Prudential treatment of crypto assets and enhancement of associated risk management procedures
Following the publication of Circular C417, the Cyprus Securities and Exchange Commission ("the CySEC") wishes therein to deliver prudential guidance to the Cyprus Investment Firms ("the CIFs") on matters regarding the treatment of crypto assets and other financial instruments relating to them.
The lack of previous regulations for cryptocurrencies, is cited within the current Circular and thus, CySEC recommends that until a common application of the current rules is developed, the following treatment should be used by the CIFs. In more detail, when CIFs perform:
A. Calculation of own funds and capital adequacy ratio (Pillar I)
CIFs that invest directly in crypto assets on a non- speculative basis, should treat these investments as a direct capital deduction from own funds which should be presented in the Form 144-14-06.1.
CIFs that invest directly in crypto assets on a speculative basis, should treat these as investments in a derivative product which are subject to both of the following risks:
Counterparty Credit Risk, where a CIF should use the market-to-market method and apply a 10% potential future exposure percentage.
Market Commodity Risk calculated according to Articles 355 to 361 of the CRR.
CIFs that act as the counterparty to their clients' trades, in crypto assets, and/or in financial instruments on crypto assets, then the CIFs are subject to Counterparty Credit risk and Market Commodity Risk, in accordance with the methodologies set out above, since the CIFs are acting as market makers for the 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 31 December 2020 which needs to be submitted to CySEC by 11 February 2021.
B. 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) together with a sensitivity analysis that shows how the risks identified affect the CIFs’ projections and, any mitigations should also be discussed, stating any additional capital that should be held in relation to the identified risks.
C. Pillar III disclosures
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.
D. 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. Moreover, considering the nature of crypto assets, CIFs should also examine taking mitigating measures against operational, cybersecurity and reputational risks.
Written by Christos Eleftheriou, Junior Compliance Associate, FAI Comply