CRR3 and MiCA Regulation: EBA’s Draft RTS for Crypto-Asset Exposures

The Capital Requirements Regulation (CRR 3) and the Markets in Crypto-Assets Regulation (MiCAR) form the foundation of the European Union’s (EU) regulatory strategy for crypto-assets. These frameworks are designed to balance prudential treatment with operational transparency, addressing the unique risks posed by the rapidly evolving crypto-asset market while supporting innovation.

Central to this regulatory initiative are the European Banking Authority’s (EBA) Draft Regulatory Technical Standards (RTS), developed under CRR 3 Article 501d(5). These standards establish detailed methodologies for calculating, managing, and aggregating crypto-asset exposures, ensuring institutions adhere to stringent risk management practices while remaining competitive in the financial sector.

This technical analysis provides an in-depth exploration of the Draft RTS, focusing on their integration with CRR 3 and MiCAR, alignment with global standards like those of the Basel Committee on Banking Supervision (BCBS), and implications for financial institutions operating within the EU’s regulatory framework.

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The EBA consults on draft technical standards on the prudential treatment of crypto assets exposures under the Capital Requirements Regulation | European Banking Authority

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EBA’s Draft Regulatory Technical Standards (RTS) under CRR 3 and MiCA

Primary Objectives of the Draft RTS

The European Banking Authority’s (EBA) Draft Regulatory Technical Standards (RTS), issued under Article 501d(5) of the Capital Requirements Regulation (CRR 3), are designed to achieve the following:

1. Establish Technical Standards: Provide a detailed framework for calculating own funds requirements related to crypto-asset exposures, ensuring precision and consistency across financial institutions.
2. Address Valuation Challenges: Mitigate the complexities arising from the volatile and opaque nature of crypto markets, which pose significant risks to accurate and reliable valuation.
3. Align with Global Prudential Standards: Harmonize the treatment of crypto-assets with international benchmarks set by the Basel Committee on Banking Supervision (BCBS) while tailoring these standards to align with the EU-specific regulatory framework under the Markets in Crypto-Assets Regulation (MiCAR).

Scope of Crypto-Assets under the Draft RTS

The Draft RTS outline a comprehensive classification of crypto-assets to facilitate accurate risk assessment and management:

1. Electronic Money Tokens (EMTs):
   • Tokens pegged to fiat currencies to provide relative stability in value.
   • Regarded as lower-risk due to their linkage to recognized legal tender.
2. Asset-Referenced Tokens (ARTs):
   • Tokens backed by one or more traditional assets, such as commodities or fiat currencies.
   • Subject to specific prudential requirements, reflecting their hybrid risk profile.
3. Other Crypto-Assets:
   • Includes unbacked assets like Bitcoin, as well as derivatives and structured financial products referencing crypto-assets.
   • These assets are treated as high-risk due to their inherent volatility, lack of intrinsic value, and liquidity challenges.
4. Exclusions:

• Tokenized Traditional Assets are excluded from the scope of the Draft RTS as they are treated similarly to conventional financial instruments under existing regulations.

CRR3: Valuation Challenges and Prudential Framework

Addressing Valuation Uncertainty

The Draft Regulatory Technical Standards (RTS) acknowledge valuation uncertainty as a fundamental challenge in the prudential treatment of crypto-assets. Key factors contributing to this uncertainty include:

• Price Discrepancies: Significant variation in prices across trading platforms.
• Limited Market Transparency: Lack of clarity in pricing mechanisms, particularly in private trading venues.

To address these issues, the Draft RTS propose robust valuation methodologies:

• Prudent Valuation Standards: As mandated by Article 105 of CRR, all crypto-assets must undergo prudent valuation processes to ensure consistency, reliability, and alignment with traditional asset valuation principles.
• Integration with MiCAR Accounting Frameworks: MiCAR supports fair value assessments for crypto-assets, harmonizing practices with international standards such as the International Financial Reporting Standards (IFRS).

Risk Weights for Crypto-Assets

The Draft RTS outline specific risk weights to reflect the unique characteristics and risks of different types of crypto-assets:

• Asset-Referenced Tokens (ARTs):
  • Assigned a 250% risk weight, reflecting their partial backing by traditional assets such as fiat currencies or commodities.
  • Recognized for their relative stability compared to unbacked crypto-assets.
• Other Crypto-Assets:
  • Assigned a 1,250% risk weight to account for their high volatility, lack of intrinsic value, and limited liquidity.
  • This conservative risk weight aims to mitigate potential systemic risks associated with unbacked or speculative assets, such as Bitcoin.

Capital Requirements and Risk Management in EBA’s Draft RTS for Crypto-Asset Exposures

Credit Risk Management

Under the Draft Regulatory Technical Standards (RTS), institutions must adopt rigorous methodologies for assessing and managing credit risk associated with crypto-assets:

• Asset-Referenced Tokens (ARTs):
  Institutions are required to analyze the issuance structures of ARTs to identify risks tied to their referenced traditional assets, such as fiat currencies or commodities.
• Unbacked Crypto-Assets:
  Both long and short positions in unbacked crypto-assets, such as Bitcoin, are subject to a 1,250% risk weight, reflecting their high volatility and systemic risk potential.

