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EU agrees regulation of crypto assets – Industry roundup: 4 July

EU agrees regulation for ‘wild west’ of crypto assets

The European Union (EU) has moved to guard against market abuse and manipulation of crypto assets by agreeing a pioneering set of rules for the sector.

At the end of last month, the European Parliament finalised the Markets in Crypto Assets (MiCA) legislative proposal. Developed to help streamline distributed ledger technology (DLT) and virtual asset regulation in the EU, it is expected to become law at the end of 2023.

Globally, crypto assets are largely unregulated, with national operators in the EU required only to show controls for combating money laundering. With the EU as the first major jurisdiction to implement a comprehensive regulatory framework for crypto, the new rules are expected to set global standards and affect regulations in other regions of the world

The MiCA Proposal regulations challenge crypto companies to help prevent money laundering and other illicit activities potentially involving digital assets. Spanish Green Party lawmaker Ernest Urtasun, who participated in the process, commented: “The new rules will enable law enforcement officials to be able to link certain transfers to criminal activities and identify the real person behind those transactions.”

Stefan Berger, the German MEP who led negotiations on behalf of the parliament, added: “Today, we put order in the wild west of crypto assets and set clear rules for a harmonised market. The recent fall in the value of digital currencies shows us how highly risky and speculative they are and that it is fundamental to act.”

MiCA gives issuers of crypto assets and providers of related services a “passport” to serve clients across the EU from a single base, while meeting capital and consumer protection rules. However it does not extend to cover non-fungible tokens (NFTs), which in 2021 was a US$40 billion market.

It also addresses the issue ‘unhosted wallets’ - wallets held by private individuals that are not managed by a licensed platform. The EU Parliament has favoured requiring crypto asset service providers (CASPs) to identify their "unhosted" counterpart when transacting.

The finalised regulations claim that: “In case a customer sends or receives more than 1k euros to or from their own unhosted wallet, the CASP will need to verify whether the unhosted wallet is effectively owned or controlled by this customer.” While this is likely to be unwelcome news for many crypto users, who value their privacy, for most transfers from/to wallets, there will not be any mandatory verification.

The EU negotiations also focused on issues such as supervision and energy consumption of crypto assets. “We have agreed that crypto asset providers should in future disclose the energy consumption and environmental impact of assets,” said Berger.

Harry Eddis, the global co-head of fintech at London-based law firm Linklaters, told UK daily The Guardian that the EU had “nailed its crypto colours to the mast”.

“Other jurisdictions have shown little appetite to date in following their lead in implementing such an all-encompassing regulation, although we can surely expect to see other financial services centres upping their game in regulating the crypto community, albeit in a more piecemeal fashion,” he added.

Italy bond issue sees highest borrowing costs in years

Italy has paid the highest borrowing costs on its debt since the wake of the eurozone debt crisis of 2010 to 2012, after the European Central Bank (ECB) decided to withdraw stimulus measures and triggered a sell-off in the bloc’s bond markets.

At the end of June, the Italian government sold €6 billion worth of medium- and long-dated bonds at an auction at the highest yields in almost a decade. Italy auctioned €2 billion worth of 10-year bonds and € 4bn worth of five-year bonds last Thursday, at yields of 3.47% and 2.74% respectively. It last sold 10 and five-year bonds at higher yields in 2014 and 2013 respectively.

The country’s government debt yields, which move inversely to their prices, remain well below the levels reached at the height of the European sovereign debt crisis. But they have moved higher since the beginning of 2022. Last month, Italy sold 10-year bonds at a 3.1% yield.

Resurgent inflation, which has been exacerbated stoked by Russia’s invasion of Ukraine and intensifying supply-chain pressures, has driven the ECB and other major central banks to end a prolonged era of loose monetary policy. Last month, the Eurozone consumer price inflation rate hit a record 8.6%.

ECB President Christine Lagarde last month pledged that the bank will act in “a determined and sustained manner” to tackle rapidly rising prices – and signalled that the ECB will withdraw its massive bond-buying programme introduced in response to the pandemic and also raise interest rates at its next meeting on 21 July for the first time. time since 2011.

