Basel cryptoasset capital standards: HKMA consults on Hong Kong implementation

A.  Classification conditions for Group 1 cryptoassets (qualifying tokenised traditional assets and qualifying stablecoins)

To qualify as a Group 1 cryptoasset, four classification conditions set out in the Basel Cryptoasset Standards and the HKMA consultation paper must be satisfied. The classification conditions impose different requirements depending on whether the cryptoasset in question is a tokenised traditional asset or a stablecoin. 

a.  Classification condition 1

Specific requirements for tokenised traditional assets under classification condition 1: A tokenised traditional asset will meet classification condition 1, and therefore be eligible to be categorised as a Group 1a cryptoasset, if:

•  it is a digital representation of a traditional asset using cryptography, DLT or similar technology to record ownership; and

•  it poses the same level of credit and market risk as the traditional (non-tokenised) form of the asset, which generally requires the cryptoasset to confer the “same level of legal rights” as the relevant traditional asset.  Generally, a cryptoasset would not meet this requirement if: (i) it first needs to be redeemed or converted into a traditional asset before receiving the same legal rights as direct ownership of the traditional asset; or (ii) through its specific construction, it involves additional counterparty credit risks compared with the traditional asset.

Specific requirements for stablecoins under classification condition 1: A stablecoin will meet classification condition 1, and therefore be eligible to be categorised as a Group 1b cryptoasset, if it has a stabilisation mechanism that is effective at all times in linking its value to a traditional asset or a pool of traditional assets (“reference asset(s)”). Specifically, the cryptoasset must satisfy each of the following specific requirements:

• The cryptoasset is designed to be redeemable for a predefined amount of a reference asset(s) or cash equal to the current market value of the reference asset(s) (e.g. HKD 1 or 1 ounce of gold). The value of the reference asset(s) to which one unit of the cryptoasset is designed to be redeemable is referred to as the “peg value”.

• The stabilisation mechanism is designed to minimise fluctuations in the market value of the cryptoassets relative to the peg value. 

• The stabilisation mechanism enables risk management similar to the risk management of traditional assets, based on sufficient data or experience. For newly established cryptoassets, there may be insufficient data and/or practical experience to perform a detailed assessment of the stabilisation mechanism.

• Banks should document and make available to the HKMA on request the assessment they conducted and the evidence used to determine the effectiveness of the stabilisation mechanism, including the composition, valuation and frequency of valuation of the reserve assets and the quality of available data. 

• There exists sufficient information that banks use to verify the ownership rights of the reserve assets upon which the stable value of the cryptoasset is dependent. 

• The cryptoasset passes the redemption risk test and the issuer is supervised and regulated by a supervisor that applies prudential capital and liquidity requirements to the issuer. The redemption risk test is aimed at ensuring that the reserve assets are sufficient to enable the cryptoassets to be redeemable at all times for the peg value, including during periods of severe stress. The redemption risk test focusses on the value, composition, quality and management of reserve assets. 

• Redemption risk test: To pass the redemption risk test, a bank must ensure that the cryptoasset arrangement meets the following conditions:
  • Value and composition of reserve assets: the value of the reserve assets (net all non-cryptoasset claims on these assets) must at all times, including during periods of extreme stress, equal or exceed the aggregate peg value of all outstanding cryptoassets. If the reserve assets expose the holder to risk in addition to the risks arising from the reference assets, the value of the reserve assets must sufficiently overcollateralise the redemption rights of all outstanding cryptoassets. The level of overcollateralisation must be sufficient to ensure that even after stressed losses are incurred on the reserve assets, their value exceeds the aggregate value of the peg of all outstanding cryptoassets.
  • Asset quality criteria for reserve assets: for cryptoassets that are pegged to one or more currencies, the reserve assets must be comprised of assets with minimal market and credit risk. The assets shall be capable of being liquidated rapidly with minimal adverse price effect. Further, reserve assets must be denominated in the same currency or currencies in the same ratios as the currencies used for the peg value (unless explicitly otherwise allowed by the HKMA). A de-minimis portion of the reserve assets may be held in a currency other than the currencies used for the peg value, provided that the holding of such currency is necessary for the operation of the cryptoasset arrangement and all currency mismatch risk between the reserve assets and peg value has been appropriately hedged.
  • Management of reserve assets: the governance arrangements relating to the management of reserve assets must be comprehensive and transparent. They must ensure that the following requirements are met:
    • The reserve assets are managed and invested with an explicit and legally enforceable objective of ensuring that all cryptoassets can be redeemed promptly at the peg value, including under periods of extreme stress.
    • A robust operational risk and resilience framework exists to ensure the availability and safe custody of the reserve assets.
    • A mandate that describes the types of assets that may be included in the reserve must be publicly disclosed and kept up to date.
    • The composition and value of the reserve assets are publicly disclosed on a regular basis. The value must be disclosed at least daily and the composition must be disclosed at least weekly.
    • The reserve assets are subject to an independent external audit at least annually to confirm they match the disclosed reserves and are consistent with the mandate.

