On February 15, 2019, the Ontario Securities Commission refused to issue a receipt for a prospectus for the Bitcoin Fund (the Fund), which is managed by 3iQ Corp. (3iQ). The OSC decision highlights the current regulatory unease in Canada regarding cryptoassets.
The Fund was structured as a non-redeemable investment fund to expose investors to bitcoin and daily price movements of bitcoin relative to the US dollar.
OSC staff argued that it was too soon to recognize bitcoin as an appropriate asset for an investment fund available to the public. Staff expressed concern about the gaps between regulatory regimes in other jurisdictions and the high potential for abuse in a cryptocurrency market that is still very difficult to monitor. Staff also expressed concern about the fact the Fund had not yet received from a customary custodian’s audit report and submitted that it would be unusual to rely on a custodian that could not provide such a report on request.
Staff argued that the Fund had not taken sufficient steps to protect investors against the risk of loss of bitcoin, such as by obtaining insurance. Staff also took the position that the prospectus was not compliant with NI 81-102, which limits a non-redeemable investment fund to investing no more than 20% of its net asset value in illiquid assets (it was argued that bitcoin is an illiquid asset, because it is not traded on market facilities on which public quotations in common use are widely available, an argument which was disputed by 3iQ).
3iQ argued that Canadian investors are already able to gain exposure to bitcoin through a number of avenues. In its view, the Fund would be a safer way to invest in cryptoassets compared to those alternatives, with the benefit of the expertise of a professional portfolio manager. 3iQ also argued that it would be able to perform diligence to establish the source of the bitcoin acquired by the Fund to minimize fraud or other illicit risks.
The OSC focused its review on a concern about the lack of established regulation for the bitcoin market, which raises investor protection issues. In deciding whether it is contrary to the public interest to issue a receipt for the Fund’s prospectus, the OSC is required to consider whether fund operational risks are adequately managed by measures other than providing disclosure of such risks to investors.
The OSC expressed concern about accurate valuation given the current state of the bitcoin market. Despite the fact that 3iQ had taken steps to ensure reliable, reputable sources of valuation information, the OSC accepted staff’s argument that trading on less reputable platforms can impact pricing on more reputable platforms. This differentiates bitcoin assets from conventional investments assets.
The OSC noted that bitcoin is a novel digital asset that requires novel custodial arrangements. It found that, without customary audit reports or insurance to protect against the risk of loss of bitcoin held in cold storage, an investment in the Fund presents a novel risk that is unacceptable for a prospectus-qualified fund offering.
The OSC also found that bitcoin is an illiquid asset, and therefore 3iQ’s prospectus was not compliant with NI 81-102.
DISCLAIMER: This post is intended to convey general information about legal issues and developments as of the date above. It does not constitute legal advice and must not be treated or relied on as such.