The Office of the Superintendent of Financial Institutions (OSFI) has issued guidance related to the regulatory treatment of cryptoassets, marking the first such framework in Canada. 

In this document, OSFI distinguishes between Group 1 and Group 2 cryptoassets. Group 1, which must meet a stringent set of criteria, is largely treated like comparable traditional assets. Group 2, which is anything outside of Group 1, has significant restrictions in terms of how those assets should be valued for risk calculations, and in the exposure financial institutions can accept.

Guidance around credit risk, counterparty risk, leverage requirements, liquidity treatment, and exposure limits are detailed in the document, but a few points bear highlighting:

• Group 1 assets are treated like comparable assets for credit risk capital treatment. Group 2 assets, however, are to be deducted from Common Equity Tier 1 (CET1) capital and may not be ascribed any collateral value (i.e., they are subject to a 100% haircut).

• Institutions should hedge or diversify between instruments referencing the same cryptoasset. Open unhedged exposures should receive a 100% capital charge.

• Funding received from cryptoasset issues, or exposures associated with the reserve assets of a stablecoin, should be treated as an exposure to a financial institution and do not contribute any stable funding credit in the net stable funding ratio (NSFR).

• Federally Regulated Financial Institutions (FRFIs) should notify OSFI in writing if total gross positions across all Group 2 cryptoasset exposures exceed 1% of capital (Tier 1 capital for DTIs and life insurers; capital available for property, casualty and mortgage insurers), or if total net short positions across all Group 2 cryptoasset exposures exceeds 0.1% of the above capital amounts.

Implications

This is an important first step in Canada in terms of classifying and standardizing cryptoassets. The guidance sets strict classification requirements, but also allows those that meet the standards to be treated largely like comparable traditional assets.  It steeply discounts the valuation of assets that don’t meet those criteria, which should help assuage concerns among traditional investors regarding the impact of cryptoassets on their own positions. This could promote conversations around adoption of crypto products in established financial institutions, but we should note that the strictness of the requirements will mean that a very limited number of products would be eligible for Group 1 inclusion.  For example, for a stablecoin to be included in Group 1, the issuer would need to be prudentially regulated by a governing body with standards comparable to OSFI’s. A sudden explosion of regulated, readily available cryptoassets is unlikely to result.

In the future, as cryptoassets increasingly come under the regulatory umbrella, this could reduce the advantage for fintechs and provide an avenue for Canadian firms to further explore the crypto space and establish or expand their offerings. At the same time, the tax and insurance implications are likely to be complex, and we would expect the requirements for inclusion in Group 1 to remain stringent. The movement of cryptoassets from “anonymous” transactions to regulated and monitored activity is likely to shift consumer perception – perhaps making them more appealing for the general public, and less appealing for early crypto adopters.

Definitions

Group 1 assets must meet all the following criteria:

• They are digital representations of traditional assets;

• A legal opinion has been obtained confirming that all rights, obligations, and interests are clearly defined, legally enforceable, and consistent with comparable traditional assets;

• A legal opinion has been obtained confirming settlement finality;

• All entities performing transfer, settlement, or redeemability functions follow robust risk governance and control policies; and

• All entities that execute redemptions, transfer, storage, or settlement, or that manage or invest reserve assets, are regulated and supervised.  For a stablecoin to receive Group 1 treament, the issuer must be subject to regulatory oversight comparable to what would be provided by OSFI.