Yesterday, the International Securities Lending Association (ISLA) announced it appointed Ashurst to perform a preliminary legal analysis on its Global Master Securities Lending Agreement (GMSLA) in the context of digital assets. Recent events, including the Celsius bankruptcy, have highlighted several legal gray areas regarding the title to digital assets, especially when pledged as security.
The Ashurst work will explore title transfer and security interest over pledged collateral. In terms of digital assets, ISLA said the focus is on tokenized traditional assets, native digital securities and forms of digital cash. This doesn’t appear to include cryptocurrencies, but we’ve asked for clarification, as this is the area with the most pitfalls. And much of the rest of this article focuses on crypto issues.
“The appointment of Ashurst to help chart our way through this landscape, ensures that the GMSLA agreements published by ISLA and used for securities lending activity globally are able to support our membership’s ability to leverage these new opportunities,” said David Shone, Director of Market Infrastructure & Technology at ISLA.
Celsius bankruptcy highlights a tricky topic
Ten days ago, a filing relating to the bankruptcy of crypto lender Celsius highlighted the challenging legal issues around digital assets used as collateral and cryptocurrencies in particular.
Any activities in the 90-day run-up to bankruptcy are reviewed to ensure some creditors aren’t disadvantaged relative to others. An $841 million transaction between Tether and Celsius is under review.
Infamously Celsius borrowed money from stablecoin firm Tether with a balance of $841 million still owing when it came to the crypto crash in May. Tether requested additional collateral in May and June, which Celsius could not provide. So it agreed that Tether could liquidate the existing cryptocurrency collateral with a loss of roughly $97 million.
This seems like a legitimate transaction. However, because of the novel legal position of cryptocurrencies, there’s a possibility that Celsius may be able to reclaim the funds turning Tether into an unsecured creditor. That’s because it’s unclear whether Tether had the right to the collateral.
In the United States, many of these transactions are governed by the Uniform Commercial Code (UCC), which is adopted by all states, at least in part. New UCC rules relating to digital assets that address many of the issues are about to come into force. Until then, there are challenges because cryptocurrencies such as Bitcoin are considered general intangible assets.
To secure title to the crypto, Tether would need to have:
- filed a UCC-1 financing statement with the secretary of state where the debtor is located to ‘perfect’ its security interest in the digital assets, or
- morph the digital assets from intangible into an investment property by having a custodian look after the keys.
In addition to the Tether scenario, another potential pitfall is that digital assets carry past liens. This was highlighted in a document penned by Tim Swanson (pg 36) back in 2015. In other words, even if someone quite innocently buys some Bitcoin, if they were pledged as security to somebody else, the buyer is out of luck.
The UK is also reviewing digital assets laws
At the end of July, the Law Commission of England and Wales opened a consultation on digital assets as personal property. It includes addressing the last point – if someone buys digital assets in good faith, unaware of any other party’s claim to it, they will retain ownership of the token.
The UK currently recognizes two kinds of personal property, things in possession (tangible objects) and things in action (property claimable through legal action or proceedings). It suggests creating a third category, ‘data objects’.
It also covers liens on digital assets, requiring them to be in writing.
How does this fit in with Basel III rules?
Banks have to comply with Basel III rules to protect their balance sheets from volatile events. The treatment of crypto-assets is currently being considered, and cryptocurrencies are treated as the highest possible risk. The first proposal didn’t account for hedging. In other words, if a bank had a long position in a crypto-asset and a put option, they would both be counted as risks rather than offsetting them.
However, last month’s Basel proposal allows for offsetting if there’s hedging.
If there are legal title issues, particularly with collateral, some offsets may not reduce risk as intended resulting in greater risk to a bank’s balance sheet.
We wondered about the murky legal position of digital assets, so we looked at the Basel wording. It puts the onus on the banks to establish legal clarity.
Is the digital asset legal title issue on anyone’s radar?
When the Financial Times highlighted the Celsius/Tether topic, we reached out to a handful of organizations to see whether these issues were on their radar. They included banks, custodians, and industry bodies (not ISLA). Judging by the response, we’d conclude that these particular legal risks have not been sufficiently considered. But ISLA’s commissioning Ashurst means that’s changing.