Blockchain for Banking Legal and IP News

GFMA, IIF push back on Basel bank treatment of permissionless blockchain

basel committee crypto

Last week, the Basel Committee on Banking Supervision (BCBS) closed its December consultation regarding updates to its crypto-asset rules. Five major industry bodies responded, pushing back on the Committee’s plans to treat any permissionless blockchain tokens, including tokenized securities, as equivalent to high-risk cryptocurrencies (group 2). For assets classified in Group 2, banks must set aside significant capital, often a dollar for every dollar of crypto.

Group 1 assets include tokenized traditional securities and eligible stablecoins.

The associations responding include the Global Financial Markets Association (GFMA), the Futures Industry Association (FIA), the Institute of International Finance (IIF), the International Swaps and Derivatives Association (ISDA) and the Financial Services Forum.

Permissionless blockchains

“We note the BCBS’s conclusion that the use of permissionless blockchains gives rise to a number of unique risks, some of which cannot be sufficiently mitigated at present. We respectfully disagree with that conclusion,” the response states.

“The principle should be that, where risks can be managed, the use of public permissionless blockchains to develop tokenized assets should be allowed in order to improve efficiency.”

Hence, they argue that banks are capable of managing the risks. Smart contracts can include the ability to seize, freeze or burn tokens. Additionally, the terms and conditions of a token could give the tokenization agent the right to remove the token from the ledger and issue it in a traditional manner.

They provided an analogy between permissionless blockchains and the internet, where the foundational network is permissionless, but the applications on top of it are often gated or require permission.

“The exclusion of permissionless public networks may impact the wider development of liquid tokenization markets not least due to the potential lack of interoperability between private blockchains,” the Associations said.

They further argued the importance of not disincentivizing banks from participating because it would drive activity towards non-bank financial institutions and shadow banking. In turn, this increases systemic risks.

The associations consider the Basel treatment of permissionless blockchain contrary to technology neutrality and the principle of “same asset, same risk”.

Infrastructure risk add-on

Early Basel Committee proposals planned an infrastructure risk add-on of 2.5% applied to tokenized traditional assets. However, Basel dropped this in the final crypto rules. December’s proposed changes suggested reintroducing it but at a 0% level. Local regulators would have the option of increasing the figure.

The industry associations want to see all references to the infrastructure risk add-on removed.

Failing that, they suggest adopting a proposal of the Hong Kong Monetary Authority (HKMA) as a fallback. It too sets the risk add-on at 0%. Instead of imposing a blanket percentage across the industry, the associations suggest individual treatment. In other words, authorities would only impost the add-on if they identify a specific internal infrastructure risk at a bank.

Settlement finality

In the proposals from Basel last December, there was a clarification that settlement finality should apply to both secondary markets and the issuance of assets. However, the associations have requested that this regulation not be enforced rigidly.

Instead, they point to the evolving legal landscape on this topic. For example, with the changes in the United States Uniform Commercial Code (UCC) and England’s Law Commission review.

Instead, they suggest that a bank should ensure it understands how and when a transaction reaches finality. Additionally, the bank should conduct a legal review. They argue that the foreign exchange market takes a similar approach.

As an aside, the associations note that DLT helps reduce settlement risks.

Stablecoin issues

The industry response covers several stablecoin issues. Firstly, they are concerned about some changes that they believe prevent a bank stablecoin reserve custodian from providing any type of bank account. That’s because of an insistence on the bankruptcy remoteness of all reserves. The associations request the exclusion of cash assets from this requirement.

Still on reserves, they request permission to use reverse repo agreements. Most major stablecoin issuers use them.

Next, they request that stablecoins be allowed to be used as collateral.

Overall, they note that the Basel stablecoin requirements are more onerous than current legislation and frameworks published by the UK, EU, Singapore, Dubai and Hong Kong.

“BCBS’s amendments should not have the effect of preventing banks from exercising rights that have already been enshrined in existing regulatory and legal frameworks,” they wrote.

Additionally, they point to an inconsistency in that banks with e-money licenses are subject to far more stringent requirements for tokenized e-money.

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