Fintech Regulatory Developments: 2019 Year in Review
As anticipated in our 2018 year in review, there were significant and notable developments in the Canadian Fintech industry in 2019. The following is a summary of some of the key Fintech developments in 2019 and some noteworthy regulatory developments to keep a watchful eye on in 2020.
WHAT WE SAW IN 2019
1. OPEN BANKING DEVELOPMENTS
- Department of Finance Canada Consultation Paper on Open Banking: On January 11, 2019, the Department of Finance Canada released a consultation paper (the “Open Banking Consultation Paper”) seeking the views of Canadians on the potential benefits and risks of an open banking system in order for such feedback to be shared with and reviewed by the Advisory Committee on Open Banking (the “Open Banking Committee”). The Open Banking Consultation Paper defined “open banking” as “a framework where consumers and businesses can authorize third party financial service providers to access their financial transaction data, using secure online channels” (“Open Banking”). The Open Banking Consultation Paper sought feedback in relation to the benefits and risks of Open Banking for Canadian consumers and what role (if any) the federal government should play in the implementation of Open Banking in Canada.
The Open Banking Consultation Paper specifically sought stakeholder perspectives on the following risks, in particular: (i) what specific consumer protection elements are needed for the sharing of financial transaction data under Open Banking; (ii) how to manage the risks or enhance the benefits that Open Banking may pose from a privacy perspective; (iii) how to manage the risks or enhance the benefits that Open Banking may pose from a cyber security perspective; and (iv) whether Open Banking presents new prudential risks to financial institutions, and how to mitigate to those risks.
Following the release of the Open Banking Consultation Paper, Finance Canada engaged in a consultation process related to Open Banking.
- Senate Open Banking Report: On June 19, 2019, the Standing Senate Committee on Banking, Trade and Commerce released its report entitled: “Open Banking: What it Means for You” (the “Open Banking Report”). The Open Banking Report examined the potential regulatory role of the federal government in respect of open banking, as well as the benefits and challenges of open banking in a Canadian context. The Open Banking Report: (i) recommended the development of a principles-based framework for open banking, to be developed by industry stakeholders and integrated with existing financial and privacy legislation; (ii) identified industry stakeholders; (iii) suggested coordination between the federal and provincial governments to facilitate initiatives related to an open banking framework; (iv) recommended that the Financial Consumer Agency of Canada (“FCAC”) be given oversight to regulate the risks posed to consumers by the practice of screen scraping; (v) recommended funding consumer protection advocacy groups to bring awareness to the benefits and risks of screen scraping; (vi) recommended that the federal government introduce legislation to establish the scope of open banking in order to ensure the continued stability of the Canadian financial system and protection of Canadian consumers; (vii) recommended the swift modernization of the Personal Information Protection and Electronic Documents Act (PIPEDA) in order to align it with General Data Protection Regulation (GDPR) as the global privacy standard; and (viii) recommended the Privacy Commissioner of Canada and the Canadian Commissioner of Competition as co-regulators of open data frameworks.
2. ANTI-MONEY LAUNDERING REGULATION DEVELOPMENTS
- New Administrative Monetary Penalties Policy and New Tools in Respect of Compliance and Examination Process: On February 7, 2019, the Financial Transactions and Reports Analysis Centre of Canada (“FINTRAC”) issued a new Compliance Framework and Assessment Manual, as well as a revised Administrative Monetary Penalties Policy (together with sample penalty calculation) and a notice on Voluntary Self-Declaration of Non-Compliance. These new tools provide significantly more insight into the examination and penalty assessment process of FINTRAC and follow the 2016 Federal Court of Appeal decision in Canada v. Kabul Farms Inc. (and other similar decisions), where the court found that the use by FINTRAC of an unpublished formula to assess the amount of an administrative monetary penalty raised procedural fairness concerns.
- Amending Regulations: On July 10, 2019, amending regulations (“Final Regulations”) were issued amending each of the existing regulations (the “PCMLTFA Regulations”) under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the “PCMLTFA”). These included changes to expand the applicability of the PCMLTFA Regulations to virtual currency activities, prepaid cards and foreign money services businesses. The primary aim of the Final Regulations was to improve the effectiveness of Canada’s anti-money laundering and counter-terrorism financing regime, close gaps in the regime and improve compliance with international standards.
