New regulations start to define the legal framework in the field of crypto custody

KEYS FACTORS OF THE ANALYSIS

• The US financial regulator, SEC, has published a new regulation that requires that any company providing crypto custody services to recognize them in the balance sheet account as both an asset and a liability.
• At the same time as the publication of these measures, in recent weeks there have been announcements about important changes in the field of crypto custody by large US banks, such as BNY Mellon and State Street.
• In Europe, the Basel Committee has made proposals regarding the standardization of crypto asset management; however, these do not include, at present, any specific treatment for crypto custody services.
• In contrast to the United States, in Spain, crypto custody, and in general anything to do with the crypto ecosystem, still generates caution in the finance sector, and the major banks are yet to firmly position themselves, as they wait for a greater clarification in the form of regulatory frameworks.
• In the meantime, the security sector in Europe is also still waiting for further clarification regarding the regulatory framework, in a market in which banks, big techs and fintechs alike are looking to carve out a position for themselves.

POSITION OF INTERNATIONAL REGULATORS

SEC

On March 31, the US financial regulator, SEC, published guidance on how private corporations should approach crypto custody, when offered as a service for clients. (1)

The importance of this document is that it can set a precedent that, if followed by other regulatory bodies worldwide, could make this service unattractive for banks as a way of doing business.

The most important aspect in terms of the new regulatory requirement is that the SEC requires that crypto assets are recognized as both an asset and a liability on the balance sheet, while the custody of conventional assets is not required to be recognized on it. However, banks do have an obligation to dedicate a certain amount of capital to the composition of their balance sheet, meaning that positioning crypto currency exclusively as a liability would lose its appeal, a priori.

The reasoning given by the SEC is that holding cryptographic keys can be too risky at a technical level, and this implies the intervention of regulators and legal entities to the point of being able to define the exact treatment of cryptocurrencies and ensuring that they comply with regulatory security requirements.

Therefore, the SEC is asking any organization that holds crypto assets to treat them the same way as conventional money. For non-bank institutions, this does not pose a bigger problem than having a very large balance sheet account, which can make audit processes more expensive; however, for banks, the impact could be much bigger, discouraging them from continuing to bet on crypto custody as a new way of doing business.

Basel

At a European level, in 2021, the Basel Committee on Banking Supervision also issued a series of proposals on the management of crypto assets. (10)

However, the provisions included in this consultation document do not address crypto custody. In fact, the explanatory note in the document relating to the tokenization of conventional assets, including stablecoins, specifies that the Basel framework does not establish an exact description of the applicable requirements for banks that provide services to consumers who invest in traditional assets. These services could include custodial services. Similarly, in the preface, it is established that the consultation document does not aim to define a treatment for crypto assets in cases in which there are no risk treatments defined in the Basel framework for traditional assets.

The question now is whether the new SEC framework will also affect the Basel Committee's treatment of crypto asset custody.

RECENT CHANGES

However, as the international regulatory framework becomes standardized, we have seen major changes recently in this new business activity, especially by big banks, but also by startups operating in the cryptocurrency exchange space:

SPANISH BANKS ARE YET TO ENTER THE BUSINESS. AN OPPORTUNITY FOR THE SECURITY INDUSTRY?

Unlike in the United States, in Spain, banks have yet to make major strides in the field of crypto custody, perhaps because they are waiting for the regulatory gaps at a European level to be filled in.

Take, for example, the fact that at the end of March, the deputy governor of the Bank of Spain, Margarita Delgado, publicly stated that "the direct and indirect exposure of the banking sector to the crypto-asset business poses a very relevant increase in asset and reputational risks". (6)

To this end, the Bank of Spain has urged caution from financial institutions in the management of the portfolios, their arrearage and the necessary coverage.

This situation is creating a dilemma for the Spanish banking industry given that, on the one hand, it could be missing out on a lucrative investment business, and, on the other, it could be exposing itself to excess risk. This aspect could, in turn, represent an opportunity for companies in the security industry, when it comes to positioning themselves as a pioneer in this business, that remains uncertain and unregulated to a certain extent in Spain.

BIBLIOGRAPHY

01. SEC. Staff Accounting Bulletin No. 121. March 31, 2022 [accessed 14/04/2022]. Available at: https://www.sec.gov/oca/staff-accounting-bulletin-121

02. LEDGER INSIGHTS. SEC crypto custody accounting rule: a serious blow for bank custodians? April 01, 2022 [accessed 14/04/2022]. Available at: https://www.ledgerinsights.com/sec-crypto-custody-accounting-rule-a-serious-blow-for-bank-custodians/

03. COINDESK. State Street to Offer Crypto Custody in Pact With Copper. March 09, 2022 [accessed 11/04/2022]. Available at: https://www.coindesk.com/business/2022/03/09/state-street-to-offer-crypto-custody-in-pact-with-copperco/

04. IEAF. Will Spanish banks enter the crypto asset business? November 04, 2021 [accessed 11/04/2022]. Available at: https://es.beincrypto.com/banco-espana-reconoce-onyze-custodiante-exchange-criptomonedas/

05. BUSINESS INSIDER. La doble amenaza de los criptoactivos para la banca, según el Banco de España: nuevo elemento de competencia y un elevado riesgo si los comercializan. March 29, 2022 [accessed 11/04/2022]. Available at: https://www.businessinsider.es/doble-amenaza-criptoactivos-bancos-banco-espana-1036065

06. BIS. Prudential treatment of cryptoasset exposures. June 10, 2021 [accessed 11/04/2022]. Available at: https://www.bis.org/bcbs/publ/d519.htm