b.  Classification condition 2

A cryptoasset will satisfy classification condition 2 if all rights, obligations and interests arising from the relevant cryptoasset arrangement are clearly defined and legally enforceable in all the jurisdictions where the asset is issued and redeemed. This requirement means that, among other things, the relevant cryptoasset arrangement must at all times be properly documented and ensure full transferability and settlement finality. A bank must conduct a legal review of the cryptoasset arrangement to ensure classification condition 2 is met, and must make the review available to the HKMA upon request. The Basel Cryptoasset Standards and the HKMA consultation paper set out detailed requirements that must be met to satisfy classification condition 2, including additional requirements for stablecoins to satisfy classification condition 2. 

The additional requirements for stablecoins to satisfy classification condition 2 include, among other things, the stablecoin must provide a robust legal claim against the issuer and/or underlying reserve assets and must ensure “full redeemability” (i.e., the ability to exchange the cryptoasset for amounts of pre-defined assets such as cash, bonds, commodities, equities or other traditional assets) at all times and at its peg value. In order for a cryptoasset arrangement to be considered as having “full redeemability”, it must allow for the redemption to be completed within 5 calendar days of the redemption request at all times.  

In addition, the cryptoasset arrangement must clearly define: (i) which parties have the right to redeem; (ii) the obligation of the redeemer to fulfil the arrangement; (iii) the timeframe for redemption to take place; (iv) the traditional assets subject to the exchange; and (v) how the redemption value will be determined. According to the Basel Cryptoasset Standards and the HKMA consultation paper, the cryptoasset arrangement must also be valid in situations where the parties involved may not be located in the same jurisdiction where the cryptoasset is issued and redeemed. At all times, settlement finality in the cryptoasset arrangement must be properly documented such that it is clear when key financial risks are transferred from one party to another, including the point at which transactions are irrevocable. 

c.  Classification condition 3

A cryptoasset will satisfy classification condition 3 if functions of the cryptoasset and the network on which it operates, including the distributed ledger or similar technology on which it is based, are designed and operated to sufficiently mitigate and manage material risks. Specifically, the functions of the cryptoasset, such as issuance, validation, redemption and transfer of the cryptoassets, and the network on which it runs, must not pose any material risks that could impair the transferability, settlement finality or, where applicable, redeemability of the cryptoasset. This means that entities performing activities associated with these functions must follow robust risk governance and risk control policies and practices to address risks including, without limitation: credit, market and liquidity risks; operational risk (including outsourcing, fraud and cyber risk) and risk of loss of data; various non-financial risks, such as data integrity; operational resilience (i.e. operational reliability and capacity); third-party risk management; and anti-money laundering / countering the financing of terrorism (AML/CFT).

