In a landmark ruling, the Ontario Securities Commission (OSC) has approved the world’s first public investment fund devoted to Bitcoin, clearing the way for crypto-based investment vehicles developed for mainstream investors.
On Oct. 30, an OSC hearing panel handed down its ruling in a closely watched case involving a proposed new investment fund from Toronto-based 3iQ Corp. The prospectus-based fund provides a way for investors to invest in Bitcoin.
Back in February, the OSC’s investment funds branch refused to approve the proposed fund’s prospectus, paving the way for a full hearing in which the OSC would consider whether a regulated fund could invest primarily in the fledgling crypto sector.
The hearing focused on two issues: whether Bitcoin should be considered an illiquid asset under securities rules; and whether approving the proposed fund’s prospectus is in the “public interest,” given a variety of concerns, such as the fund’s ability to keep its assets safe and to value its assets accurately.
On both counts, the OSC panel sided with 3iQ, declaring that determining whether an underlying investment is sound is not up to regulators. The panel acknowledged that Bitcoin is risky, but ruled that it is still suitable for investment.
“Bitcoin is a novel asset in an emerging and evolving market,” the panel’s ruling states. “Some novel asset classes and securities products fail. They become tulip bulbs or dot-coms. Others succeed and become gold or the next great technology. Securities regulators are not mandated to try to pick winners and losers.”
The panel also applauded 3iQ’s efforts to provide access to Bitcoin through a regulated fund. Until now, investors seeking exposure to Bitcoin have had to trade it directly through unregulated cryptoasset platforms, via the exempt market or through back-door listings in the venture markets.
The OSC’s ruling notes there now are approximately 10 companies trading on junior exchanges that essentially hold crypto as their only assets, thereby providing shareholders with indirect exposure to the asset class. These companies gained their listings through reverse takeovers (RTOs), which enabled those companies to avoid a regulatory prospectus review, the OSC ruling states.
The hearing panel’s ruling notes that companies that have entered the public markets through this sort of back-door access have given Canadian markets some of their most notorious failures – including Sino-Forest Corp. and YBM Magnex International Inc. – and have had “catastrophic financial consequences for investors.”
The existence of back-door avenues to crypto investing factored into the regulator’s decision to approve the 3iQ fund; the company has been seeking “front door” market access for its Bitcoin fund since 2016 and now aims to launch it by the end of this year.
“The notion of ‘professionalizing’ investing in risky assets to mitigate risks should be encouraged; not discouraged,” the panel’s ruling states, adding that 3iQ’s approach is innovative.
However, investor advocates are wary of the OSC panel’s stance.
Neil Gross, chair of the OSC’s Investor Advisory Panel, says the decision “reflects a very orthodox approach to securities regulation – saying, essentially, that the proposed Bitcoin fund is acceptable because the fund’s administration will actually exist, even if Bitcoin itself turns out to be nothing but a mirage and a leavening agent for fraud.”
Gross says that while this may be an important distinction from a legal perspective, “it’s probably not one most people would find very compelling or comforting. So, it’s hard to see how the decision will foster confidence in our capital markets – at least, among investors.”
The OSC panel sees things differently. It maintains that approving a regulated fund that invests in crypto will give investors a safer alternative to riskier avenues, such as exempt market products and RTO listings, and enable investors to diversify their portfolios.
Fintechs and other industry firms looking to develop novel products should welcome the OSC ruling. Bay Street law firm Osler Hoskin & Harcourt LLP, which acted for 3iQ in the case, says the panel’s decision “sends a strong message in support of innovation in capital markets and encourages the development of new fund products that invest in new asset classes.”
Yet, the OSC’s ruling also indicates that the regulator won’t approve every proposed new crypto investment that firms dream up. The panel’s ruling indicates that a fund’s structure matters: for example, the ruling suggests that the regulator may reach a different conclusion if a proposed fund is structured as an ETF. Indeed, the U.S. Securities and Exchange Commission recently rejected several proposed crypto-based ETFs.
The OSC ruling notes that there are fundamental differences between ETFs and 3iQ’s fund. The panel’s ruling points out that because the 3iQ fund will be a non-redeemable investment fund, it will require only monthly price reporting and be subject to annual redemptions. Conversely, an ETF requires constant trading, which, the OSC ruling states, may make such an ETF more vulnerable to the sort of market manipulation that appears to be happening in the existing Bitcoin markets.
The OSC panel’s ruling acknowledges that there is evidence of shady trading in the existing Bitcoin markets, but whether that shadiness has a significant impact on Bitcoin prices is unclear. Much of the fake trading is designed to create the illusion of volume and liquidity on particular platforms in a bid to attract volume to those platforms rather than to dictate the price for Bitcoin, the panel’s ruling suggests.
The OSC panel’s ruling concludes that there’s enough genuine trading activity to support price discovery in the Bitcoin market, adding that many of the concerns about market manipulation could apply equally to other commodity markets.
On the issue of security, the ruling acknowledges that “Bitcoin can be stolen or lost,” like any other commodity – but most of the losses so far have happened on unregulated trading platforms. In 3iQ’s case, the firm has arrangements with custodians to keep the fund’s assets safe, the panel’s ruling notes.
Ultimately, the OSC’s ruling doesn’t throw the gates open to crypto-based investment vehicles. However, the ruling does sketch out a path to further innovation in this emerging sector. IE