Prudential Treatment of Crypto Assets & Enhancement of Risk Management Procedures Associated with Crypto Assets

MNK Risk Consulting > News > Regulatory Developments > Prudential Treatment of Crypto Assets & Enhancement of Risk Management Procedures Associated with Crypto Assets

RE:         CySEC Circular C417

Scope: Cyprus Investment Firms

The Cyprus Securities and Exchange Commission (the ‘CySEC’) on the 25th of November 2020 provided guidance to Cyprus Investment Firms (‘CIFs’) on issues relating to crypto assets through circular C417 (the “Circular”).

The Circular addresses 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. Specifically, it covers the below:

Calculation of own funds and minimum capital adequacy ratio (Pillar I)

As noted in the EBA’s report on crypto assets, there is no reference in the current prudential framework for crypto assets. As such, 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:

  1. Direct investment in crypto assets on a non-speculative basis (‘banking book’ / non-trading 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’), i.e. 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:
  1. Counterparty Credit Risk (“CCR”) calculated according to Article 274 of the CRR, i.e. a CIF should use the market-to-market method and apply a 10% potential future exposure percentage (PFCE);
  2. 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 in point b above, as the CIF is acting as a market maker for its clients.

CIFs are expected to reflect the above treatment in the submission of the Form 144- 14-06.1 (calculation of own funds and capital adequacy ratio) for the period ended 31st December 2020 which needs to be submitted to CySEC by 11th February 2021.

Internal Capital Adequacy Assessment Process (‘ICAAP’) (Pillar II)

CIFs should assess the risks emanated 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).

Pillar III disclosures

CIFs should disclose within their Pillar III disclosures any material crypto-asset 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.

Enhancement of risks management procedures associated with crypto assets

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 this product are duly taken into consideration.

For a more detailed discussion of how this issue might affect your business, please contact:

 info@mnkriskconsulting.com

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