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Stock-trading policy change looms over cannabis industry

Medical marijuana plants are pictured in this file photo.

Dave Chan/The Globe and Mail

A company owned by Canada's major stock-exchange operator is considering a move that would make it difficult for investors to trade the shares of cannabis companies with U.S. assets, potentially disrupting the flow of millions of dollars into the burgeoning marijuana industry.

The company, Canadian Depository for Securities Ltd. (CDS), is a clearing house involved in millions of trades a day. It performs critical back-office functions in the capital markets and ensures that when investors make trades, the cash and securities wind up in the right hands. Sources say that CDS is contemplating a policy shift that would see it refuse to settle trades in a small group of cannabis firms with American investments.

CDS is owned by TMX Group Ltd., which runs the Toronto Stock Exchange as well as other venues in which investors exchange financial assets. The Canadian markets have become a magnet for investors looking to cash in on the liberalization of marijuana laws in Canada, where legalization is set to take place next year, and in some U.S. states. Dozens of players in the pot industry have gone public on Canadian exchanges; the largest, Smiths Falls, Ont.-based Canopy Growth Corp., has a stock-market value of $1.5-billion.

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But amid the frenzy of activity, there is growing concern about companies that are raising capital in Canada, but conducting business in the United States. That's because while cannabis has become legal in recent years for medical or recreational purposes in more than two dozen states, growing and selling pot violates federal law in the United States. That tension between federal and state statutes has long existed, but the administration of U.S. President Donald Trump has hinted that it could start to more strictly enforce federal laws, even in states where weed is legal in some form.

Against that backdrop, TMX Group is in the process of assessing the potential liability it or any of its subsidiaries could face by facilitating transactions in shares of marijuana companies whose operations may fall into a legal grey zone. The situation illustrates the morass that governments, regulatory bodies and corporations must navigate as Canada moves toward expected legalization next summer. While Ottawa has set out the broad rules under which people will be able to grow and possess the drug, there is still a thicket of regulation to be worked out – from how and where marijuana will be sold to the rules that will govern the companies that supply it.

If CDS were to decide that it will not handle trades in those stocks, it would have major implications for a marijuana industry that has raised hundreds of millions of dollars from investors in the Canadian market.

There are cannabis companies with U.S. assets listed today on two exchanges operated by TMX Group – the Toronto Stock Exchange and the TSX Venture Exchange – and on a lesser-known rival called the Canadian Securities Exchange. A ban by CDS could put future trading of these stocks in jeopardy, at least for a while, and make it difficult for those firms to raise money.

If CDS makes that decision, "we're going to have to find some other way for providing for clearing and settlement if we're going to continue to trade those securities," said Richard Carleton, the chief executive officer at the CSE. "And it's not immediately obvious how that would happen."

It is still uncertain whether TMX will decide to do that; it's not even clear whether CDS, which is highly regulated, has the authority to do so. But the option is, indeed, one alternative being considered as the discussion rages on at TMX and the securities regulators.

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"We are monitoring ongoing developments in the marijuana industry," a spokesman for CDS said in an e-mailed statement. "Consistent with how CDS approaches issues affecting any industry, this monitoring process includes considering the potential effects these developments may have on CDS and its participants, as well as the public interest."

Separately, TMX is also working on a policy on how it will handle U.S.-linked cannabis companies that want to list on its two exchanges, which could include a future ban on such listings. Recent media reports have described a recent, though unwritten and unconfirmed, shift in policy at TMX to freeze new listings from pot companies with U.S. ties, raising the level of uncertainty in the sector for investors and issuers.

On behalf of the provincial securities commissions, the Canadian Securities Administrators (CSA) declined to respond to questions about the possibility of CDS banning these cannabis stocks from its platform, whether CDS would be allowed to do so and what would happen if this occurred.

"With regards to media reports you've seen concerning the listing of issuers in the cannabis sector with U.S. assets, the CSA, as oversight regulatory authorities of market structures, is having discussions and is engaging with the exchanges on this complex topic," Louis Morisset, chair of the CSA, said in a statement sent through a spokesman.

A number of the companies that have been turned away by TMX have shown up on the doorstep of the much smaller Canadian Securities Exchange, Mr. Carleton said.

Forty-six of the CSE's 301 listings are cannabis companies. The pot stocks have a combined market capitalization of $1.8-billion, which is 44 per cent of the total market cap of all the stocks listed on the CSE. So far in 2017, 52 per cent of the total volume traded on the exchange has been in cannabis stocks.

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Ten of the 46 stocks have exposure to the U.S. market. Mr. Carleton said there are more that want to list on the CSE in the future. But the prospect of a ban by CDS would throw a wrench into those plans.

"If that's the way we go, there's no precedent. That's what I have been thinking about at 3 o'clock in the morning. What do we do? How do we do it?" he said.

"If companies with exposure to the U.S. cannabis industry have to be backed out of the [CDS] system, they become extraordinarily hard for the brokers to deal with. Most brokers, I would guess, except maybe for a large institutional client, would simply not permit their clients to trade them."

There are 23 TSX and TSXV issuers in the cannabis business, with a total market value of $5.2-billion as of June 30. Most are involved in medical marijuana. Although many of the companies are small, there are some sizable players, such as Aphria Inc., a company with a market cap of $873-million that has investments in Arizona and Florida.

Mr. Carleton, who is a director of CDS, said the board hasn't had any formal discussions about the matter to date. At the CDS's last board meeting in May, he said it was mentioned that management was reviewing and a recommendation would be brought forward for the board to likely vote on it.

In July, he said, the Ontario Securities Commission contacted the CSE to ask about its policies for how cannabis companies were disclosing potential legal risks to investors and if it had any contingency plans in the event that CDS disqualifies these securities from its platform.

At this point, Mr. Carleton says the CSE has mulled several alternatives, including a workaround that would allow the CSE to clear and settle trades in these stocks in the United States instead of in Canada, or setting up its own clearing house.

"That's a big project and we're still a small organization," he said. "We've been gaming all sorts of potential responses if we have to go down this road."

Andrew Willis: Why you shouldn't buy into the pot boom and bust (The Globe and Mail)
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About the Author
Capital Markets Reporter

Christina Pellegrini is a reporter at The Globe and Mail and a regular contributor to Streetwise, covering capital markets, the exchange business and market structure.She writes about the capital markets divisions of BMO, CIBC and National Bank; independent brokerages such as Canaccord Genuity; and the Canadian operations of foreign dealers including JP Morgan, Goldman Sachs, Credit Suisse and Citigroup. More

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