The Tribune

By NEIL HARTNELL

Tribune Business Editor

nhartnell@tribunemedia.net

The Central Bank yesterday rejected assertions it is being “excessive” in requiring licensees to hold 12.5 times’ the amount of capital involved to back trades of non-stablecoin digital assets.

The regulator, unveiling its Digital Asset Guidelines 2023 that will apply to all its bank, trust and payment provider licensees, defended this stipulation on the basis that all other digital assets are “highly volatile” and expose investors to what it termed “material market risk”.

Its position was set out in response to feedback from an unnamed licensee during consultation on the guidelines. It bluntly told the Central Bank: “Requiring supervised financial institutions to hold 12.5 times’ the amount of capital to basically back for all trade positions outside of stablecoins seem excessive.”

The Central Bank, though, justified this stance by asserting: “Group two digital assets are considered highly volatile, thus exposing investors and digital trading platforms to material market risk. The application of the 1,250 percent risk weight set out in the guidelines will ensure that supervised financial institutions are required to hold minimum risk-based capital at least equal in value to their Group two digital asset exposures.”

As a result, paragraph 41 in the digital assets guidelines states: “There is no separate trading book and banking book treatment for Group two digital assets. For Group two digital assets exposures, a risk weight of 1,250 percent is applied to the greater of the absolute value of the aggregate long positions and the absolute value of the aggregate short positions to which the supervised financial institution is exposed.”

The guidelines define so-called ‘Group two’ digital assets as those, including unbacked assets, stablecoins and traditional tokenised assets, that fail to meet what it described as “classification” conditions. The Central Bank views these as more risky than stablecoins that comply with the “classification”, which requires them to have a “stabilisation mechanism” linked to assets such as fiat currency.

Other conditions that digital assets must meet to fall in the less risky category are that ownership rights are “legally enforceable” in all jurisdictions where they are issued and redeemed; that distributed ledger (blockchain) technology helps mitigate risk; and redemptions, transfers and settlement are regulated and supervised.

Elsewhere, the Central Bank also clarified that the digital assets guidelines apply to all its licensees - money transmission businesses, credit unions and electronic payment providers - not just traditional banks and trust companies.

One licensee had inquired: “Section seems to be limited to banks rather that all supervised financial institutions under regulatory purview. Primary concern is the omission of payment providers, which are Fintech (financial technology) in nature and inherently, and by market perception, more open to engage in digital asset activities.

“Particularly since their primary customers are retail participants, which have been the most vulnerable in digital asset faux pas. No expectation here from me to have the Central Bank to overstep their regulatory range and prescribe to outside institutions.”

The Central Bank, though, clarified that the Digital Assets Guidelines’ paragraph five states that “these guidelines apply, as appropriate, to all supervised financial institutions that are or seek to be engaged in digital asset business activities...”

The regulator added: “It is not the intent of the Central Bank to limit these guidelines to only banks. The Central Bank’s supervised financial institutions (SFIs) include banks, bank and/or trust companies, private trust companies (PTCs), money transmission businesses (MTBs), electronic money service providers and co-operative credit unions.”

Setting out its regulatory philosophy on digital assets, the Central Bank said: “Digital assets are a diverse asset class with varying characteristics that, in certain cases, may resemble traditional financial assets such as bonds, equities, commodities and cash held in custody.

“The Central Bank subscribes to the philosophy of ‘same risk, same activity, and same treatment’. Therefore, the prudential treatment of digital assets is based on the risks that are associated with the underlying characteristics of these assets.....

“This framework represents the Central Bank’s identification of accepted best practices for effective risk management in supervised financial institutions. The Central Bank appreciates that the breadth of the risk management programme in each supervised financial institution will depend on the scope and sophistication of the activities of the supervised financial institution, the nature and complexity of its digital asset-related businesses activities, and the types and levels of the risks that it assumes,” the Central Bank added.

“However, failure to adopt a satisfactory risk management programme appropriate to a supervised financial institution’s business activities constitutes an unsafe and unsound practice, and could subject the supervised financial institution to regulatory sanctions and/or other supervisory intervention measures.”