A&O Shearman | FinReg | Final Global Prudential Requirements for Banks' Exposures to Crypto-Assets
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  • Final Global Prudential Requirements for Banks' Exposures to Crypto-Assets

    The Basel Committee on Banking Supervision has published its final bank prudential requirements for exposures to crypto-assets. The Basel Committee consulted on these requirements in 2021 and 2022 and has now set the minimum standards based on the principle of "same risk, same activity, same treatment." These standards will be implemented by January 1, 2025. The Basel Committee has maintained the different prudential approaches depending on whether a crypto-asset meets certain conditions. Crypto-assets that meet all of the conditions are referred to as "Group 1 crypto-assets" and are generally tokenized crypto-assets and stablecoins. Group 2 crypto-assets are all other crypto-assets, which are deemed to present additional and higher risks than Group 1 crypto-assets. The capital requirements for Group 1 crypto-assets will be based on the risk weights for exposures under the existing Basel framework. Exposures to Group 2 crypto-assets will attract a higher capital charge.

    The conditions that crypto-assets must meet to fall within Group 1 for the purpose of a bank's exposure requirements are:
    • The crypto-asset either is a tokenized traditional asset or has a stabilization mechanism that is effective at all times in linking its value to an underlying traditional asset or a pool of traditional assets.
    • All rights, obligations and interests arising from crypto-asset arrangements that meet the condition above are clearly defined and legally enforceable in jurisdictions where the asset is issued and redeemed. In addition, the applicable legal framework(s) ensure(s) settlement finality.
    • The functions of the crypto-asset and the network on which it operates, including the distributed ledger or similar technology on which it is based, are designed and operated to sufficiently mitigate and manage any material risks.
    • Entities that execute redemptions, transfers, storage or settlement finality of the crypto-asset, or manage or invest reserve assets, must be regulated and supervised and have a comprehensive governance framework.

    Banks will need to assess on an ongoing basis whether a particular crypto-asset meets the above conditions and be able to demonstrate that to their regulator. Policies and procedures about the processes used to identify and assess the risks to crypto-assets or related activities must be established.

    The prudential treatment of exposures to Group 1 crypto-assets would be split between tokenized crypto-assets (Group 1a) and stablecoins (Group 1b). Exposures to tokenized crypto-assets could be treated as at least equivalent to those of traditional assets for the purpose of calculating minimum capital requirements for credit and market risk. This would mean the same capital treatment as is applied to bonds, loans, deposits, equities, commodities or cash. A crypto-asset that must first be redeemed or converted into one of these traditional assets to receive the same legal rights as direct ownership of a traditional asset would constitute a stablecoin. For exposures to stablecoins (Group 1b crypto-assets), the Basel Committee has decided not to apply a basis risk test; however, the redemption risk test, which requires that there are sufficient reserve assets so that the crypto-assets are redeemable at all times for the amount to which they are pegged, will continue to apply. Stablecoins would only fall within Group 1 if they were fully reserved at all times, which may increase the onerous monitoring requirements. In addition, a stablecoin would need to be supervised and regulated, including being subject to prudential capital and liquidity requirements. The add-on for infrastructure risk has been maintained for exposures to Group 1 crypto-assets. However, the add-on will not be a fixed 2.5% of all Group 1 crypto-assets.

    Exposures to Group 2 crypto-assets will be subject to a new prudential regime. Group 2 crypto-assets will be split into two categories. The first category, referred to as 2a, will be those that meet a set of hedging criteria and for which restricted hedging will be permitted. No hedging will be permitted for exposures to the second category of Group 2 crypto-assets, referred to as 2b. A bank must keep its aggregate exposures to Group 2 crypto-assets below 1% of its Tier 1 capital. An exposure will be assessed as the higher of the gross long and gross short position in each crypto-asset. This is a change to the proposed aggregate of the absolute values of long and short exposures. If the 1% threshold is breached, the Group 2b capital treatment will apply to the amount by which the limit is exceeded. This replaces the proposal that the Group 2b capital treatment would apply to all Group 2 exposures at the point of breach. However, that treatment will apply if a bank’s exposure exceeds 2% of its Tier 1 capital.

    There are also new requirements for banks to regularly disclose information regarding their crypto-asset exposures, including the application of the existing guiding principles in the Basel Framework and a requirement to disclose the exposure amounts, capital requirements and accounting classification for material exposures. There are specific quantitative disclosure requirements such as the requirement for the value (daily) and composition (weekly) of reserve assets to be publicly disclosed. Banks will also need to disclose an overview of their crypto-asset-related activities and the risks related to their crypto-asset exposures, including risk management principles.

    The Basel Committee intends to monitor the implementation and effects of these new requirements, and notes that changes may be issued over time. The Committee will work further on some specific issues, including:
    • How the risks of crypto-assets that use permissionless blockchains could be mitigated to allow them to be included in Group 1b.
    • The composition of the reserve assets of stablecoins and the use of statistical tests to assess the stability of stablecoins.
    • Whether Group 1b crypto-assets received by a bank as collateral could be regarded as eligible collateral for calculating regulatory capital requirements. This is not the case under the final standard.
    • The hedging criteria and thresholds for Group 2 crypto-assets, and the Group 2 exposure limits.

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