- Updated Guidance on Verifying the Identity of Individuals and Other Entities: FINTRAC updated its guidance on Methods to verify the identity of an individual and confirm the existence of a corporation or an entity other than a corporation effective October 2019. The updated guidance reflected the change to “authentic, valid and current” documentation and provides greater flexibility to businesses to effectively comply with identification requirements by allowing the use of new technologies to verify identity and authenticate documents.
- Financial Action Task Force Guidance on Virtual Assets: On June 21, 2019, the Financial Action Task Force (the “FATF”) released Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers as well as a Draft Interpretive Note to FATF Recommendation 15 addressing virtual assets (together, the “FATF Guidance”). The FATF Guidance clarifies a risk-based approach to virtual assets and virtual asset service providers for anti-money laundering and counter terrorism financing purposes (including the application of the travel rule to virtual assets). The FATF has provided member countries (which include Canada) with 12 months to adopt these guidelines, with a review set for June 2020.
3. DIGITAL IDENTITY DEVELOPMENTS
- Digital ID & Authentication Council of Canada Releases Pan-Canadian Trust Framework: On June 3, 2019, the Digital ID & Authentication Council of Canada (the “DIACC”) released its initial draft of its Pan-Canadian Trust Framework (the “PCTF”) for public consultation. Building on the DIACC’s digital identity ecosystem principles, the draft PCTF sets out the framework’s general structure, key concepts, and in-scope identity-related functions and processes. In particular, the PCTF sets out the roles for participants in the digital identity ecosystem, and their respective functions and processes (and, where applicable, the process’ conformance criteria) they may perform within the PCTF, for the creation and management of digital representations, the use of digital representations and the enablement of digital identity systems.
- Financial Action Task Force Draft Guidance on Digital Identity: On October 31, 2019, the FATF released its draft guidance on digital identity (the “Digital ID Guidance”). The Digital ID Guidance is intended to help governments, regulated entities and other relevant stakeholders with applying a risk-based approach to use digital identity systems consistently with the FATF’s customer due diligence recommendations in support of the FATF’s anti-money laundering and counter terrorism financing efforts. The Digital ID Guidance’s release was timely, as it came on the heels of: (i) FINTRAC’s updated guidance on individual identity and corporate existence verification methods; and (ii) recent amendments to the Bank Act, which permit federally regulated financial institutions to provide identification, authentication and verification services.
4. PAYMENT INDUSTRY DEVELOPMENTS
- Payments Modernization Project: In 2019, Payments Canada continued developing its payments modernization project, currently: (i) planning, building and testing its new large value transfer system (“LVTS”) for wire payments, called Lynx; (ii) building and testing its new real-time payments system, called the Real-Time Rail, in preparation for its anticipated launch in 2020; and (iii) enhancing regulation for its Automatic Clearing Settlement Systems to enable better, faster payment options. Payments Canada’s modernization efforts appear to be aligned with Canadians’ adoption of emerging payment channels and the greater convenience that they find in them. As identified in Payment Canada’s latest report, between 2013-2018, cash payments have declined sharply by 40%. Debit cards are now the most favoured form of payment at point-of-sale and, if the recent trend continues, credit card use is poised to overtake debit card use in the coming years.
- Payments Canada New Rule for Debit Payments: On May 24, 2019, Payments Canada issued its consultation paper to solicit feedback from interested parties on its proposed rule to accommodate delayed authorization of point-of-service debit card payments where it may not be possible to have immediate authorization by the cardholder’s financial institution. The proposed rule is aimed at increasing the availability of point-of-service debit card acceptance in Canada and broadening the number of debit-enabled payment options for consumers.
- Payments Canada Consultation on Policy Framework for High-Value Payments: On October 9, 2019, as a part of its broader modernization program, Payments Canada issued a proposed policy framework for Lynx, which is the new LVTS for wire payments that Payments Canada is developing to replace Canada’s current LVTS. The proposed Lynx policy framework set out Payment Canada’s proposals on, and invited interested parties to provide comments on, access (i.e. eligibility to participate in Lynx), finality of a payment to payee, and deduction of service charges from the original amount of a Lynx payment.