In addition, all key elements of the network must be well-defined such that all transactions and participants are traceable. The Basel Cryptoasset Standards and the HKMA consultation paper set out detailed requirements that must be met to satisfy classification condition 3. 

d.  Classification condition 4

A cryptoasset will satisfy classification condition 4 if entities that execute redemptions, transfers, storage or settlement finality in respect of the cryptoasset, or manage or invest reserve assets: (i) are regulated and supervised, or are subject to appropriate risk management standards; and (ii) have in place and disclose a comprehensive governance framework. According to the Basel Cryptoasset Standards and the HKMA consultation paper, entities subject to condition 4 include operators of the transfer and settlement systems for the cryptoasset, wallet providers and, for cryptoassets with stabilisation mechanisms, administrators of the stabilisation mechanism and custodians of the reserve assets.   

B.    Classification conditions for Group 2 cryptoassets

Group 2 cryptoassets are cryptoassets (including tokenised traditional assets, stablecoins and unbacked cryptoassets such as Bitcoin) that do not meet the classification conditions for Group 1 cryptoassets. Group 2 cryptoassets are further subdivided into Group 2a cryptoassets and Group 2b cryptoassets. Group 2a cryptoassets are those cryptoassets that satisfy the Hedging Recognition Criteria while Group 2b cryptoassets are those cryptoassets that do not satisfy the Hedging Recognition Criteria. A Group 2 cryptoasset must be categorised as Group 2b, unless the bank demonstrates to the HKMA that the cryptoasset satisfies the Hedging Recognition Criteria.

The Hedging Recognition Criteria requires that:

(1)  The bank’s cryptoasset exposure is one of the following:

• A direct holding of a spot Group 2 cryptoasset where there exists a derivative or exchange-traded fund (“ETF”) or exchange-traded note (“ETN”) that solely references the cryptoasset and that is traded on a regulated exchange that clears these trades through a qualifying central counterparty (“QCCP”).
• A derivative or ETF/ETN that references a Group 2 cryptoasset, where the derivative or ETF/ETN has been approved by a jurisdiction’s financial markets regulator for trading or the derivative is cleared by a QCCP.
• A derivative or ETF/ETN that references a derivative or ETF/ETN that meets the criterion immediately above.
• A derivative or ETF/ETN that references a cryptoasset-related reference rate published by a regulated exchange that clears these trades through a QCCP.

(2)  The bank’s cryptoasset exposure, or the cryptoasset referenced by the derivative or ETF/ETN, is highly liquid, meaning that the average market capitalisation was at least HKD 78 billion over the previous year and the 10% trimmed mean of daily trading volume with major fiat currencies is at least HKD 390 million over the previous year.

(3)  Sufficient data is available regarding the cryptoasset over the previous year, meaning that there were at least 100 real price observations and sufficient data exists regarding trading volumes and market capitalisation. 

C.   Minimum regulatory capital requirements for Group 1 cryptoassets

Under the Basel capital rules (as implemented in Hong Kong), a bank’s assets are generally allocated to either the banking book (which are subject to the Basel credit risk capital rules as implemented in Hong Kong) or the trading book (which are subject to the Basel market risk capital rules as implemented in Hong Kong). 

The Basel Committee has published “boundary criteria” to demarcate the boundary between the banking book and the trading book and to guide banks on how to allocate their assets between the banking book and trading book. These rules generally apply to Group 1 cryptoassets, provided that Group 1a cryptoassets must be assigned based on the application of the boundary criteria to the equivalent non-tokenised traditional assets and Group 1b cryptoassets must be assigned to the banking book or trading book based on the application of the boundary criteria to the relevant reference asset(s). 

Furthermore, cryptoasset exposures are not subject to the regulatory capital deduction requirement that applies to intangible assets under the existing Basel capital rules (as implemented in Hong Kong), even where the cryptoasset is classified as an intangible under applicable accounting standards. 

Group 1a cryptoassets (qualifying tokenised traditional assets): Group 1a cryptoassets held in the banking book will generally be subject to the same rules to determine credit risk-weighted assets (“RWAs”) as non-tokenised traditional assets. For example, a tokenised corporate bond held in the banking book will be subject to the same risk weight as the non-tokenised corporate bond held in the banking book. 

