On 10 June 2021, global standard setter the Basel Committee on Banking Supervision (“BCBS”) published a consultation on the prudential treatment of banks’ cryptoasset exposures, with comments to be submitted by 10 September 2021. This anticipated consultation follows earlier international and domestic statements on this topic, including the Financial Stability Board’s Report to the G20 in July 2018 and a Dear CEO Letter from the Prudential Regulation Authority to UK banks, insurance companies and designated investment firms in June 2018.
Among other things, the BCBS is proposing a new conservative prudential treatment for certain high-risk cryptoassets such as bitcoin, which would mean they carry a high capital charge that may in practice disincentivise investment, and new disclosure requirements for cryptoasset exposures. The BCBS makes it clear that its proposals would represent a minimum standard and jurisdictions would be free to apply additional and more conservative measures if thought appropriate (such as banning cryptoasset exposures altogether).
The proposed prudential treatment divides cryptoassets into two broad groups, recognising their inherent difference in risk and proposing that banks are responsible for monitoring compliance with the classification conditions on an ongoing basis.
Group 1 cryptoassets: this group includes tokenised traditional assets (i.e. digital representations of traditional assets using cryptography, distributed ledger technology or similar) and stablecoins that meet stringent classification conditions. Group 1 cryptoassets would be eligible for treatment under the existing Basel Framework, with some modifications and additional guidance.
Group 2 cryptoassets: this group includes cryptoassets that do not fulfil the Group 1 cryptoasset classification conditions (e.g. bitcoin) and that have not already been deducted from Common Equity Tier 1 capital (e.g. cryptoassets classified as intangibles for accounting purposes). Owing to the unique risks posed by Group 2 cryptoassets, the proposed prudential treatment in relation to credit and market risk requirements is based on a 1,250% risk weight applied to the greater of the absolute value of the aggregate long positions and the absolute value of the aggregate short positions to which the bank is exposed. In practice, this would mean banks would need capital of at least equal value to their exposures to Group 2 cryptoassets. Funds of Group 2 cryptoassets must also be treated under this category. For derivatives of Group 2 cryptoassets, the ‘absolute value’ would be the value of the underlying cryptoassets.
Further detail on market and credit risk and on counterparty credit risk is set out in the consultation. At this stage, the BCBS is not proposing to prescribe any new regulatory treatment for either Group 1 or Group 2 cryptoassets under the leverage ratio, large exposures framework, or liquidity coverage ratio (“LCR”) requirements, although at this time the BCBS is of the view that all cryptoassets would not qualify as high-quality liquid assets for LCR purposes. An interesting omission from the consultation is the treatment of Central Bank Digital Currencies, which we would expect to be subject to a more favourable prudential treatment.
The UK is a member of the BCBS and so in due course any adjustments to the Basel Framework should be implemented through changes to the UK’s Capital Requirements Regulation. Forthcoming changes to the UK’s prudential regime for investment firms should not affect the application of the new BCBS treatment to investment firms’ cryptoasset exposures, because under the current proposals certain parts of the UK CRR will continue to apply.
Co-authored by Alexander Parkin