On 25 November 2020, the Cyprus Securities and Exchange Commission (CySEC) issued Circular No. 417 providing direction to the Cyprus Investment Firms (CIFs) on issues relating to crypto assets. This circular deals with the prudential treatment of crypto assets and financial instruments relating to crypto assets, as well as, how the risk management procedures of CIFs should be enhanced.
As noted in EBA’s report on crypto assets, here, there is no reference in the current prudential framework for crypto assets. Therefore, until a common application of the current rules is developed, the following treatment should be used by the CIFs when calculating their own funds and capital adequacy ratio, accordingly:
- Direct investment in crypto assets on a non-speculative basis (banking book exposure)
When a CIF invests directly in crypto assets on a non- speculative basis, it should treat these investments according to Article 36(1)(b) of the Regulation (EU) No. 575/2013 (the CRR), ie direct capital deduction from own funds.
- Direct investment in crypto assets on a speculative basis (trading book exposure)
When a CIF invests directly in crypto assets for speculative basis, it should treat these as investments in a derivative product subject to both of the following risks:
- Counterparty Credit Risk (CCR) calculated according to Article 274 of the CRR, ie a CIF should use the market-to-market method and apply a 10 per cent potential future exposure percentage (PFCE).
- Market Commodity Risk calculated according to Articles 355 to 361 of the CRR.
- Direct investment of CIFs’ clients in crypto assets and/or in financial instruments relating to crypto assets with the CIF acting as the counterparty to these transactions
When a CIF acts as the counterparty to its clients' trades by taking the opposite position to each client's transaction in crypto assets, and/or in financial instruments on crypto assets, the CIF is subject to Counterparty Credit risk and Market Commodity Risk, in accordance with the methodologies set out above, as the CIF is acting as a market maker for its clients.
CIFs are expected to reflect the above treatments in the submission of Form 144-14-06.1 (calculation of own funds and capital adequacy ratio) for the period ended 31 December 2020 which needs to be submitted to CySEC by 11 February 2021.
CIFs should assess the risks arising from trading in crypto assets, and/or in financial instruments relating to crypto assets, for their own account or for their clients within the Internal Capital Adequacy Assessment Process (ICAAP).
CySEC also notifies that CIFs should disclose within their Pillar III disclosures any material crypto-asset holdings and include information on: the exposure amounts of different crypto-asset exposures, the capital requirement for such exposures and the accounting treatment of such exposures.
CIFs, which trade in crypto assets, and/or in financial instruments relating to crypto assets, should revisit their risk management procedures and strategies and ensure that all risks associated with said product(s) are duly taken into consideration. Considering the nature of crypto assets, CIFs should also examine taking mitigating measures against operational, cybersecurity and reputational risks.
CySEC’s Circular 417 can be found here.
EBA’s Report on crypto assets can be found here.