5. NEW PROVINCIAL FINANCIAL REGULATORS
- Financial Services Regulatory Authority of Ontario: As of June 2019, the new Ontario financial regulator, the Financial Services Regulatory Authority of Ontario (“FSRA”) launched and assumed the regulatory duties of the Financial Services Commission of Ontario (FSCO) and the Deposit Insurance Corporation of Ontario (DICO).
- FSRA Innovation Office: FSRA announced in its 2019-2020 priorities and budget and further advanced in its draft 2020-2021 priorities and budget its intention to create an Innovation Office which would:
- support an “open for business” approach to facilitate the process for regulated entities seeking to bring innovative products and services to market;
- where FSRA has the authority, seek to develop and implement customized trials and new product and service offerings using its regulatory powers to grant waivers and exemptions; and
- work with stakeholders and the Ontario Ministry of Finance to identify legal and regulatory barriers to innovation, and develop and promote ways to adapt the regulatory regime to foster innovation.
- BC Financial Services Authority: BC introduced in 2019 via legislation a new provincial financial regulator, the BC Financial Services Authority (“BCFSA”), which will replace the BC Financial Institutions Commission. The BCFSA is expected to launch in 2020.
6. INSURTECH DEVELOPMENTS
- Québec Regulation Respecting Alternative Distribution Methods: As of June 13, 2019, adequately registered firms may offer financial products or services in Québec without the intermediary of a natural person. Consequently, clients can enter into a contract via the Internet, without having to go through a representative, in the sectors of insurance, claims settlement, and financial planning. Certain conditions apply, notably:
- clients who ask to deal with a representative must be given access to a representative registered with the Autorité des marchés financiers (“AMF”) in the sector required to offer the product or service and attached to the firm (chatbots and robo-advisers do not meet this requirement);
- clients have a 10-day period to cancel an insurance contract entered into via the Internet at no cost; and
- firms using a digital transaction space to interact with clients and allow them to enter into a contract must comply with specific regulation concerning the design, operation and monitoring of the space.
7. CRYPTOCURRENCY AND CRYPTO ASSET REGULATION DEVELOPMENTS
- CSA and IIROC Consultation on Proposed Regulatory Framework for Crypto-Asset Trading Platforms: The Canadian Securities Administrators (the “CSA”) and the Investment Industry Regulatory Organization of Canada (“IIROC”) published a joint Consultation Paper on a Proposed Framework for Crypto-Asset Trading Platforms (the “Consultation Paper”). The Consultation Paper seeks feedback on how securities legislation applicable to crypto-asset trading platforms may be tailored to address the novel features and risks of these platforms. The CSA and IIROC intend to use this feedback to establish a framework that provides regulatory clarity to crypto-asset trading platforms, addresses risks to investors and creates greater market integrity. The framework will apply to both platforms operating in Canada and to foreign-based platforms that have Canadian participants.
- Hydro-Québec New Framework for Digital Currency Miners: In its April 29, 2019 ruling, the Régie de l’énergie (the “Régie”) issued a decision approving the creation of a new class of customers for digital currency mining and also announced that a new electricity block of 300 megawatts will be reserved for this class of customers (with 50 megawatts allocated to projects of 5 megawatts or less). This decision is in addition to the 158 megawatts that have previously been allocated by Hydro-Québec to existing consumers as well as the 210 megawatts allocated by municipal distributors. Following the Régie’s decision, the electricity reserved for this class (which includes the agreements that have already been concluded with existing consumers) will be distributed according to the existing M and LG tariffs.
