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The Basel Committee has addressed the issue of crypto-asset risks and defined key guidelines for dealing with this new class of assets in the form of standard d545. While blockchain technology simplifies settlement and clearing processes, it also gives rise to new risks that need to be identified and managed. The standard includes practical recommendations for capital adequacy based on classification conditions; these should start to appear in national legislation as from 2025. Alongside the relevant European frameworks, MiCaR (Markets in Crypto Asset Regulation) and pilot regimes, the standard supplements regulatory requirements at global level while also providing explicit details of how supervisory bodies can best handle common Pillar 1 issues.
Regulatory standard d545 (cf. footnote i) was published on 16 December 2022. While the standard itself does not have any force of law, the Basel Committee has called on national regulatory authorities to implement the framework by 1 January 2025. When assessing exposures, financial institutions must divide crypto assets into two different groups, as shown in the figure below:
Diagram: Overview of crypto assets – Group 1 and Group 2
Group 1
Assets in Group 1 must meet all prescribed classification conditions in full.
Group 1a includes tokenised traditional assets that may also be described as security tokens. They include dematerialised securities that are issued via distributed ledger (DLT) or similar technologies and exposed to the same credit and market risks as the traditional forms of the assets in question.
Group 1b includes crypto assets with effective stabilisation mechanisms (in other words, stablecoins). These are designed such that they can be redeemed against a predefined amount of one or more reference assets. This amount may be covered by, for example, fiat currencies, cash, or gold. Fluctuations in the market value of the crypto assets in relation to their collateral (peg) value should be minimised. Continuous monitoring of the stabilisation mechanism is mandatory.
The regulatory requirements for all Group 1 crypto assets align with the capital requirements for the relevant “traditional” assets or reference assets under the existing Basel Framework.
Group 2
All crypto assets that are not classified in Group 1 are automatically assigned to Group 2. Those crypto assets for which a limited degree of hedging is recognised fall into Group 2a. Where no hedging is recognised at all, they should be classified in Group 2b. Due to the higher risks posed by these assets, new capital treatment rules have been defined.
In view of the greater risk exposure of Group 2 crypto assets, higher capital requirements apply. The financial institution’s total (aggregate) exposure to these assets should also be limited. The absolute limit is two percent of the institution’s Tier 1 capital, although stricter exposure requirements already apply above the one percent threshold.
The following classification requirements have been specified for Group 1 exposures and others (cf. footnote ii), and must be monitored by the institutions themselves:
To minimise the workload for institutions, the International Tokenisation Standardisation Association (ITSA) is working hard to classify all crypto tokens available on the market.
In the case of Group 1 crypto assets, the standard makes provision for an add-on to risk-weighted assets (RWAs) to cover infrastructure risk. A flexible approach has been taken, so that supervisory authorities may activate or increase the add-on based on observed weaknesses in the underlying infrastructure. This approach is intended as an incentive for institutions to actively address infrastructure risks with the aim of avoiding add-ons.
In addition, Group 1 crypto assets must pass a redemption risk test. Reserve assets must be sufficient to ensure that the crypto assets are always redeemable at their full (peg) value, even in conditions of extreme stress. The reserve assets must either cover or exceed the aggregate peg value of all crypto assets at all times.
Specific Executive Education courses in risk management help consultants and employees specialising in risk management to further develop their expertise. A more detailed analysis of the exposure classes mentioned in the blog can be found in a separate specialist article.
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(i) The classification conditions described here are just an extract. The full list of Group 1 classification conditions may be found in sections 60.8–60.19 of the standard.
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