Crypto Exposure Criteria Perspectives and Events Finalized by the Basel Committee

On December 16, 2022, the Basel Committee on Banking Supervision (“Basel Committee” or “BCBS”) will finalize standards for banks to monitor and manage their exposure to crypto assets (the “Crypto Standards”). did.¹ The Crypto Standards amend the Basel Committee’s overarching framework for prudential regulation to regulate the prudentiality of banks’ exposure to crypto assets.

Although the Crypto Standard will take effect immediately, it is not legally enforceable per se, so the Basel Committee has asked national regulators to implement it by January 1, 2025. This legal update will review the Basel Committee’s changes to draft Crypto Standards and discuss what the industry can expect next.

Background

The Basel Committee is a group of dozens of central banks and banking supervisors that set standards for bank prudential regulation and provide a regular forum for cooperation on banking supervision issues. The Basel Committee’s standards are not legally enforceable but must be adopted by its members (i.e. national regulators) or replaced by applicable legal requirements within a particular jurisdiction. Over the years, the Basel Committee has promulgated and revised standards on capital and liquidity requirements for banking organizations (in addition to other prudential standards). The last major revision was made in 2017.²

In June 2021, the Basel Committee published a public consultation. Careful handling of crypto asset exposures We focused on the emergence of crypto-assets as a new asset class that poses unique risks to banks.³ This proposal was moderately amended through subsequent consultations in June 2022.^Four

The proposal and final crypto standard divide crypto-assets into two groups, each with two subgroups (i.e. groups 1a and 1b, and 2a and 2b). Group 1 includes less volatile crypto-assets that are either (a) tokenized traditional assets or (b) with effective stabilization mechanisms. Group 2 assets are also divided into two subgroups. (a) where a limited degree of hedging is permitted; and (b) where no hedge is recognised.

As explained in our previous Legal Update and our June 2022 Proposal, the Crypto Standard also includes provisions to address infrastructure risk add-ons. reimbursement risk testing and supervisory/regulatory requirements; exposure limits for Group 2 exposures; An explanation of how operational risk, liquidity, leverage ratios, and wholesale exposure requirements apply to banks’ crypto exposures. supervisory review process; and disclosure requirements.

Changes from the June 2021 release

The Crypto Standard comprises a new chapter of the Basel Committee Framework for Bank Prudential Regulation, with over 130 sections, addressing the application of most types of prudential standards to crypto assets. . Crypto Standard has largely tracked his June 2021 proposal, which was amended in June 2022, with some changes during the finalization process. These changes are:

1. Infrastructure Risk Add-on. In its June 2022 proposal, the Basel Committee included a fixed add-on to risk-weighted assets set at 2.5% of the exposure value of all Group 1 crypto assets. In the crypto standard, the Basel Committee replaced this with a more flexible approach, allowing national regulators to initiate and increase add-ons based on observed weaknesses in the underlying infrastructure of a given crypto asset. .
2. Basis risk tests, reimbursement risk tests, and supervisory/regulatory requirements. The June 2022 proposal included a requirement that cryptoassets with stabilization mechanisms pass the redemption risk test and the basis risk test. The purpose of the redemption risk test is to ensure that there is sufficient reserve capital to allow the cryptocurrency to be redeemed at all times, including during periods of extreme stress, at a fixed amount. A quantitative test based on the market value of a crypto-asset, the basis risk test was intended to ensure that the crypto-asset owner could sell in the market for an amount that closely tracks the peg value. The Basel Committee has stated in the Crypto Standard that supervisory/regulatory requirements should be applied in addition to the requirement to pass the reimbursement risk test. Additionally, for crypto-assets pegged to one or more currencies, the redemption risk test will now also include a requirement that reserves must consist of assets with minimal market and credit risk. became. However, after deliberating on the advantages of these different approaches, the Basel Committee decided not to implement a basis risk test in the cryptographic standard.
3. Group 2 exposure limit. The Crypto Standard retains the proposed requirement that banks keep their total exposure to Group 2 crypto assets below the threshold of 1% of Tier 1 capital, but with certain changes. In the first amendment, as proposed in the June 2022 Proposal, the exposure will be the higher of the gross long and gross short positions in each crypto asset, rather than the sum of the absolute values ​​of the long and short exposures. It is measured as The second amendment relates to the capital consequences of limit violations and is intended to mitigate the cliff effect of violations (e.g. apply punitive measures only to amounts exceeding the 1% limit). .
4. Responsibility for evaluating classification criteria. The June 2022 proposal would have required banks to assess crypto-assets against classification criteria and seek prior supervisory approval to finalize classification. The Crypto Standard will revise the process to remove the supervisory pre-approval element. Instead, banks must notify regulators of their classification decisions, and national regulators have the power to override these decisions if they disagree with a bank’s assessment.
5. Assets under custody. Respondents to the June 2022 proposal expressed concerns about the application of standards related to client assets for which banks act as custodians. As this was clearly not the intention of the Basel Committee, the Crypto Standard was revised to clarify which elements apply to custody services provided by banks.

Although the Crypto Standard is a final standard, it indicates that some issues are under consideration by the Basel Committee. These include treating permissionless blockchains as Group 1 assets, appropriate statistical testing to reliably identify low-risk stablecoins, and adjusting Group 2 exposure limits.

Industry impact

The Basel Committee indicated in the Crypto Standard that it intends to closely monitor its implementation and will likely make additional refinements and clarifications over time. On the one hand, this can be seen as a positive development, as some aspects of cryptographic standards are highly prescriptive and subject to change as technology develops. Unsolicited changes impose a heavy burden on banks and should be avoided whenever possible. Overall, this open-mindedness is probably a good position for the Basel Committee to take due to the evolving nature of crypto-assets and the risks presented.

As discussed in relation to the Basel Committee’s Climate Risk Management Principles, the Crypto Standard has no legal effect in the United States. Crypto Standard included in pending Basel endgame rulemaking being considered by U.S. regulators (i.e., the process of incorporating the Basel Committee’s 2017 amendments to general capital requirements into U.S. regulation) It is unclear whether and how the recent discovery of negligence will take place. The management of cryptocurrency companies influences the regulation of banks’ crypto exposure. Given the pressing need to adopt the Basel endgame, US regulators are expected to delay his response to cryptocurrency standards until 2023 and beyond.

additional authors Dean A. Corrado

¹ BCBS, Careful handling of crypto asset exposures (16 December 2022), https://www.bis.org/bcbs/publ/d545.htm.

² BCBS, Governors and Supervisors Finalize Basel III Reforms (December 7, 2017).

³ BCBS, Careful handling of crypto asset exposures (10 June 2021), https://www.bis.org/bcbs/publ/d519.htm.

^Four BCBS, Careful Handling of Crypto Asset Exposures – 2nd Consultation (30 June 2022), https://www.bis.org/bcbs/publ/d533.htm.