For AIs adopting the basic approach, only Group 1a cryptoassets issued by the Hong Kong government and domestic public sector entities (DPSEs, e.g. HKMC) held in the banking book will be subject to the same rules to determine risk-weighted amounts for credit risk as non-tokenised traditional assets. Other Group 1a cryptoassets held in the banking book must be risk-weighted at 1,250% and will not be eligible to be used as collateral for credit risk migration.

Taking into account different market liquidity characteristics: The regulatory capital treatment outlined above is based on the assumption that if two exposures confer the same level of legal rights (to cash flows, claims in insolvency, ownership of assets, etc.) and the same likelihood of paying the owner all amounts due on time (including amounts due in case of default), they will likely have very similar values and pose a similar risk of credit losses.  However, there are areas of the Basel credit risk capital rules (as implemented in Hong Kong) that aim to capture risks that are not directly related to the legal rights of an asset held by a bank or likelihood of timely payment. Banks must separately assess the tokenised traditional asset against these rules, and not assume qualification for a given treatment simply because the traditional (non-tokenised) asset qualifies. For example, when considering the eligibility of being recognised as collateral, it should be noted that a tokenised asset may have different market liquidity characteristics than the traditional (non-tokenised) asset. This could arise because the pool of potential investors that are able to hold tokenised assets might be different to non-tokenised assets.

Recognising Group 1a cryptoassets as eligible collateral: The capital rules include a list of eligible forms of financial collateral that may be recognised as a credit risk mitigation technique for the purpose of calculating the RWA of an exposure. Generally, only Group 1a cryptoassets that are tokenised versions of the instruments included on the list of eligible financial collateral set out in the capital rules may qualify as recognised collateral.

The potential for market liquidity characteristics and market values of tokenised assets to differ from non-tokenised assets is important in considering whether Group 1a cryptoassets meet the requirements for the purposes of credit risk mitigation. Also, the speed with which a secured creditor could take possession of cryptoasset collateral may be different from that for a traditional asset. Therefore, before such assets are recognised as collateral for the purposes of credit risk mitigation, banks must separately assess whether they comply with the relevant eligibility requirements for collateral recognition, such as whether the collateral can be liquidated promptly and legal certainty requirements.

In addition to assessing whether tokenised assets held as collateral are eligible to be recognised as credit risk mitigation, banks must analyse the period of time over which they can be liquidated and the depth of market liquidity during a period of downturn. Cryptoassets can only be recognised as collateral where volatility in values and holding periods under distressed market conditions can be confirmed to not be materially increased compared with the traditional asset or pool of traditional assets.

Group 1b cryptoassets (qualifying stablecoins): As a result of the classification conditions, Group 1b cryptoassets must be designed to be redeemable for a predefined amount of a reference asset(s), or cash equal to the value of the reference asset(s). In addition, the cryptoasset arrangement must include a sufficient pool of reserve assets to ensure the redemption claims of cryptoasset holders can be met.

Depending on the way they are structured, stablecoins may expose a bank to risks arising from reference asset as well as the default risk of the redeemer. 

If the reference asset (e.g., a bond) for a Group 1b cryptoasset gives rise to credit risk, banks must calculate RWAs for a direct holding of the reference asset using the applicable Basel credit risk capital rules (as implemented in Hong Kong). In addition, if the reference asset gives rise to foreign exchange or commodities risk, banks must calculate RWAs for a direct holding of the reference asset using the applicable Basel market risk capital rules (as implemented in Hong Kong).

For Group 1b cryptoassets that reference a pool of traditional assets, banks must apply the requirements applicable to equity investments in funds to determine the RWA applicable as if the banks had a direct holding of the referenced pool of traditional assets. 

