Prudential treatment of crypto-assets: a new exposure class in the making?

Currently, EU capital adequacy regulations do not include provisions specific to crypto-assets. Regulators worldwide are assessing how banks are dealing with their exposures to crypto-assets in different jurisdictions and contemplating creating a new exposure-class for crypto-assets.

What is the current EU regime?

Basel III does not provide for a separate exposure class for crypto-assets, but it sets out minimum requirements for the capital and liquidity treatment of “other assets”. Similarly, Article 147 of the Capital Requirements Regulation, which provides the methodology for banks to assign their exposures to asset classes does not provide for a crypto-assets class. Instead it provides for a wide and inclusive definition of “other non-credit obligation assets”.

Is this good enough?

The existing exposure classes were determined by the Basel Committee on Banking Supervision (BCBS) almost a decade ago and remain largely unchanged (with a few additions made in December 2017).

With the growing prominence of crypto-assets in the financial world, it seems that regulators are querying whether the current regime is adequate to reflect the specific risks of exposures to crypto-assets.

What approach are different regulators taking?

• FSB (Global): The FSB in its Report to the G20 on crypto-assets (July 2018) announced that it is conducting research on how its members treat exposures to crypto-assets at a national level.
• BCBS (Global): At the same time, the BCBS is carrying out an extensive quantitative analysis of the materiality of banks’ direct and indirect exposures to crypto-assets. Based on its research, the BCBS says it will consider providing clarification of the prudential treatment of crypto-assets under Pillar I (credit risk, counterparty credit risk, market risk and operational risk).
• European Parliament (EU): The European Parliament has issued two reports on crypto-asset regulation generally, one of which highlights the prudential risks and opportunities that fintech presents for incumbent banks.
• PRA (UK): Recently the PRA adopted a similar approach in its letter to CEOs of PRA-regulated firms (banks, investment firms and insurers) on existing or planned exposures to crypto-assets. The letter stated that “crypto-assets represent a new, evolving asset class”, and classification “will depend on the precise features of the asset”, presumably because “crypto-assets” cover a wide range of products (from tokens or securities represented on distributed ledgers to cryptocurrency).
• Consistent with the BCBS’ earlier statements, the PRA clarified that crypto-assets should not be treated as currency for prudential purposes.
• Finally, the PRA required firms to include any risks from crypto-assets in their internal capital adequacy assessment process (ICAAP) and hinted on more guidance to come, including measures under Pillar II (which means discretionary supervisory measures and could include additional capital charges).

What’s happening next?

We are expecting regulators to publish more guidance over the next months on the prudential regulatory treatment of crypto-assets and will keep you updated with any developments.