One year after they raised several objections to an initial proposal, a group of financial markets industry associations have again pushed back against proposals in a second consultation on the treatment of cryptoassets under the Basel legislation.

ISDA, along with the Global Financial Markets Association (GFMA), the Futures Industry Association (FIA), the Institute of International Finance (IIF), the International Securities Lending Association (ISLA), the Bank Policy Institute, the International Capital Markets Association (ICMA) and the Financial Services Forum, have responded to the Basel Committee on Banking Supervision’s (BCBS) second consultation on the prudential treatment of crypto-asset exposures. This was arranged after considering the initial responses to its proposals in mid-2021.

In their response, the associations stress their support the design of a cryptoasset exposure framework that facilitates bringing these financial activities within the prudential framework where associated risks will be subject to robust capital and liquidity regulation, sound risk management and ongoing supervisory oversight. “To that end, we encourage a suitably conservative but appropriately structured and designed regulatory framework and we believe our goal is very closely aligned with the objectives of the Basel Committee,” they state.

That said, after what they term a “comprehensive review” of the second consultation, they have identified some features and calibrations that individually and collectively would meaningfully reduce banks’ ability to – and in some cases effectively preclude banks from – utilising the benefits of DLT to perform certain traditional banking, financial intermediation and other financial functions more efficiently.

“As a result, banks would be limited in their ability to respond to their customers’ demand for access to cryptoasset products and services,” the associations write. “That outcome is not in the best interests of customers, investors or the financial system more broadly. Indeed, the role of banks in the financial system and the scope of the financial sector within the purview of prudential regulators could be affected.”

They add their comments aim to improve the mutual understanding of current and emerging risks, the role of existing processes and frameworks for regulated entities to manage such risks, and to identify balanced solutions to help in the design of a capital framework that supports enhancing financial stability while avoiding overly restrictive limits to innovation.

Allowing appropriately risk-managed cryptoasset banking and other financial activities to take place within the regulatory perimeter should be a central goal of the final Basel Committee standards

“Getting this right is critical to meet customer demand and harness the benefits of DLT and similar technologies,” they reiterate. “For example, the speed by and transparency with which transactions can be recorded using DLT, combined with the ability to swap and record assets and cash simultaneously, would help mitigate counterparty, liquidity and settlement risk, allow transactions to settle, and funds and assets to reach their intended recipient, faster and allow for efficiencies in collateral management.”

The associations argue that recent heightened volatility in cryptoasset markets has underscored the risks that emerge when a significant financial market develops outside a prudential risk management framework where excess leverage, inadequate liquidity, and lack of capital can materialise, regardless of the benefits of technology. “Allowing appropriately risk-managed cryptoasset banking and other financial activities to take place within the regulatory perimeter should be a central goal of the final Basel Committee standards,” they write. “A prudential framework that permits banks to support the growth of cryptoassets benefits supervisors by providing better insight into the evolution and growth of these activities (e.g., by requiring the reporting of cryptoasset exposures). At the same time, customers and investors will benefit from more transparent trusted alternatives and the protections of fully regulated institutions providing services.

“Otherwise, un- and -lesser-regulated entities are likely to be predominant providers of cryptoasset-related services,” they continue. “The result would be an unlevel playing field and a lack of transparency in the build-up of leverage and risk in the financial system outside the regulatory perimeter. In that case, the absence of regulated financial institutions engaging in cryptoasset-related activities would be net worse than if banks were providing these services subject to an appropriately calibrated framework.”

The associations stress their overarching goal is to help in the design of a prudential framework that supports enhanced financial stability and avoids overly restrictive limits to innovation.