On November 25, 2020, the Cyprus Securities and Exchange Commission (‘CySEC’) issued Circular C417 “Prudential treatment of crypto assets and enhancement of risk management procedures associated with crypto assets” which provides additional information to Cyprus Investment Firms (‘CIFs’) on issues relating to crypto assets and their associated financial instruments.
This Circular reaffirms that CIFs can only transact in crypto assets if they have obtained permission to provide such services as per the article 6(9)(b) of Law 144(I)/2007 (the old CIF Law) or article 5(5) of Law 87(I)/2017 (the new CIF Law).
Furthermore, the Circular provides guidance on the regulatory requirements referred to here:
CIFs should follow the treatments below when calculating their own funds and capital adequacy ratio:
|
No. |
When a CIF |
Treatment |
Reflected in |
|
1 |
Invests directly in crypto assets on a non-speculative basis (i.e. an asset that is reflected in the banking book) |
Deduction from own funds as an intangible assets (since cryptocurrency meets the definition of intangible asset in line with the standard IAS 38) as per Article 36(1)(b) of the Regulation (EU) No. 575/2013 (‘CRR’) |
Form 144-14-06.1, “CA1” tab, Row 350 |
|
2 |
Invests directly in crypto assets on a speculative basis (trading book exposure) |
Counterparty Credit Risk should be calculated as per Article 274 of the CRR. (Crypto assets should be treated as commodity assets with 10% potential future exposure percentage) |
Form 144-14-06.1, “MKR SA COM” tab, Row 05 |
|
Market Commodity Risk should be calculated as per Articles 355 to 361 of the CRR. |
Form 144-14-06.1, “MKR SA COM” tab, Row 050 |
||
|
3 |
Acts as the market maker for its clients by taking the opposite position to each client’s transaction in crypto assets and/or in financial instruments associated with crypto assets. |
Counterparty Credit Risk should be calculated as per Article 274 of the CRR. |
Form 144-14-06.1, “MKR SA COM” tab, Row 05 |
|
Market Commodity Risk should be calculated as per Articles 355 to 361 of the CRR. |
Form 144-14-06.1, “MKR SA COM” tab, Row 050 |
The above Capital Adequacy calculation treatments mainly affects CIFs which are authorised for the Dealing on Own Account investment service.
Moreover, CIFs are expected to apply the above treatment in the upcoming CRDIV CoRep Form for the period ended 31 December 2020 and onwards.
2. Internal Capital Adequacy Assessment Process (ICAAP – Pillar II)
CIFs should consider the potential impact of their activity in derivatives on virtual currencies on their wider operations and adequately address the risks associated with these activities in the context of their ICAAP. CIFs must also include the risks associated with their activities relating to derivatives on virtual currencies when calculating their capital adequacy ratios. Where relevant, they should adjust their risk mitigation strategies.
The financial projections and stress testing of the CIF should assess the identified risks (as identified in the above section) for cryptocurrency exposures, which will then be reflected in the CIFs’ forward-looking capital planning. In addition, any mitigation techniques and additional capital held in relation to the respective risks should be discussed in the report.
3. 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 as per Part 8 of the CRR. Moreover, the capital requirement for such exposures, which are calculated as per the provisions of the CRR, should be disclosed in the report as per the Article 438 of the CRR. Finally, CIFs should also disclose the accounting treatment that is followed for such exposures.
4. Enhancement of risks management procedures associated with crypto assets
CIFs should ensure that the risk management procedures and strategies reflect all risk associated with the crypto assets and/or their associated financial instruments. These procedures should be periodically reviewed and updated in accordance with the company’s nature, scale and complexity. Furthermore, considering the nature of crypto assets, CIFs should also examine taking mitigating measures against operational, cybersecurity and reputational risks.
Moreover, CIFs shall ensure that the Board of Directors approves and periodically reviews the strategies and policies for taking up, managing, monitoring and mitigating the risks the CIF may face or be exposed to as per the paragraph 6 of Directive DI144-2014-14.
Finally, CIFs should ensure that the remuneration policy is consistent with and promotes sound and effective risk management and does not encourage risk-taking that exceeds the CIF’s level of tolerated risk.