Current Status of Cryptoassets Regulation for EU Banks
BCBS believes that the lack of standardization, the fast growth and high volatility of crypto-assets justify a global prudential standard.
The Basel Committee on Banking Supervision (BCBS) published a discussion paper on “Designing a prudential treatment for cryptoassets” in December 2019.¹ In this paper, the BCBS discusses the design of a prudential framework for cryptoassets by first attempting to classify them based on their economic function and potential sources of value. In a second step, the Committee discusses possible capital and liquidity requirements for banks with cryptoasset exposure.
In the discussion paper, the BCBS points out that cryptoassets entail specific risks in addition to traditional risks, such as liquidity, credit, market, compliance, reputational and operational risks. The Committee also lists all possible ways in which the Bank may be exposed to these specific risks.
Crypto-Asset Definition as the Foundation for Regulation
According to the BCBS, the current definition of cryptoassets is too general to establish specific requirements for them. In addition, it has been recognized that certain cryptoassets are similar to existing asset classes (e.g. tokenization of equity or debt) and derive their value from sources similar to traditional asset classes (cash flows or use of services or platforms) and may also be limited in supply. The Committee considers the following general principles in this regard:
- “Same risk, same activity, same treatment”
- Minimum standards
According to the Basel Committee, “high-risk” cryptoassets have no intrinsic value, are digitally, cryptographically secured and recorded. This definition covers bitcoin, ether and other similar cryptoassets, each of which provides for a full capital deduction as capital requirements for claims in the banking book. This corresponds to a risk weighting factor of 1250%, which is the highest possible factor applied only to the worst externally rated securitizations). As an example, a risk position of EUR 1,000 can be taken, which is multiplied by the risk weighting factor 1250%, resulting in risk weighted assets (RWA) of EUR 12,500. This position multiplied by the required equity capital of 8% results in EUR 1,000 additional required capital, which corresponds to a full deduction of the corresponding position.
Crypto-Assets in the Trading Book
Cryptoassets held in the trading book would also be subject to the equivalent full deduction treatment for market risk and Credit Valuation Adjustment risk (CVA). Exposures with residual risk would be subject to the appropriate add-on. Furthermore, banks would not be permitted to use internal modelling approaches for cryptoassets. Moreover, cryptoassets would not be permitted as financial collateral for the credit risk mitigation framework and would not be permitted as highly liquid assets for the Liquidity Coverage Ratio (LCR) or Net Stable Funding Ratio (NSFR). However, cryptoassets would be included in the core Leverage Ratio Exposure and thus form part of the Leverage Ratio (LR) numerator.
Pillar II-approach for Crypto-Assets
With regard to Pillar II and Pillar II requirements, the BCBS refers to its Report of March 2019, in which it specified the expectations for banks holding cryptoassets or providing related services.² The Bank is expected to have the necessary expertise to assess cryptoasset risks by implementing a robust governance and risk management framework for cryptoassets and integrating it into the overall risk management process. Also, as part of regular financial disclosure, material cryptoasset exposures or related services, regulatory information on current or planned cryptoasset exposures or activities should be reported.
The European Banking Authority (EBA) commented on cryptoassets in a report dated 9 January 2019 and is also prepared to provide the European Commission with further advice once the BCBS discussion paper has been finalized.³ In the meantime, the EBA will also consider whether support is needed to support a common application of the current rules of the Capital Requirements Directive (CRD) and the Capital Requirements Regulation (CRR). The EBA notes that no supervisor currently applies a specific Pillar II treatment to cryptoassets. However, as part of the Supervisory Review and Evaluation Process (SREP), the relevant supervisors will need to assess whether the arrangements, strategies, processes and mechanisms implemented by the institutions and the capital and liquidity held by them are adequate. Institutions should ensure sound risk management and coverage of risks arising from the activities of institutions, including other business activities (e.g. cryptoassets). Where the supervisory authorities do not consider the provisions and precautions to be sufficiently implemented, the authorities may impose additional capital requirements under Pillar II (Art. 104 CRD).
Crypto-Assets as Client Deposits
Currently, cryptoassets classified as client assets are held by institutions as off-balance sheet items. In the absence of regulation, it appears necessary to clarify the appropriate accounting treatment of cryptoassets. The EBA also notes that there is no absolute clarity at both national and international level on accounting standards bodies as to whether the ownership of cryptoassets should become an intangible asset. Furthermore, this lack of clarity regarding the accounting treatment raises questions about the regulatory treatment under current EU law (CRD / CRR). Clarification of treatment at the international level is urgently needed to avoid the emergence of divergent treatment approaches at the national level, which would undermine the level playing field between Member States.
It can be stated that there is currently a lack of clarity in the EU regarding the treatment of cryptoassets, as these are still considered unregulated and, accordingly, at least client assets can be managed as off-balance sheet items. The BCBS’s initiative to draft a global supervisory standard for the treatment of cryptoassets is very welcome, but a more specific consultation paper should be published in the near future to provide more regulatory clarity and legal certainty to institutions with cryptoasset activities. This should show whether the EBA’s advice on the inclusion of Pillar II capital requirements will be taken into account or whether only the less flexible Pillar I approach to capital requirements for cryptoassets will be applied.
- BCBS Discussion paper — Designing a prudential treatment for cryptoassets — Issued for comment by 13 March 2020 — December 2019
- BCBS Statement on crypto-assets — 13 March 2019
- EBA Report with advice for the European Commisson on crypto-assets — 9 January 2019