- Cryptocurrency Taxation Update: On May 17, 2019, the Department of Finance released proposals (the “Proposals”) to amend the Excise Tax Act (Canada) (the “ETA”) to treat certain virtual currency as a financial instrument for GST/HST purposes. If the Proposals become law, they will have a significant impact on whether certain participants in the virtual currency industry will be able to claim input tax credits on expenses incurred in the course of making supplies of and processing transactions involving such virtual currency. The Proposals would enact this change by introducing the new definition of “virtual payment instrument” into the ETA and by amending the definition of “financial instrument” in subsection 123(1) to include a reference to such definition. Tax compliance in respect of cryptocurrency continues to be a focus area of the Canada Revenue Agency (“CRA”). In June 2019, the CRA released a statement underscoring its commitment to combat international and transnational tax crime, global tax evasion and money laundering using cryptocurrency as a member of the Joint Chiefs of Global Tax Enforcement (J5), an international collaborative effort between revenue authorities in Australia, Canada, the Netherlands, the United Kingdom and the United States. In this regard, the 2019 federal budget included a commitment of $150 million over five years to allow the CRA to fund new initiatives and expand existing programs to target non-compliance associated with the digital economy including cryptocurrency transactions. The CRA continues to publish new administrative positions on the taxation of cryptocurrencies. On March 8, 2019, the CRA published a guide for cryptocurrency users and tax professionals, which summarized the CRA’s position on a number of issues including providing examples of when a cryptocurrency user’s activities will cause the user to be considered to be carrying on a business, discussion of the appropriate methods of valuing cryptocurrency inventory and specific books and records requirements for cryptocurrency transactions. On August 8, 2019, the CRA published CRA Document Number 2018-0776661I7 “Bitcoin mining”, which specified that both the block reward received by a bitcoin miner and transaction fees must be included in the miner’s income from the provision of services under section 9 of the Income Tax Act (Canada) (“ITA”), the general provision governing income and losses from business or property in the ITA.
- G7 Working Group on Stablecoins: Investigating the Impact of Global Stablecoins: In October 2019, the G7 Working Group on Stablecoins (the “Working Group”) released its report on the impact of global stablecoins (the “Report”). The Report identifies the benefits that blockchain-based stablecoins could provide as a payment system and store of value. The Report also notes that there are many risks and challenges associated with the implementation of stablecoins, especially when they are global scale stablecoins (“GSCs”). The Working Group concluded that before a global stablecoin project begins, the operational, legal, regulatory, oversight and public policy risks associated with the GSCs must be addressed. To help address these risks, the Report: (i) sets out concepts for how stablecoin arrangements may be defined; (ii) details the regulatory, oversight and policy issues associated with stablecoin initiatives, including how these issues may be amplified or new issues may arise if stablecoins reach a global scale; and (iii) reviews existing regimes that may be applicable to stablecoins and notes groups that are currently assessing whether there may be regulatory gaps around GSCs.
- TokenGX Exemptive Relief: On October 22, 2019, the Ontario Securities Commission (the “OSC”) provided time-limited relief from applicable securities law requirements to allow TokenGX Inc. (“TokenGX”) to test pilot its securities token trading platform. The OSC granted the relief on the following conditions, amongst others: (i) trading on the TokenGX platform is limited to (1) tokens of its affiliate, Token Funder Inc. (“Token Funder”), (2) the tokens of no more than 10 other Ontario issuers whose tokens were issued through Token Funder’s token issuance platform (“Issuer Tokens”) and (3) “settlement balance tokens”, which are tokens issued by TokenGX for the sole purpose of facilitating payment for tokens on the TokenGX platform; (ii) any Issuer Tokens made available on the TokenGX platform will have completed at least one distribution under the “offering memorandum” prospectus exemption such that an offering memorandum is available; (iii) a “know-your-client” and suitability assessment is to be conducted for each investor; and (iv) TokenGX is to ensure that only residents of Ontario will participate on its platform.
- The Bitcoin Fund Decision: On October 29, 2019, the OSC released a decision that will allow The Bitcoin Fund (the “Fund”), which will be a public, non-redeemable investment fund that will invest substantially all of its assets in bitcoin, to receive a receipt for a final prospectus from the OSC, provided that the OSC is satisfied that there are no grounds for the OSC to refuse to issue a receipt, other than those grounds noted in the decision. The OSC, in reaching its decision, considered if: (i) bitcoin is an illiquid asset such that the Fund will not be compliant with securities law restrictions on the amount of illiquid assets that a non-redeemable investment fund can hold or purchase; and (ii) issuing a receipt for the Fund’s prospectus is not in the public interest, which included an assessment of the Fund’s ability to value its assets for investors given the significant market integrity concerns regarding the trading of bitcoin, the security and safekeeping of the Fund’s bitcoin, and the Fund’s ability to file audited financial statements, as required.