If the bank holding the cryptoasset has a secured or unsecured claim against the redeemer in case of default, the bank must calculate RWAs for its exposure to the redeemer using the applicable Basel credit risk capital rules (as implemented in Hong Kong). On the other hand, certain stablecoins may be structured to avoid cryptoasset holders being exposed to the credit risk (either directly or indirectly) of the redeemer. For example, where the underlying reserve assets are held in a bankruptcy remote special purpose vehicle on behalf of the holders of cryptoassets who have direct claims on the underlying reserve asset(s), a bank may not need to calculate credit RWAs in respect of the redeemer provided that the bank has obtained an independent legal opinion for all laws relevant to the parties involved, including the redeemer, the SPV and custodian, confirming that relevant courts would recognise underlying reserve assets held in a bankruptcy-remote manner as those of the cryptoasset holder.

The Basel Cryptoasset Standards and the HKMA consultation paper also contain detailed rules for calculating RWAs where intermediaries perform the redemption function in respect of a stablecoin. For example, Group 1b cryptoassets may be structured such that only a subset of holders (“members”) are allowed to transact directly with the redeemer to redeem the cryptoasset. Holders that cannot transact directly with the redeemer (“non-member holders”) are therefore reliant on the members for the cryptoassets to maintain their value relative to the reference assets. There are different rules for calculating RWAs where a bank is a member and where the bank is a non-member holder.

Group 1b cryptoassets are NOT eligible collateral: Group 1b cryptoassets, including those that can be redeemed for traditional instruments that are on the list of eligible financial collateral, are not recognised collateral. This is because the process of redemption may add counterparty risk that is not present in a direct exposure to a traditional asset.

Market risk: The Basel Cryptoasset Standards and the HKMA consultation paper set out detailed rules for determining the risk-based capital requirements for Group 1 cryptoasset exposures using the Simplified Standardised Approach, the Standardised Approach and the Internal Models Approach under the Basel market risk capital rules (as implemented in Hong Kong). 

Derivatives on Group 1 cryptoassets: Derivatives on Group 1 cryptoassets will generally be subject to the same capital requirements for counterparty credit risk (“CCR”) and credit valuation adjustment (“CVA”) as non-tokenised traditional assets. 

Add-on for infrastructure risk for Group 1 cryptoassets: According to the Basel Committee and HKMA, the technological infrastructure for cryptoassets (e.g., DLT) is relatively new and a bank’s regulator must have the power to apply an add-on to the capital requirement for exposures to Group 1 cryptoassets. The add-on for infrastructure risk will initially be set as zero but can be activated and increased by the HKMA based on any observed weakness in the infrastructure used by Group 1 cryptoassets.

D.   Minimum capital requirements for Group 2 cryptoassets

Under the Basel Cryptoasset Standards and the HKMA consultation paper, minimum capital requirements for Group 2a and Group 2b cryptoassets are calculated differently. 

a.  Group 2a cryptoassets

At a high level, the capital requirements for Group 2a cryptoassets will be calculated according to a modified version of the Simplified Standardised Approach (“SSA”) or a modified version of the Standardised Approach (“SA”) under the Basel market risk rules (as implemented in Hong Kong), regardless of whether the Group 2a cryptoassets are actually allocated to the bank’s banking book or the trading book. Details regarding these modified approaches, which permit some recognition of hedging, are set out in the Basel Cryptoasset Standards and the HKMA consultation paper. The Internal Models Approach (“IMA”) under the Basel market risk rules (as implemented in Hong Kong) is not applicable to Group 2a cryptoassets. 

Derivatives referencing Group 2a cryptoassets will be subject to the Standardised Approach for Counterparty Credit Risk (“SA-CCR”), as modified in the manner described in the Basel Cryptoasset Standards and the HKMA consultation paper.

b.  Group 2b cryptoassets

Under the Basel Cryptoasset Standards and the HKMA consultation paper, there is no separate trading book and banking book treatment for Group 2b cryptoassets. Instead, the conservative capital treatment for Group 2b cryptoassets is intended to capture both credit and market risk, including CVA risk. In addition to direct exposures to Group 2b cryptoassets, the conservative capital treatment also applies to: (i) funds of Group 2b cryptoassets (e.g., Group 2b cryptoasset ETFs) and other entities, the material value of which is primarily derived from the value of Group 2b cryptoassets; and (ii) equity investments, derivatives or short positions in these funds or entities.

