On June 10, 2021, the Basel Committee on Banking Supervision (BCBS) issued a public consultation (2021 Consultation) on preliminary proposals for the prudential treatment of bank cryptoasset exposures. This document builds on the contents of a 2019 BCBS discussion paper (2019 Paper) and responses received to the 2019 Paper from a broad range of stakeholders, as well as on certain ongoing cryptoasset initiatives undertaken by the international community (see Legal Update, BCBS Discussion Paper on Prudential Regulatory Treatment of Cryptoassets).

BCBS notes that bank exposure to cryptoassets is currently limited. BCBS further observes that the continued growth and innovation in cryptoassets and related services, coupled with the heightened interest of some banks, could raise global financial stability concerns and risks to the banking system in the absence of prudential treatment.

Public comment on the proposals should be uploaded to the BCBS website by September 10, 2021.

The 2021 Consultation states that the prudential treatment of central bank digital currencies (CBDCs) is not within its scope (see Legal Update, Central bank group report on principles and features of central bank digital currencies).

The BCBS divides cryptoassets into two broad groups, Group 1 cryptoassets and Group 2 cryptoassets, based on the degree to which the particular cryptoasset satisfies each of the following four basic principles:

BCBS Group 1 cryptoassets. Group 1 cryptoassets include tokenized traditional assets (Group 1a) and cryptoassets with effective stabilization mechanisms (Group 1b). Group 1 cryptoassets are subject to at least equivalent risk-based capital requirements based on the risk weights of underlying exposures as set out in the existing BCBS capital framework. Cryptoassets that fail to meet any of the BCBS classification conditions for Group 1 cryptoassets will be classified as Group 2 cryptoassets.

BCBS Group 2 cryptoassets. Those cryptoassets that fail to meet all of the classification conditions for Group 1 will fall into Group 2. Group 2 cryptoassets will be subject to a newly prescribed conservative capital treatment set out in Section 3 of the 2021 Consultation, with a risk-weighting of 1,250% applied to the maximum of long and short positions. This risk weighting is required by BCBS because its position is that Group 2 cryptoassets pose additional credit and market risks, as well as other unique risks, as compared with Group 1 cryptoassets. Group 2 includes cryptocurrencies like bitcoin that would be subject to the new conservative prudential treatment with a risk-weighting of 1,250%, due to their unique risks.

Section 2 of the 2021 Consultation describes the minimum BCBS risk-based capital requirements for Group 1 cryptoassets and further divides those cryptoassets into two sub-groups.

Group 1a cryptoassets. These cryptoassets are tokenized traditional assets that fulfill a set of conditions and are eligible for treatment under the existing BCBS risk framework. These tokenized cryptoassets may be treated as equivalent to a traditional asset for the purpose of calculating minimum capital requirements for credit and market risk if they pose the same level of credit and market risk as traditional (non-tokenized) assets.

The following tokenized traditional assets may be treated as equivalent to traditional (non-tokenized) assets if they meet the Group 1 classification conditions:

Group 1b cryptoassets. These certain types of Group 1 cryptoassets may not confer the same level of legal rights as ownership of a traditional asset but may seek to link the value of a cryptoasset to the value of a traditional asset or a pool of traditional assets through a stabilization mechanism. Cryptoassets under this category must be redeemable for underlying traditional assets including cash, bonds, commodities, and equities.

BCBS notes that it cannot set out the capital treatment for every type of cryptoasset structure in Group 1b. BCBS includes two stylized cryptoasset structures as illustrative examples and examines how capital rules would be applied in these cases. As the issues raised in these generic examples are likely to be relevant for many cryptoasset structures, these examples are intended to serve as an indication of the current thinking of BCBS for these types of cryptoassets.

For cryptoassets that confer direct claims on a pool of traditional assets held in a bankruptcy-remote vehicle, BCBS states that if an institution has obtained a legal opinion for all laws relevant to involved parties, including the redeemer, the special purpose vehicle (SPV), and the custodian affirming that relevant courts would recognize underlying assets held in a bankruptcy remote manner as those of the cryptoasset holder, then the credit risk exposure to the bankruptcy remote assets of the redeemer may be set to zero.

BCBS notes that the Equity Investments in Funds (EIF) approach should be applied for cryptoassets with a stabilization mechanism fully collateralized by a pool of traditional assets.

The prudential treatment of cryptoassets set out by BCBS is guided by the following general principles:

Same risk, same activity, same treatment. A cryptoasset that provides equivalent economic function and poses the same risks compared with a "traditional asset" should be subject to the same capital, liquidity, and other requirements as the traditional asset. As a starting point, the BCBS prudential framework would apply the concept of "technology neutrality" and not be designed in a way to explicitly advocate or discourage the use of specific technologies related to cryptoassets. The prudential treatment of cryptoassets should, however, account for any additional risks arising from cryptoasset exposures relative to traditional assets.

Simplicity. BCBS prudential treatment of cryptoassets should be simple since cryptoassets are currently a relatively small asset class for banks. As the market, technologies, and related services of cryptoassets are still evolving:

Minimum standards. Any BCBS-specified prudential treatment of cryptoassets would constitute a minimum standard for internationally active banks. Jurisdictions would be free to apply additional or more conservative measures if warranted or both. As a result, jurisdictions that prohibit their banks from having any exposures to cryptoassets would be deemed compliant with a global prudential standard.

For more information on regulation of digital assets, see Practice Notes:

See also Practical Law's Blockchain Toolkit.