8. CRYPTOCURRENCY ENFORCEMENT ACTIVITY
2019 witnessed securities regulators and law enforcement in Canada and the US continuing the global trend of monitoring and in certain circumstances, taking aggressive investigation and enforcement steps against individuals and companies involved in perceived violations of law.
Most notably in Canada:
- The OSC, the Federal Bureau of Investigation (“FBI”) and the Royal Canadian Mounted Police (“RCMP”) commenced investigations into the collapse of QuadrigaCX in early 2019. When it collapsed, QuadrigaCX was one of Canada’s largest cryptocurrency exchanges and left its creditors (mostly clients) with claims in excess of $200 million. An investigation by Ernst and Young, the court-appointed monitor, has accused the company’s founder, Gerald Cotten, of creating fake trades and transferring clients’ fiat and crypto funds into his personal accounts.
- The OSC successfully prosecuted Oliver Folkard for defrauding investors with a bitcoin trading scheme between January 2014 and February 2016. Mr. Folkard was sentenced to eight months in prison and three years of probation for defrauding at least 14 people out of approximately $155,000.
- The OSC and Securities and Exchange Commission (“SEC”) concluded settlement agreements with NextBlock Global Limited and its chief promoter in connection with misleading statements they made in offering memoranda provided to prospective investors in 2017. As a part of its settlement with the OSC, NextBlock agreed to pay an administrative penalty of $700,000 plus costs of $100,000. Additionally, the promoter agreed to pay an administrative penalty of $300,000 and voluntarily declined approximately $3 million in carried interest that he was entitled to based on NextBlock’s profits.
- Québec's Tribunal administratif des marchés financiers (“TMF”) determined that USI-Tech Limited (“USI-Tech”), a company purportedly headquartered in Dubai, United Arab Emirates, had conducted an illegal distribution of securities and had engaged in unregistered dealing. USI-Tech offered investors significant returns through Bitcoin trading and a crypto-token. The TMF ordered, among other things, that USI-Tech be prohibited from engaging in any activity with respect to transactions in securities. The OSC issued an inter-jurisdictional order to enforce the TMF’s order.
- The OSC settled with CoinLaunch Corp., a firm that operated in the crypto-asset sector, for engaging in and holding itself out as engaging in the business of trading in securities without registration. CoinLaunch agreed to wind down its operations and pay an administrative penalty of CAD $30,000 and disgorge CAD $12,223.06. Its CEO also agreed not to become or act as a director or officer of any company which engages in or holds itself out as engaging in trading securities, without the applicable registration or an exemption under Ontario securities law.
- The SEC commenced an enforcement action against Ontario-based Kik Interactive Inc. for what it alleges was an illegal USD$100 million initial coin offering in 2017.
- Greece agreed to extradite a Russian citizen Alexander Vinnik to France, who US authorities claim was the mastermind of a $4 billion Bitcoin laundering ring through the BTC-e cryptocurrency exchange.
- The SEC settled with Blockchain of Things Inc. (“BCOT”) for launching an initial coin offering in 2017 without registering with the SEC. BCOT agreed to pay $250,000 and refund investors who notify the firm they want their money back. Notably, BCOT will register its tokens as securities and file periodic reports with the SEC.
9. CRYPTOCURRENCY CIVIL LITIGATION
As in prior years, civil lawsuits continued to be filed in the US against individuals and companies associated with cryptocurrency issuers, their directors and officers, major shareholders and payment processors. This year’s lawsuits included a wide range of legal theories such as (i) the unregistered offer and sale of securities; (ii) unfair, deceptive, untrue or misleading acts; (iii) manipulation of the bitcoin spot and bitcoin derivatives markets; and (iv) the negligent promotion of a crypto-exchange where crypto-assets went missing.
WHAT TO WATCH FOR IN 2020
1. GLOBAL DEVELOPMENTS
- Financial Stability Board 2020 priorities. On December 17, 2019, the Finacial Stability Board (the "FSB") published its work programme for 2020, which sets out its policy priorities. These priorities “reflect the evolving nature of the global financial system and associated risks to financial stability”, the FSB said. Fintech is at the top of the list. The FSB will continue to monitor financial innovation developments and assess their potential implications for financial stability. Complementing its December 9th report on BigTech in finance, the FSB will report on the perspectives of emerging markets and developing economies on this topic.
