The Global Financial Markets Association, the Futures Industry Association, the Institute of International Finance, the International Swaps and Derivatives Association, the International Securities Lending Association, the Bank Policy Institute, the International Capital Markets Association, and the Financial Services Forum responded to the Basel Committee on Banking Supervision’s second consultative document on the “Prudential treatment of crypto asset exposures”.
Since the first consultation, the Basel Committee designing a prudential framework for crypto assets that is risk sensitive, including the creation of a Group 2a crypto asset category, and the partial recognition of hedging for and the use of modified versions of the standardized capital approaches for that category.
The associations also identified some features and calibrations that individually and collectively would meaningfully reduce banks’ ability to—and in some cases effectively preclude banks from—utilizing the benefits of distributed ledger technology (DLT) to perform certain traditional banking, financial intermediation and other financial functions more efficiently.
Bringing crypto asset-related activities into the prudential regulatory perimeter would (1) garner the benefits of the operational risk management and operational resiliency of banks and (2) enhance customer protection due to the existing frameworks for claims against banks and their regulated affiliates, in the unlikely event of bankruptcy or insolvency.
There are a range of issues that the associations have asked the Basel Committee to address. Among them, two could have a gating effect, the associations wrote: (1) the design and calibration of the Group 2 exposure limit and (2) the proposed infrastructure risk add-on for Group 1 crypto assets. If these issues are not addressed in whole, it may not be economically viable and rational to make the investments necessary to facilitate clients’ needs on crypto asset-related activities, which likely would result in a shift of activity in this space to the nonbank sector.
While a 2.5% risk-weighted asset (RWA) increase may not sound material, the overall position of banks trying to lessen RWA constraints combined with significant build expense would make the decision to engage in DLT infrastructure unattractive.
This result also could derail the market and associated regulatory innovation via the introduction of regulatory sandboxes in a few jurisdictions starting in Q1 2023, whereby banks would need to justify additional capital requirements that would result from participation.
Therefore, to avoid an effective preclusion on banks participating and developing in these markets, the associations underscored their view that the Basel Committee should address these two issues.
Among the recommendations, the joint letter noted that Group 2 crypto assets exposure limit is prohibitive and should be recalibrated and calculated on a net, rather than double-gross, basis; and that the infrastructure risk add-on is unnecessary and seeks to address risks that are already adressed by the existing prudential framework and risk management systems.
The associations also chimed in on under what conditions crypto assets should be designated as eligible financial collateral. From the report: “The Second Consultation summarizes the current framework for identifying eligible financial collateral, the preconditions for which are ‘whether the collateral can be liquidated promptly and legal certainty requirements.’ As this eligibility framework has been used to determine the current list of eligible financial collateral, it should also be used when evaluating crypto assets.”