Counterparty Credit Risk (CCR)

The Draft RTS provide a structured approach to calculate counterparty credit risk (CCR) for derivatives and other transactions involving crypto-assets:

• Replacement Cost (RC):
  Netting is allowed only within enforceable and eligible netting sets of the same crypto-asset, ensuring precision in exposure calculations.
• Potential Future Exposure (PFE):
  Calculated at 50% of gross notional value for derivatives, the methodology accounts for the inherent volatility of crypto-assets.
• Leverage Adjustments:
  Institutions must ensure that derivatives reflect the maximum possible losses, aligning exposures with the actual underlying risks.

Market Risk Assessment

To address market risk associated with crypto-assets, institutions must adhere to the methodologies outlined in Part Three, Title IV of CRR, with crypto-specific adaptations:

• Net Position Calculation:
  The Net Position Formula isolates long and short positions to calculate exposure:

• Non-Delta Risk for Options:
  Institutions must apply scenario-based methodologies using a ±100% shift in the underlying price and relative volatility to assess non-delta risks associated with options.
• Curvature Risk:
  Curvature risk is calculated using delta risk weights, aggregated through bucket-specific formulas to provide a comprehensive view of risk exposure.

Hedging, Netting, and Liquidity Provisions

Hedging Recognition for Crypto-Assets

The European Banking Authority's (EBA) Draft Regulatory Technical Standards (RTS) introduce specific criteria for recognizing hedging activities based on the characteristics of crypto-assets:

• Asset-Referenced Tokens (ARTs):
  Hedging is recognized under flexible criteria, reflecting the stability provided by their backing with traditional assets such as fiat currencies or commodities.
• Other Crypto-Assets:
  Hedging recognition is highly restricted due to the inherent volatility, limited liquidity, and lack of intrinsic value of unbacked crypto-assets.

Netting Rules for Crypto-Asset Exposures

Stricter netting provisions apply to high-risk crypto-assets classified under Article 501d(2), point (c) of the Capital Requirements Regulation (CRR):

• Net Exposures:
  Institutions must calculate net exposures within enforceable and eligible netting sets, ensuring that high-risk positions are accurately isolated and assessed.

Liquidity and Collateral Restrictions

Liquidity management and collateral eligibility are critical areas addressed in the Draft RTS to mitigate risks posed by the volatility and market dynamics of crypto-assets:

• Liquidity Risks:
  Institutions are required to adopt conservative assumptions regarding the liquidity of crypto-assets, considering the uncertain depth of crypto markets, particularly during downturns.
• Collateral Restrictions:
  Crypto-assets classified under Article 501d(2), points (b) and (c) are deemed ineligible for credit risk mitigation purposes, as per Article 108 of CRR. This ensures a conservative approach to collateral acceptance.
• Prudential Haircuts for SFTs:
  A 30% prudential haircut applies to crypto-assets lent in securities financing transactions (SFTs). This accounts for valuation risks and the potential difficulty of redeeming such assets in stressed market conditions.

Issuer Default Risk and Recovery Obligations under MiCAR

Addressing Issuer Default Risk for Asset-Referenced Tokens (ARTs)

Under the Markets in Crypto-Assets Regulation (MiCAR), financial institutions must account for the issuer default risk associated with Asset-Referenced Tokens (ARTs) when issuers fail to meet redemption obligations, as stipulated under MiCAR Article 39. This ensures that institutions hold sufficient capital to address potential systemic vulnerabilities.

• MiCAR Recovery Plans:
  MiCAR mandates the implementation of liquidity fees, redemption limits, and other recovery measures to mitigate the systemic risks posed by ART issuers during periods of financial distress.
• Consultation Considerations:
  Stakeholders are invited to discuss whether the 1,250% risk weight adequately captures issuer default risk during the transitional period or if additional provisions are required.

Implementation and Transitional Market Risk Framework

Pre-FRTB Period (Until 2026)

During the transitional phase, institutions are required to calculate unfloored market risk using simplified standardized approaches. This provisional method allows for consistent market risk assessment until the Basel III Fundamental Review of the Trading Book (FRTB) standards are fully implemented.

Post-FRTB Period (After 2026)

The Draft RTS provide technical guidelines for adopting the alternative standardized approach and internal model approach, aligning with the updated Basel III framework.

• Output Floor Calculations:
  Both simplified and alternative standardized approaches are designed to ensure proportional treatment of crypto-assets, addressing their unique risk profiles while maintaining consistency with broader market risk frameworks.

Operational Implications for Financial Institutions

Data and System Requirements

To comply with the Draft RTS, institutions must ensure robust operational capabilities:

• Data Access:
  Institutions must have access to reliable datasets, including price observations and trading volumes, to accurately assess market exposures.
• System Enhancements:
  Systems must support:
• Segregation of netting sets to isolate high-risk exposures.
• Adjustments for leveraged exposures to reflect true risk levels accurately.

Compliance and Reporting Obligations

Institutions are required to adhere to stringent compliance and reporting measures:

• Documentation:
  Maintain detailed records of exposure calculations and adjustments for regulatory scrutiny.
• Reporting:
  Significant losses associated with high-risk crypto-asset exposures must be promptly reported to competent authorities.

Stakeholder Engagement and Next Steps

Consultation Timeline

The EBA has outlined a structured consultation process to ensure stakeholder engagement and feedback:

• 4 March 2025: Virtual public hearing to discuss the Draft RTS and gather stakeholder input.
• 8 April 2025: Deadline for submitting written feedback on the Draft RTS.

Final Adoption

Following the consultation process, the EBA will finalize and submit the RTS to the European Commission by 10 July 2025 for adoption. Stakeholder input will be incorporated to ensure the regulatory framework is robust, inclusive, and effective.