FSB releases consultative report addressing regulation, supervision and oversight of crypto-asset activities and markets

The Financial Stability Board, as mandated by the G20, has scrutinised the regulatory and supervisory risks raised by crypto-asset activities and published their findings in a comprehensive report. In this article, we unpack the Regulation, Supervision and Oversight of Crypto-Asset Activities and Markets: consultative report.

Systemic risks to financial systems

The Financial Stability Board (FSB) is an international body that coordinates and liaises with national financial authorities with the aim of ensuring international financial stability. A key function of the FSB is to identify systemic risks to financial systems and set out policy recommendations on effective mitigation strategies.

The report discusses the issues related to implementing a sufficient regulatory framework for crypto-assets and proposes nine policy recommendations (which we have set out at the end of this article). The policy recommendations aim to ensure that future innovation in the area is sustainable and safe for the global financial environment.

Key risks

The FSB, in consultation with policymakers, outlined what it considers to be the most prominent issues and challenges in the regulation of the crypto-asset market. These include:

• the challenges related to the reach of regulatory and supervisory powers where the crypto-asset activities are offered globally and extend past jurisdictional legal perimeters.
• the fact that crypto-asset activities mostly occur on what is known as a decentralised finance (DeFi) system in which the operations and governance of the activities is unclear. Therefore, determining accountability/apportioning liability can be very difficult as there is no natural person or company with direct oversight.
• effective cross-border regulatory supervision of crypto-asset activities, where the same activity may be defined or regulated differently in and across different jurisdictions. This leads to further issues, in particular that crypto-asset businesses may structure themselves differently depending on the jurisdiction they operate in, so as to avoid regulatory oversight.
• the risk-management issues related to wallet services, in particular non-custodial wallets, where users hold custody of their crypto-assets themselves and these assets are unrecoverable in the event of password loss, account inaccessibility or a cyber incident.
• the increased interconnectedness of the crypto-asset system and the wider financial system. Increased trading between the two systems means that there could be significant ramifications on the wider financial market should there be failures or distrust in the crypto market because of the lack of regulation or sufficient oversight.
• conflicts of interests, which arise because of crypto-asset service providers engaging in a range of functions such as trading, custody, brokerage, lending, settlement/clearing, issuance and promotion.
• the lack of available and reliable data on crypto-asset activities raises issues as to a regulator’s ability to properly monitor and assess the risks or instability in the crypto-asset sector and the potential for spillover into the wider financial system. The lack of data is a result of the fact that the entities which hold/collect the data are unregulated and not subject to any reporting requirement, as well as the fact that, while the blockchain is publicly available, only limited information is stored on it (and what is stored on the blockchain is anonymised).

The path forward

The report makes an important observation that the economic functions and activities of the crypto-asset market bear certain similarities to the traditional financial system. The traditional financial system has its own set of international policies, and standard, which could be adapted to cover the crypto-asset market. The FSB holds the position that effective regulation is based off the principle of ‘same activity, same risk, same regulation’.

The FSB also noted that most authorities are already applying existing financial market regulation to crypto-asset activities based on the crypto-asset’s function. The key however, is to ensure the regulatory framework and its enforcement is internationally consistent.

The report reinforced the notion that existing international standards/frameworks could be applied as they are, or added to, to regulate the crypto-asset market. For example, the Basel Framework imposes prudential requirements on banking institutions. The FSB proposes that the Basel Framework be amended to include guidelines on the banking sector’s crypto-asset exposure.

Proposed recommendations

The FSB’s proposed recommendations for the regulation, supervision and oversight of crypto-asset activities are based on an approach which is consistent, comprehensive, and internationally enforced.

In developing a framework for crypto-asset regulation, the report proposes that the authorities should:

• ensure they have the appropriate powers and tools, and adequate resources, to regulate, supervise, and oversee crypto-asset activities and markets, including crypto-asset issuers and service providers, as appropriate;
• apply effective regulation, supervision, and oversight to crypto-asset activities proportionate to the financial stability risk they pose, or potentially pose;
• cooperate and coordinate with other regulatory institutions (domestically and internationally) to encourage consistency of regulatory and supervisory outcomes;
• require that crypto-asset issuers and service providers have in place a comprehensive governance framework, which provides clear lines of responsibility and accountability;
• require crypto-asset service providers to have an effective risk-management framework;
• require that crypto-asset issuers and service providers have in place robust frameworks for collecting, storing and safeguarding data, as well as reporting this data in a timely and accurate manner;
• require that crypto-asset issuers and service providers disclose to users and relevant stakeholders comprehensive, clear and transparent information regarding their operations, risks and financial conditions;
• identify and monitor the relevant interconnections within the crypto-asset ecosystem, as well as between the crypto-asset ecosystem and the wider financial system; and
• ensure that crypto-asset service providers that combine multiple functions and activities, are subject to regulation and oversight that addresses the risks associated with individual functions specifically as well as those arising from the combination of functions.