This article appears in the April 2021 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
Giving retail investors access to regulated crypto products has put Canadian authorities in an unusual position: being well ahead of their U.S. counterparts.
Earlier this year, the Ontario Securities Commission (OSC) gave the green light to the world’s first direct custody Bitcoin ETF, which is offered by Toronto-based Purpose Investments Inc. That was quickly followed by the OSC approving similar offerings from Evolve Funds Group Inc. and CI Investments Inc. An expansion into other sorts of crypto funds is on the horizon; CI has also proposed an Ethereum fund.
So far, fund manufacturers and retail investors in the U.S. can only look on with envy. The U.S. Securities and Exchange Commission (SEC) has consistently rejected proposals to launch Bitcoin ETFs.
So, why have Canadian regulators been prepared to go where U.S. regulators have not? The divergence has its roots in a groundbreaking October 2019 decision by the OSC to approve a closed-end Bitcoin fund launched by Toronto-based fund manager 3iQ Corp.
“The Bitcoin Fund was not an ETF, but the decision permitting it to be publicly traded set the stage for the approval of the current slate of Bitcoin ETFs,” said Eva Markowski Belmont, associate with Siskinds LLP in London, Ont.
The OSC declined to comment on its approvals of Bitcoin ETFs for this story, but the regulator did point to its 2019 3iQ decision.
OSC staff initially rejected the proposed 3iQ fund in a February 2019 decision. But after a hearing the following fall, the OSC reversed its decision, ruling that while the regulatory concerns underpinning the initial rejection were valid, they didn’t justify denying the fund’s approval.
In that foundational decision, the OSC stressed that the job of regulators is not to rule on the merits of a particular investment.
“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 OSC stated in its decision to approve the 3iQ fund.
That decision also signalled the OSC’s preference for giving investors access to innovative but regulated opportunities. Markowski Belmont pointed to a specific section of the ruling: “Denying investors the opportunity to invest in Bitcoin through a public fund would not promote fair and efficient capital markets and confidence in capital markets. Instead, it would suggest that investors should acquire Bitcoin through unregulated vehicles, and capital market participants should be encouraged to create those vehicles.”
That last sentence, Markowski Belmont suggested, shows the OSC views its role as engaging with capital market participants and facilitating innovation: “It hints at optimism that cryptocurrency can be tamed, and that doing so is better than the alternative of driving investors underground toward riskier, unregulated platforms.”
The OSC uses a pre-filing review process to engage with the investment industry on innovative products. This allows fund manufacturers to get confidential feedback from the regulator on proposed novel products before filing a preliminary prospectus, a process that expedites the eventual prospectus review without publicly revealing the details of proposed products.
The first handful of approved Bitcoin ETFs made use of this procedure. For example, according to the OSC, Purpose Investments pre-filed its proposed prospectus for its first Bitcoin ETF in September 2020. The preliminary prospectus wasn’t submitted until Feb. 10 of this year, and approval was granted on Feb. 11.
In contrast, the SEC has so far been unmoved by the U.S. investment industry’s efforts to produce regulated crypto investments. According to Markowski Belmont, the U.S. regulator takes “a more pessimistic view about whether cryptocurrency risks can be adequately managed.”
The SEC has repeatedly rejected retail crypto funds on the basis that the underlying market for Bitcoin is too vulnerable to fraud and manipulation.
In a 2017 decision rejecting a proposed ETF listing — the Winklevoss Bitcoin Trust, which would have been listed on the Bats BZX Exchange — the SEC stated, “the significant markets for Bitcoin are unregulated.” An exchange could therefore not enter into “the type of surveillance-sharing agreement that has been in place with respect to all previously approved commodity-trust [exchange-traded products (ETPs)] — agreements that help address concerns about the potential for fraudulent or manipulative acts and practices in this market.”
Some of these same concerns were raised by the OSC when it initially reviewed the 3iQ fund. While the OSC panel concluded those concerns were “warranted and should be taken seriously,” they were not enough to reject the fund outright.
At least one SEC commissioner now seems to be on board with Canada’s approach. SEC commissioner Hester Peirce, when speaking at an industry conference in March, suggested that the SEC’s decisions to reject Bitcoin ETFs have subjected these proposed products to tougher standards than other ETPs that are also based on risky underlying assets, such as precious metals.
“Not only is it unclear whether prior non-crypto ETP filings could have passed muster under this more rigorous approach, the ever-shifting goalposts are unfair to innovators who spend ever-increasing amounts of money on attorneys and quantitative experts only to find that they have failed to hit a target that has moved once again,” Peirce said.
Peirce also criticized her colleagues at the SEC for being “slow to provide regulatory certainty on a host of crypto-related issues,” noting that the SEC has lagged Canada’s regulators.
The SEC continues to grapple with proposed crypto ETF filings. A recent regulatory filing from Cboe BZX Exchange Inc., which is seeking permission to list and trade a Bitcoin ETF, suggested that the lack of access to regulated, exchange-traded Bitcoin products in the U.S. is “disadvantaging U.S. investors and leaving them with more risky means of getting Bitcoin exposure.”
While the apparent success of the crypto fund launches in Canada is one source of hope for U.S. crypto advocates, another is that Gary Gensler, the Biden administration’s pick to head the SEC, is viewed as being more open than his predecessor to allowing crypto-based investments into the mainstream U.S. market.
“The SEC needs a clearer approach to considering applications for crypto ETPs that is more consistent with precedent,” Peirce said. “On these and other issues, SEC chairman nominee Gary Gensler will bring deep appreciation for the growth and ingenuity in the digital assets space and the need for regulatory clarity.”
If a Gensler-led SEC does finally approve a Bitcoin ETF, it will be a rare instance of U.S. regulators being slower to act than their Canadian counterparts.