Canada’s Stablecoin Act: overview and implications

The proposed Stablecoin Act introduces a regulatory framework for stablecoins in Canada which aims to strengthen consumer protection, financial stability and market integrity in the rapidly evolving digital asset ecosystem. The proposed legislation attempts to align Canada with other jurisdictions that are regulating—or moving toward regulating—stablecoins as payment instruments.

The proposed framework

The draft legislation proposes the following elements in the Canadian stablecoin framework:

• Registration requirement. Issuers must register with the Bank of Canada and be subject to its oversight.
• 1:1 reserve requirements and composition. Issuers must maintain a reserve of assets with a value that is equal to or greater than the par value of outstanding stablecoins composed exclusively of the reference currency and other high-quality liquid assets.
• Reporting requirements. Issuers must provide monthly reports to the Bank of Canada, in addition to providing incident reports and notice of significant changes.
• Customer protection. Stablecoin reserves must be held by qualified custodians (e.g., financial institutions that meet any requirements provided for in the regulations) in a manner segregated from the assets of the qualified custodian’s and the issuer’s other assets (and protected from creditor claims). In addition, issuers must implement and disclose policies in respect of the governance, risk management, data security and recovery and resolution requirements of their stablecoin arrangement.
• National security review. Applications may also be reviewed and assessed for reasons related to national security.

Exemptions to the Stablecoin Act

A critical feature of the proposed stablecoin legislation (subject to regulations) is that it does not apply to (i) an issuer that is a financial institution (as defined under the Bank Act); (ii) central banks; and (iii) closed-loop stablecoins.

It appears that the legislative intent is to permit federal financial institutions to acquire and hold entities that “issue” stablecoins by virtue of certain cross-references within the proposed legislation to the investment regimes under the Bank Act, the Trust and Loan Companies Act and the Insurance Companies Act, respectively—but further clarity is required to determine the extent to which a financial institution subsidiary can “deal in” stablecoins. Specifically, the proposed Stablecoin Act indicates that the “issuing” of a stablecoin does not constitute dealing in securities for purposes of the general restriction in the Bank Act, the Trust and Loan Companies Act and the Insurance Companies Act which prohibits federal financial institutions from acquiring or holding a non-regulated entity that deals in securities. However, since the proposed Stablecoin Act only refers to the “issuing” of a stablecoin as opposed to “issuing, redeeming and otherwise dealing in” stablecoins, it is not clear whether a stablecoin issuer held by a federal financial institution could redeem stablecoins.

In addition, there is a lack of guidance from certain Canadian regulators regarding their members’ engagement with payment stablecoins. For example, the Office of the Superintendent of Financial Institutions Canada (OSFI) has released guidance relating to the capital and liquidity treatment of crypto-asset exposures for financial institutions; however, OSFI has not provided more general guidance on the extent to which financial institutions may issue or support the transfer, storage, redemption and processing of stablecoins.

What’s not a stablecoin

The proposed legislation also does not permit issuing stablecoins that:

1. pay the holder any form of interest or yield;
2. are legal tender (i.e., it does not apply to central bank digital currencies);
3. are a deposit or proof of a deposit (i.e., it does not apply to digital assets that are tokenized deposits); and
4. are insured under a public deposit insurance system (i.e., insured under the CDIC or another similar government or public backed deposit insurance system).

Regulatory requirements

In addition to the proposed Stablecoin Act, other federal regulatory frameworks will also apply to stablecoin activities in Canada. First, proposed amendments to the Retail Payments Activities Act (Canada) (the RPAA), which were released in tandem with the draft Stablecoin Act in Bill C-15, would expand the definition of “payment function” to include the transmission or maintenance of an end user’s encrypted or tokenized payment instrument or private key. This amendment should therefore bring custodied wallet providers, digital asset custodians and other payment service providers that are involved in stablecoin transactions within the scope of the RPAA: entities engaged in these payment activities would, subject to exemptions, be required to register with the Bank of Canada as payment service providers (PSPs) and comply with RPAA’s requirements, including those relating to risk management, incident response and end-user funds safeguarding.

Second, the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (the PCMLTFA) was amended in 2020 to include the concept of “dealing in virtual currency” as a money services business (MSB) activity. “Virtual currency” is broadly defined in the regulations such that stablecoins would be captured, and those who conduct “virtual currency exchange services” and “virtual currency transfer services” fall within the scope of the MSB category. As such, certain parties that deal with the exchange and transfer of stablecoins will be required to register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) as an MSB, and comply with applicable requirements including maintaining a compliance program and conducting transaction reporting, recordkeeping and know-your-client identification. It remains to be seen whether the PCMLTFA or FINTRAC’s guidance will be amended to provide greater clarity on how know-your-client identification is to be used in the context of tokenized payment instruments such as stablecoins.

Federal/provincial jurisdiction

Although the proposed legislation is an important step in clarifying the regulatory framework applicable to stablecoin activities in Canada, there remain some open questions regarding how the federal and provincial governments will negotiate their regulation.

The Canadian Securities Administrators (CSA) outlined their view that stablecoins (referred to as “value-reference crypto assets” in Canadian securities law discourse) may constitute securities and/or derivatives in CSA Staff Notice 21-332 Crypto Asset Trading Platforms: Pre-Registration Undertakings – Changes to Enhance Canadian Investor Protection. Given the release of the proposed Stablecoin Act, it remains to be seen how Canadian provincial securities regulators will clarify their role in respect of the issuance, distribution, settlement and trading of fiat-backed stablecoins and how the proposed federal Stablecoin Act will interface with Canadian provincial securities laws.

In addition, regulating payments can fall under both federal and provincial jurisdictions, which will also require provincial and federal government coordination.

Implications for financial institutions

In addition to seeking regulatory clarity on the ambiguities identified above, considerations for financial service providers also include establishing what services to provide to payment stablecoin issuers, how to service merchants that accept payment stablecoins, whether to deploy payment stablecoins in their internal and client-facing operations and how to otherwise participate in the transfer, settlement, redemption and custody of payment stablecoins. These considerations will require service providers to develop and deploy technical capabilities and third-party partnerships to develop the infrastructure to operationally support these instruments. Financial institutions will also need to consider carefully the money laundering risks associated with stablecoins and entities in the stablecoin ecosystem—especially the entities that are not MSBs.

Looking ahead

While many of the technical details relating to the proposed Stablecoin Act have yet to be released, the proposed legislation reflects a step forward by the Canadian government. Although the current proposed legislation focuses on fiat-backed payment stablecoins, we expect further developments impacting adjacent areas such as tokenized deposits, custody of reserve assets and on-chain settlement more broadly. These developments are part of a global convergence toward “cash-on-chain” frameworks seen in the U.S., EU and UK.