Federal Reserve Staff Economists Propose Separate Crypto Risk Class in ISDA SIMM

Federal Reserve Board staff economists proposed creating a distinct cryptocurrency risk class for uncleared derivatives within ISDA's Standardized Initial Margin Model ("SIMM"). 

In a Finance and Economics Discussion Series paper, the authors examined the prospective classification of cryptocurrency risks within the SIMM framework. They explained that while SIMM functions as the industry standard for calculating initial margin, it currently lacks a methodology for crypto-sensitive assets despite the crypto market reaching approximately $4 trillion in capitalization. The authors argued that because cryptocurrencies "rely on distributed ledger technology" and generate risk dynamics distinct from traditional asset classes, they should be treated as a standalone classification rather than being incorporated into existing commodity or FX risk classes.

The authors highlighted the following for integrating cryptocurrencies into SIMM:

1. Establishing a Distinct Risk Class. The authors proposed creating a distinct cryptocurrency risk class within SIMM, divided into two buckets: "pegged" stablecoins and "floating" unpegged cryptocurrencies. They argued this separation is necessary because the two groups exhibit materially different volatility and stress-period clustering, which cannot be adequately captured if cryptocurrencies are treated as traditional commodities or combined into a single bucket.
2. Calibrating Stress Periods. The authors noted that historical stress periods for cryptocurrencies do not align with the S&P GSCI, the "pseudo-index" used to calibrate SIMM’s commodity risk class.
3. Assessing Correlations. The authors estimated that the inter-bucket correlation between floating and pegged cryptocurrencies is "slightly negative [but extremely] close to zero," and they recommended setting it to zero.