Federal Banking Regulators Clarify Capital Treatment of Tokenized Securities
Commentary by Sebastian Souchet
The Office of the Comptroller of the Currency, Board of Governors of the Federal Reserve System, and Federal Deposit Insurance Corporation (collectively, the Banking Agencies) issued guidance clarifying the regulatory capital treatment of "eligible tokenized securities."
In responses to Frequently Asked Questions, the Banking Agencies stated that, for regulatory capital purposes, banking organizations should treat "eligible tokenized securities" (i.e., tokenized securities that "confer legal rights identical to those of the non-tokenized form of the security") in the same manner as their non-tokenized forms. In addition, the Banking Agencies stated that "a derivative that references an eligible tokenized security should be treated for capital purposes as a derivative that references the non-tokenized form of the security."
The Banking Agencies clarified that the capital regulations are "technology neutral," and that "technologies used to issue and transact in a security do not generally impact its capital treatment." The Banking Agencies also noted that the regulations do not provide different regulatory capital treatment based on whether tokens are issued on permissioned or permissionless blockchains.
The Banking Agencies stated that "technologies used to confer legal rights to a security do not impact its ability to meet the definition of 'financial collateral'." As a result, an eligible tokenized security that satisfies the definition of "financial collateral" may be recognized by a banking organization as a credit risk mitigant (assuming all the other relevant requirements in the capital rule are met) and would be subject to the same haircuts as the non-tokenized form of the relevant security.
The Banking Agencies emphasized that banking organizations holding tokenized securities must continue to "apply sound risk-management practices and comply with applicable regulations" with respect to such exposures.
Commentary
Banking organizations should note that the guidance applies specifically to "tokenized securities that, under applicable law, confer legal rights identical to those of the non-tokenized form of the security" (emphasis added). Accordingly, a banking organization seeking to rely on the guidance must make its own determination as to whether the relevant tokenized security confers identical legal rights as compared to its non-tokenized form. Relatedly, banking organizations must also make their own determinations as to whether an eligible tokenized security qualifies as "financial collateral" under the capital rules.
As the regulators will soon issue their re-proposal of the Basel III Endgame, banking organizations should also actively analyze the re-proposal (when issued) to determine its potential impact on the positions taken in the guidance.