For each Group 2b cryptoasset to which it is exposed, a bank must apply a very high risk weight of 1,250% to the greater of the absolute value of the aggregate long positions and the absolute value of the aggregate short positions in the cryptoasset.  The 1,250% risk weight also applies to short positions. However, short positions and certain other types of exposures could lead to unlimited losses. Therefore, in some cases, applying a 1,250% risk weight may be insufficient to cover potential future losses. Banks are responsible for demonstrating the materiality of these risks under the supervisory review of cryptoassets and whether risks are materially underestimated. The HKMA will then consider imposing an add-on capital charge in cases where banks have material exposures to short positions in cryptoassets or to cryptoasset derivatives that could give rise to losses that exceed the capital required by the 1,250% risk weight.

E.   Minimum capital requirements for operational risk

In addition to credit risk and market risk, the Basel capital rules (as implemented in Hong Kong) also impose minimum capital requirements for operational risk, which means the risk of loss to a bank resulting from inadequate or failed internal processes, people and systems or from external events. 

According to the Basel Cryptoasset Standards and the HKMA consultation paper, operational risks arising from cryptoasset activities should generally be captured by the existing components of the Basel operational risk framework, such as the Business Indicator component (which should include income and expenses resulting from activities relating to cryptoassets) and the Internal Loss Multiplier component (which should include the operational losses resulting from cryptoasset activities).

F.   Leverage ratio requirements

In addition to risk-based capital requirements, the Basel capital rules (as implemented in Hong Kong) also impose minimum leverage ratio requirements. The leverage ratio captures both on- and off-balance sheet sources of a bank’s leverage. It is non-risk based “backstop” measure designed to restrict the build-up of excessive leverage in the banking sector to avoid destabilising deleveraging processes that can damage the broader financial system and the economy.

According to the Basel Cryptoasset Standards and the HKMA consultation paper, consistent with the existing Basel leverage ratio rules, cryptoassets should generally be included in the leverage ratio’s “exposure measure” according to their value for financial reporting purposes, based on applicable accounting treatment for exposures that have similar characteristics. 

G.   Minimum liquidity risk requirements

In addition to risk-based and leverage capital ratio requirements, the Basel prudential rules (as implemented in Hong Kong) also impose minimum liquidity risk requirements on banks. Among other things, in-scope banks are required to comply with minimum liquidity coverage ratio (“LCR”) and net stable funding ratio (“NSFR”) requirements.

By way of background, the LCR promotes the short-term resilience of a bank's liquidity risk profile. It does this by ensuring that a bank has an adequate stock of unencumbered high-quality liquid assets (“HQLAs”) that can be converted into cash easily and immediately in private markets to meet the bank’s liquidity needs for a 30 calendar day liquidity stress scenario. The NSFR requires a bank to maintain a stable funding profile in relation to its on- and off-balance sheet activities, thus reducing the likelihood that disruptions to a bank's regular sources of funding will erode its liquidity position in a way that could increase the risk of its failure and potentially lead to broader systemic stress.

According to the Basel Cryptoasset Standards and the HKMA consultation paper, for the purposes of complying with the LCR and NSFR requirements, cryptoasset exposures (including assets, liabilities and contingent exposures) must generally follow a treatment that is consistent with existing approaches for traditional exposures with economically equivalent risks. Having said this, the treatment should also appropriately reflect the additional risks presented by cryptoassets compared with traditional assets, and the relative lack of historical liquidity data in respect of cryptoassets. Therefore, while the treatment of cryptoassets largely relies on the principles and calibrations set forth in the Basel Committee’s existing LCR and NSFR rules, these rules require additional clarifications to address the unique risks posed by cryptoassets. These additional clarifications are set out in the Basel Cryptoasset Standards and the HKMA consultation paper. 

Among other things, the Basel Cryptoasset Standards and the HKMA consultation paper clarify that Group 1a cryptoassets that are a tokenised version of an HQLA may only be considered as an HQLA for the purposes of the LCR to the extent both the underlying assets in their traditional form and the tokenised form of the assets satisfy the characteristics of HQLA set out in the Basel liquidity rules. 

