EU publishes text for Basel III encryption rules for banks – Ledger Insights

In January, the European Parliament voted on legislation that includes plans to implement the Basel Committee’s rules for banks and cryptoassets, which impose capital and liquidity requirements. On Friday, the EU published the wording used for the parliamentary vote. It confirms that banks are expected to treat cryptoassets with a risk weight of 1250% as a temporary measure until detailed legislation is implemented. That means they must have one euro of capital for every euro of crypto on their balance sheet.

It also highlights the problematic draft wording because the Basel Committee included tokenized securities in the term “crypto-assets” but gave them a conventional risk weighting. Basel intended the 1250% risk weighting to apply mainly to cryptocurrencies, not securities, but the draft EU text fails to distinguish this. That is why the industry body AFME is concerned about the wording of the draft legislation.

There is still time to correct the wording because the EU Parliament has only taken its first vote. The legislation is now going through a trilogue negotiation process between the Commission, Parliament and the European Council representing each country.

An additional point is that crypto disclosures are required by the EU even if the amounts are not significant. Most Basel rules require disclosure mainly for material elements.

The three relevant sections of the amendments to the Capital Requirements Regulation are copied below for convenience.

42a:
The rapid increase in the financial markets’ activity on crypto-assets and potentially increasing involvement of institutions in crypto-asset-related activities should be thoroughly reflected in the Union’s supervisory framework, in order to reduce the risk of these instruments to the institutions’ financial stability. This is even more urgent in light of the recent adverse developments in the crypto asset markets. The existing supervisory rules are not designed to capture the risks associated with crypto-assets. The recently published BCBS standards for the prudent treatment of exposures to cryptoassets, to be implemented by 1 January 2025, provide a dedicated supervisory treatment that should be implemented in Union law in time. The Commission should follow up these developments and, if appropriate, adopt a legislative proposal by 31 December 2024 to transpose the various elements of the BCBS standards into Union law. Until the bill is passed, the institutions’ exposure to crypto-assets should apply prudent equity requirements.

Article 451b shall be inserted: Disclosure of exposures to crypto-assets and related activities

1. Institutions must publish the following information about crypto-assets and crypto-asset services as well as activities related to crypto-assets:
   (a) the direct and indirect exposure amounts in relation to crypto-assets, including the long and short components of net exposures;
   (b) the risk-weighted exposure amounts for each crypto-asset, to be supplemented by a breakdown by category and the related capital requirement;
   (c) the total risk exposure amount for operational risk divided by business areas as set out in table 2 of article 317;
   (d) the accounting classification for crypto asset exposures;
   (e) a description of the business activities related to cryptoassets, and their impact on the institution’s risk profile; institutions shall provide more detailed information for significant business activities, including the issuance of significant asset-referenced tokens within the meaning of Articles 43 and 44 of the MiCA Regulation, significant e-money tokens within the meaning of Articles 56 and 57 of the MiCA Regulation and the provision of services [under Art. 9(c)(d) of MiCA Regulation];
   (f) a specific description of their risk management policies related to crypto asset exposures and crypto asset related services.
2. Institutions shall not apply the exception set out in Article 432 in connection with the information requirements in No. 1.’

   The editors note: Article 432 would generally dispense with the need to disclose non-tangible items.

Article 461b shall be inserted: Precautionary treatment of crypto-assets

1. The Commission shall, where appropriate, present a legislative proposal to the European Parliament and the Council by 30 June 2023 to implement a dedicated supervisory treatment for exposures to crypto-assets, taking due account of the recently published international standards and requirements set out by [insert reference to MiCA Regulation]. This bill shall include, but not be limited to, the following:
   (a) criteria for assigning cryptoassets to different categories of cryptoassets based on their risk characteristics and compliance with specific conditions;
   (b) specific capital requirements for all risks associated with each category of crypto-assets;
   c) specific supervisory authorities with respect to crypto-asset exposure allocation, monitoring and calculation of equity requirements;
   (d) specific liquidity requirements for exposures to cryptoassets;
   (e) disclosure requirements.
2. Until 30 December 2024, institutions must apply a risk weight of 1250% to their exposures to crypto assets in the calculation of the capital requirement. Institutions shall not apply the deduction in Article 36 no. 1, letter b) for the calculation of their own capital requirement.’

   Editor’s note: 36(1)(b) refers to intangible assets.