETFs found that they “did not encounter any significant difficulties in meeting redemption requests” and that even large redemption requests were met without the funds taking extraordinary measures to meet those requests.
Regulators also found that fund managers in the sector use a variety of tools to ensure adequate liquidity, and the review confirmed that fund assets are appropriately segregated, held and insured.
However, the CSA also identifies some areas of concern.
For example, regulatory guidance emphasized the importance of fund managers relying on active, regulated markets for valuation data. He warned that evidence of manipulation in some cryptocurrency markets – such as widespread fake trading or wash trading – means these markets cannot be relied upon for correct price data.
“CSA staff believe this would impair or limit (the fund manager’s) ability to determine the fair value of a given crypto asset for purposes of calculating (net asset value),” it said.
To this end, the Notice sets out issues that managers should consider when determining whether the market is providing useful pricing data.
“To accurately value a crypto asset, (fund managers) should consider whether the market for that crypto asset is characterized by real and significant trading volume, in large sizes, both in absolute terms and in comparison to other commodity and equity markets,” he said. .
Additionally, price data from regulated futures markets can also help with accurate pricing, the notice suggests – although in this case there are also concerns about manipulation in unregulated markets.
“CSA staff believe that the presence of a regulated futures market for specific crypto assets promotes better price discovery, as confirmed by recent research,” he said.
Given these concerns, at this point, the only cryptocurrencies that are likely to have adequate and reliable price data are Bitcoin and Ether, the report noted.
“In the future, greater institutional support and mainstream adoption of other crypto assets may result in these crypto assets becoming suitable investments for publicly distributed mutual funds,” he said.
At the same time, given the volatility in cryptocurrency markets and the sudden outage of some large cryptocurrency trading platforms, regulators have urged fund managers to ensure they have effective liquidity management procedures in place, including stress testing and continuous monitoring of the underlying asset. cryptocurrency market liquidity.
The guidance also cautions fund managers to ensure they assess whether certain cryptoassets may be considered securities or derivatives, which may result in, among other things, concentration restrictions or securities lending restrictions.
To this end, the guidance also addressed the practice of “staking” in the cryptocurrency sector – locking certain assets in smart contracts – which regulators say may amount to the issuance of securities (or derivatives) and may result in the creation of an asset that would otherwise be considered liquid becomes an “illiquid asset” under securities laws and may also result in restrictions on securities lending.
“We encourage interested parties to review these guidelines to better understand our expectations for public crypto asset funds,” Stan Magidson, chair of the CSA and chair and CEO of the Alberta Securities Commission (ASC), said in the release.
“It is important that such funds clearly understand their existing regulatory obligations given recent developments in the cryptocurrency market.”