H.   Large exposures requirements

Besides regulatory capital and liquidity requirements, the Basel prudential rules also impose large exposure requirements on banks, which address the risk of significant losses associated with the failure of a counterparty or a group of connected counterparties (a “single counterparty”) by limiting a bank’s large exposures to any single counterparty.

According to the Basel Cryptoasset Standards and the HKMA consultation paper, the treatment of cryptoassets will follow the same principles as for other exposures set out in the existing Basel large exposures rules (as implemented in Hong Kong). Accordingly, cryptoasset exposures that give rise to a credit risk exposure should generally be included in a bank’s large exposure measure according to their accounting value. 

Note that the large exposure requirements are separate from the Group 2 Exposure Limit discussed earlier in this article. 

I.     Risk management requirements

According to the Basel Cryptoasset Standards and the HKMA consultation paper, cryptoasset activities introduce new types of risks to a bank and increase certain traditional risks. Therefore, banks with direct or indirect cryptoasset exposures or that provide related services in respect of cryptoassets must establish policies and procedures to identify, assess and mitigate, on an ongoing basis, the risks (including operational risks, credit risks, liquidity risks including funding concentration risk and market risks) related to cryptoassets or related activities.

A bank’s policies and procedures for cryptoasset activities should be informed by existing HKMA and Basel Committee publications on operational risk management (e.g., SPM modules OR-1 ‘Operational Risk Management’ and OR-2 ‘Operational Resilience’) and cryptoassets. 

The decision to hold cryptoassets (either under trading or banking book) and provide services to cryptoasset operators must be fully consistent with a bank’s risk appetite and strategic objectives as set down and approved by the board, as well as with senior management’s assessment of the bank’s risk management capabilities, in particular for market and counterparty risk (including CVA), liquidity risk (including funding concentration risk) and operational risk.

The Basel Cryptoasset Standards and the HKMA consultation paper include further details on the risk management requirements with which banks should comply. 

J.   Disclosure requirements

By way of background, Pillar 3 of the Basel prudential framework is designed to promote market discipline through regulatory disclosure requirements. These disclosure requirements enable market participants to access key information relating to a bank’s regulatory capital and risk exposures in order to increase transparency and confidence about a bank’s exposure to risk and the overall adequacy of its regulatory capital.

According to the Basel Cryptoasset Standards and the HKMA consultation paper, the disclosure requirements for banks’ exposures to cryptoassets or related activities must follow the five general guiding principles for banks’ disclosures under the Basel Committee’s existing Pillar 3 disclosure rules. Among other things, a bank must disclose an overview of its activities related to cryptoassets and the key risks related to its cryptoasset exposures, including descriptions of:

• business activities related to cryptoassets, and how these business activities translate into components of the risk profile of the bank; 
• risk management policies of the bank related to cryptoasset exposures; 
• scope and main content of the bank’s reporting related to cryptoassets; and 
• most significant current and emerging risks relating to cryptoassets and how those risks are managed. 

In accordance with these general guiding principles, banks must disclose information regarding any material Group 1a, Group 1b, Group 2a and Group 2b cryptoasset exposures on a regular basis, including for each specific type of cryptoasset exposure information on:

• the direct and indirect exposure amounts (including the gross long and short components of net exposures);
•  the capital requirements; and
• the accounting classification.

In addition to the separate disclosure requirements set out above that apply to all Group 1a, Group 1b, Group 2a and Group 2b cryptoassets, banks must include exposures to Group 1 cryptoassets in the relevant existing disclosure templates that apply to traditional assets (e.g. for credit risk and market risk).

In October 2023, the Basel Committee proposed a set of standardised disclosure templates regarding banks’ cryptoasset exposures. The standardised cryptoasset disclosure templates require banks to publish detailed qualitative information regarding their cryptoasset activities and related risk management practices as well as quantitative information regarding their cryptoasset risk exposures.