Recession fears “leave €40bn of European corporate bonds in distress”

More than €40 billion of European corporate bonds are now trading at distressed levels, according to a Financial Times report, which says that it reflects how a worsening economic outlook has sparked concerns about companies’ ability to pay their debts.

The FT’s calculations based on Ice Data Services indices suggest that the pile of euro-denominated corporate bonds flashing warning signs has jumped in six months, from €6 billion at the end of 2021.

Over the period of 31 May to 30 June alone, the stock of distressed corporate debt more than doubled from, highlighting mounting concerns that central banks’ decisions to tighten monetary policy could push major economies into recession. Investors also worry that high levels of inflation will increase companies’ cost of doing business.

“Credit markets have rapidly moved towards pricing in a recession,” European credit analysts at JPMorgan said on Friday (1 July). The investment bank’s cautious tone echoed a report earlier last week from S&P Global, which warned on Europe’s “increasingly murky outlook for credit quality”.

“Credit ratings are likely to come under pressure into 2023 as supply constraints keep food and energy prices elevated, households increasingly struggle with falling real incomes, and central banks prioritize inflation over growth,” the rating agency said.

Sentiment has rapidly grown more downbeat since the rush into risky assets triggered by the major stimulus measures introduced in 2020 by central banks and governments to lessen the impact of the Covid-19 crisis.

Bonds trading at distressed levels – with a yield above government benchmarks, or spread, of more than 10 percentage points – now account for 8.8% of the Ice index of euro-denominated junk bonds, compared with 1.3% at the end of 2021. It shows that investors are pricing in the risk that they will not receive money when bonds mature, pushing up the yield of companies’ bonds.

Meanwhile, the iTraxx Crossover, which tracks the cost of junk bond credit default swaps – insurance-like products that protect against defaults on Europe’s riskiest bonds – has risen to levels last seen in April 2020.

BIS says banks can keep 1% of reserves in Bitcoin

The Bank for International Settlements (BIS), which has maintained a sceptical tone towards digital currencies – intensified during the recent cryptocurrency market crash – has nonetheless indicated willingness to extend its hand to the new asset class by allowing banks to hold up to 1% of reserves in cryptocurrencies such as Bitcoin.

BIS’s Basel Committee on Banking Supervision (BCBS) has made the proposal for limiting the banks’ total exposures to Group 2 cryptossets to 1% of Tier 1 capital in its consultative document titled ‘Second consultation on the prudential treatment of cryptoassets’, published on 30 June.

Group 2 refers to the assets that do not meet classification conditions and includes specific tokenised traditional assets and stablecoins, as well as unbacked crypto assets, while Group 1 includes tokenised traditional assets and stablecoins that meet classification conditions.

The document states: “Banks’ exposures to Group 2 cryptoassets will be subject to an exposure limit. Banks must apply the exposure limit to their aggregate exposures to Group 2 cryptoassets, including both direct holdings (cash and derivatives) and indirect holding (ie those via investment funds, ETF/ETN, special purpose vehicles).”

It also specifies that “a bank’s total exposure to Group 2 crypto assets must not be higher than 1% of the bank’s Tier capital at all times,” in line with the Basel Framework, which includes all the BCBS’s standards.

As it explains:“The large exposure rules of the Basel Framework are not designed to capture large exposures to an asset type, but to individual counterparties or groups of connected counterparties. This would imply, for example, no large exposure limits on cryptoasset where there is no counterparty, such as Bitcoin.” 

With this in mind, “the Committee proposes, therefore, to introduce a new exposure limit for all Group 2 cryptoassets outside of the large exposure rules.” Meanwhile, this provisional limit set at 1% of Tier 1 capital would be reviewed periodically.

US dollar Libor transition begins countdown to D-Day

The one-year countdown began last week to the end of the publication of the tarnished London Interbank Offer Rate (Libor) for existing US dollar-denominated contracts, but reports suggests that volatile market conditions have delayed the switch to new rates for some market participants.