- As a second priority, the FSB will take stock of the range of practices related to the use of RegTech and SupTech. This aligns with a report that is due to be issued by the International Financial Consumer Protection Organisation (FinCoNet) in 2020 on the topic of SupTech.
- A deeper focus on the introduction of global “stablecoins” ranks third among the FSB priorities. It intends to conduct a public consultation on addressing regulatory issues related to stablecoins in April.
- Cross-border payments come in as the fourth priority. In coordination with the Committee on Payments and Market Infrastructures and other relevant international organisations and standard-setting bodies, the FSB will develop and deliver to the G20 Saudi Arabian Presidency a roadmap on how to enhance global cross-border payments.
- Based on its position that LIBOR poses a continued risk to financial stability, the FSB will take stock of the implementation of benchmark reforms and report on the remaining challenges to benchmark transitions. This is intended to help improve understanding and increase awareness of the importance of ensuring a transition by the end of 2021.
2. FEDERAL DEVELOPMENTS
- Dealers in virtual currency can now voluntarily register with FINTRAC and are required to register by June 1, 2020.
- The report of the Advisory Committee on Open Banking is expected to be delivered in 2020.
- As noted above, the Payments Canada modernization initiative will continue with the anticipated launch of the Real-Time Rail expected to occur in 2020.
- Draft legislation implementing the much anticipated proposed federal retail payments oversight framework regulating payment service providers is expected to be issued in 2020.
3. PROVINCIAL DEVELOPMENTS
- In Ontario, FSRA will complete its first full year in existence. FSRA’s goal is to be a modern, dynamic regulator responding rapidly to changes in the financial services marketplace, promoting financial services products and regulatory innovation through its Innovation Office and protecting the public interest.
- The new BCFSA is expected to launch in 2020. It will be a Crown agency, with the goal of regulatory financial services in a more transparent and independent manner.
For more information about our firm’s Fintech expertise, please see our Fintech group’s page.
 The FATF is an intergovernmental policy-making body (of which Canada is a member) that sets standards and promotes the implementation of legal, regulatory, and operational measures to combat threats to the integrity of the international financial system.
 The Digital ID & Authentication Council of Canada is a non-profit coalition of public and private sector leaders committed to developing a Canadian digital identification and authentication framework to enable Canada’s full and secure participation in the global digital economy.
 Autorité des marchés financiers c Usi-Tech Limited, 2018 QCTMF 24. The TMF made a minor amendment to the decision on March 19, 2018, to correct the name of a respondent.
 A class action lawsuit was filed against Ripple by investors claiming they lost money after Ripple induced them to buy XRP, a cryptocurrency that is integral to the company's business operations. The lawsuit seeks unspecified damages and a declaration that XRP is a security. See https://fortune.com/2019/09/20/ripple-xrp-securities-lawsuit/.
 A lawsuit alleges that cryptocurrency exchange Bitfinex and its sister company Tether manipulated the digital currency market and “engaged in unfair, deceptive, untrue or misleading acts” by failing to disclose that Tether was not backed 1:1 to by the US dollar. The plaintiffs, cryptocurrency traders estimate the damages at more than $1 trillion. See https://thenextweb.com/hardfork/2019/10/08/class-action-lawsuit-alleges-bitfinex-tether-cost-cryptocurrency-market-1-4t/.
 A class-action suit was filed against cryptocurrency derivatives exchange FTX, partner firm Alameda Research and several associated individuals alleging they are, “well known among cryptocurrency traders for being principal manipulators of the Bitcoin spot and Bitcoin derivatives markets.” See https://www.crowdfundinsider.com/2019/11/153707-class-action-suit-launched-alleging-market-manipulation-in-crypto-targets-alameda-research-ftx-trading/.
 A class action lawsuit was filed against U.S.-based blockchain developers and cryptocurrency issuer Nano f/k/a RaiBlocks alleging unregistered offer and sale of securities (XRB) and inducing investors to open accounts and stake their assets at small Italian cryptocurrency exchange BitGrail, where $170 million of XRB were declared “missing” in February 2018. See https://www.silvermillerlaw.com/wp-content/uploads/2019/01/2019-1-3-Dkt.-No.-1-CLASS-ACTION-COMPLAINT.pdf.