Existing UK and EU capital requirements on cryptoasset exposures will soon be updated to reflect the new international standard published by the Basel Committee on Banking Supervision (BCBS).
First published in Butterworths Journal of International Banking and Financial Law, May 2023.
The BCBS published its new standard on the prudential treatment of cryptoasset exposures on 16 December 2022 (BCBS Standard). The BCBS Standard is not legally binding but provides a harmonised international regulatory and supervisory approach to be implemented across the globe, including in the UK and the EU, with an implementation deadline of 1 January 2025. The BCBS Standard is broad and the definition of a “cryptoasset” covers a wide range of digital assets, including tokenised securities, stablecoins and unbacked cryptoassets but excludes central bank digital currencies (CBDCs). The BCBS Standard broadly distinguishes between tokenised traditional assets and stablecoins that meet certain classification conditions (Group 1 cryptoassets) and all other cryptoassets, including unbacked cryptoassets (Group 2 cryptoassets). The prudential treatment of cryptoassets as set out in the BCBS Standard continues to approach the prudential treatment of tokenised securities in the same way as traditional securities but introduces a very conservative approach for unbacked cryptoassets and stablecoins with ineffective stabilisation mechanisms. This conservative approach is likely to discourage banks’ activities in respect of these assets. Group 1 cryptoassets are subject to the existing capital requirements for traditional assets based on the risk weights of underlying exposures, with the exception of stablecoins which need to meet a redemption risk test and a supervision/regulation requirement in order to fall within the Group 1 cryptoasset perimeter. Group 2 cryptoassets are subject to a more conservative capital treatment (a risk weight of 1250%) with further nuances introduced depending on whether these cryptoassets are hedged or unhedged. The BCBS Standard describes how the operational risk, liquidity, leverage ratio and large exposures requirements should be applied in the context of Group 2 cryptoassets and imposes an exposure limit under which Group 2 cryptoassets should not be higher than 1% of the bank’s Tier 1 capital. If the 1% threshold is breached, the excess exposure is subject to further conservative requirements and if the 2% threshold is breached the bank’s entire group exposures are subject to even more conservative requirements. These thresholds are designed to disincentivise significant exposures above 1% and limit the contagion of shocks in the cryptoasset market to banks.
There are currently no specific prudential rules in the UK and the EU dealing with the treatment of cryptoasset exposures. In the UK, the Prudential Regulation Authority (PRA) indicated in its 2022 CEO Letter to the banks (PRA Letter) that until a specific framework for cryptoasset exposures is introduced, a combination of strong risk controls, operational risk assessments, robust new product approval processes, Pillar 1, Pillar 2, and ongoing monitoring arrangements should provide appropriate interim treatment. We expect the PRA to consult on new rules governing the treatment of cryptoasset exposures based on the BCBS Standard shortly, although the precise timing remains to be seen. In the EU, on 15 February 2023, the European Central Bank published a statement that the next step for the EU will be to transpose the BCBS Standard. In the interim, the European Banking Authority has indicated that firms and regulators need to rely on first principles and the wider prudential framework and should adopt a conservative approach to the treatment of cryptoasset exposures in Pillar 1, supplemented by Pillar 2 requirements if necessary. The EU is also expected to put in place interim conservative rules addressing the prudential treatment of cryptoassets that will be effective until the end of 2024 (one day before the implementation date of the BCBS Standard). In particular, the latest version of the Capital Requirements Regulation 3 Proposal (the CRR 3 Proposal) requires that cryptoassets are assigned a 1250% risk-weight and additional liquidity and disclosure requirements are introduced for this interim period until the implementation of the BCBS Standard. The CRR 3 Proposal does not currently define “cryptoassets”, and thereforefurther clarification will be required before this proposal applies to banks. EU transposition of the BCBS Standard also complements the Markets in Cryptoassets Regulation (MiCA) which is expected to come into force in 2023. MiCA sets additional capital requirements for cryptoasset service providers (rather than asset exposures), and therefore some banks may need to comply with both the cryptoasset prudential regime under CRR 3 and MiCA.