“We have 12 months until D-Day from a legacy paper perspective,” Tal Reback told Reuters. Reback, who leads KKR’s global Libor transition effort across private equity, credit, capital markets and real estate, added: “The next six to nine months are really the critical range because you already lost a few months due to market volatility this year.”

In the leveraged loan market, unsettled market conditions have prevented many issuers from tapping the markets, which is when they would normally revisit existing debt and potentially convert it to another interest rate benchmark, slowing the transition, Reback said.

According to JPMorgan and IHS Markit, 87.8% of leveraged loans are still linked to Libor, which until it became discredited was the global benchmark for pricing everything from mortgages and student loans, to derivatives and credit cards.

Regulators mandated Libor's end after fining banks billions for rigging the rate and have recommended market participants use alternatives compiled by central banks, such as the Federal Reserve's secured overnight financing rate (SOFR).

Calculated in five currencies, Libor was largely phased out for new contracts at the end of 2021, though the bulk of existing US dollar-denominated contracts have until the end of June 2023to make the switch.

Other parts of the market have made substantial progress, with SOFR futures surpassing the number of eurodollar futures contracts on the Chicago Mercantile Exchange (CME) for the first time in April, and federal legislation in March enabling contracts that lack the mechanics to switch from one rate to another to move to SOFR.

Crypto lender Vauld suspends withdrawals

Singapore-headquartered crypto lending and exchange start-up Vauld, which is backed by Coinbase, said it has suspended withdrawal, trading and deposits and hired advisers to explore a potential restructuring.

The three-year-old start-up, which has raised about US$27 million, appears to be the latest casualty of the slump in digital assets. Vauld said that it is facing financial challenges amid the market downturn, which it said has prompted customer withdrawals of about US$198 million since 12 June.

Vauld founder and chief executive Darshan Bathija said that it has engaged with Kroll for financial advice and Cyril Amarchand Mangaldas and Rajah & Tann for legal advice in India and Singapore.

The start-up intends to apply to the Singapore courts for a moratorium. “We are confident that, with the advice of our financial and legal advisors, we will be able to reach a solution that will best protect the interests of Vauld’s customers and stakeholders,” Bathija wrote in a blog post, adding that the Vauld will make “specific arrangements” for certain customers who need to meet their margin calls.

Chinese developer Shimao defaults on US$1bn bond

Chinese property developer Shimao Group Holdings said it had missed payment on a US$1 billion note that matured at the weekend. It marks the group’s first default on a public bond after months of mounting stress and adds to a record year of offshore-bond delinquencies in the sector.

The luxury building developer said in a Hong Kong exchange filing that it also failed to make principal payments involving some other offshore debts and has been in discussion with creditors while trying to reach “amicable resolutions." If these efforts fail, “creditors may have the right to demand acceleration of repayment" and take enforcement actions, according to the company.

Shimao’s delinquency is among the biggest dollar payment failures so far this year in China and the firm has about US$5.5 billion in outstanding offshore bonds.

Concerns about the group’s financial health have grown over recent months, as a sweeping crackdown on China’s real estate industry triggers a record wave of delinquencies. Shimao, the country’s 14th-biggest developer by contracted sales last year and which also builds commercial properties, last month failed to pay off a private note, a delinquency that heightened concerns about hidden bills at Chinese builders.

South Korea’s pension fund completes rare FX hedging

South Korea’s National Pension Service sold a small amount of dollars on the forward market in May in its first foreign exchange hedging since early 2020, an official at the agency told Reuters on Thursday.

The official, who declined to be named due to the sensitivity of the issue, did not disclose any more details such as the timing of the sale and amounts involved.

The agency held a combined 312.3 trillion won (KRW) – around US$240.2 billion – worth of foreign stocks and bonds as of the end of April, according to the latest data from the agency.

The KRW has been in decline against a broadly stronger US dollar in recent months and fell below a psychologically important KRW 1,300-per-dollar level in June for the first time since 2009.

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