In 2008, a loose US regulatory and rating regime relating to collateralised debt obligations, credit default swaps and other esoteric securities led to the collapse of Lehman Brothers and brought global markets to their knees.
The emergence of a new breed of alternative investments centred on cryptocurrencies is making supervisory agencies in Asia and further afield a lot more cautious in 2022.
The charm offensive by Changpeng Zhao (CZ), the founder and chief executive of Binance, the world’s biggest cryptocurrency exchange, illustrates the need for providers and regulators to work more closely together.
A year ago, the UK's Financial Conduct Authority ordered Binance to stop all regulated activities in that jurisdiction, saying it was “not capable of being effectively supervised”.
In an interview last week (25 June) with the UK newspaper The Observer, CZ said he is on a mission to talk to governments and regulators, to explain how Binance is structured and how the exchange plans to tighten its security to avoid being used as a conduit to launder billions in drug money.
Family office crypto investor Timothy Tsui told AsianInvestor, “First of all regulators have to understand what the coin or the DeFi organisation does. Then they have to get up to speed with what’s happening in the market. If they can get to grips with that, then they can rate it or regulate it.”
The Monetary Authority of Singapore (MAS) has been engaging with participants in the digital assets market, believing that decentralised finance (DeFi) could enhance the accessibility and affordability of financial services.
At the end of May, the MAS announced Project Guardian, an initiative that seeks to explore the economic potential of asset tokenisation, initially in the creation of a common market infrastructure.
Sopnendu Mohanty, chief fintech officer at the MAS, said at the time, “Through practical experimentation with the financial industry, we seek to sharpen our understanding in this rapidly transforming digital assets ecosystem.”
The first pilot under Project Guardian, which DBS Bank, JP Morgan Chase and Marketnode (a Singapore Exchange and Temasek joint venture digital infrastructure operator) are leading, aims to enable secured borrowing and lending on a public blockchain-based network through the execution of smart contracts.
In Hong Kong, the local securities regulator is most concerned with investor protection. The Securities and Futures Commission (SFC) included guidance in its annual report published last Wednesday (June 22) on its progress in regulating virtual assets.
“We strive to provide a clear, well-defined environment to support the development of fintech, including the rapidly growing field of virtual assets”, it said. This includes providing input to the Hong Kong government as it prepares to update the Anti-Money Laundering and Counter-Terrorist Financing Ordinance.
These changes would give the SFC the power to license and regulate centralised virtual asset exchanges trading non-security tokens. The government is aiming to introduce the draft bill into the Legislative Council by the end of this week (end June 2022).
Meanwhile, the commission is warning investors to exercise caution in trading stock tokens and virtual assets on unregulated platforms. The regulator issued a joint circular with the Hong Kong Monetary Authority in January 2022 that provided guidance to intermediaries on engaging in virtual asset dealing and advisory services.
Some unlicensed virtual asset trading platforms have offered stock tokens - virtual assets backed by depository portfolios of overseas listed stocks - to Hong Kong investors. Marketing or distributing them to Hong Kong investors constitutes a regulated activity, said the SFC.
"Unless an exemption applies, it may be an offence for any person to offer them to the Hong Kong public without our authorisation or registration."
"Without oversight by an independent third party, there may be no way to confirm that stock tokens are actually backed by an equivalent depository portfolio of the underlying shares," the guidance added.
In addition, said the SFC, the rights attached to stock tokens might not be fully disclosed to investors.
"We have received complaints from investors who had difficulty withdrawing fiat currencies or virtual assets from accounts opened with unregulated platforms. Where appropriate, we will not hesitate to take enforcement action against unlicensed platform operators.”
In 2020, South Korea took its first step toward comprehensive regulation of digital assets, passing legislation that took effect in September 2021. However, since then the Terra/Luna debacle has tested its regulatory powers. The authorities in Seoul are investigating allegations of embezzlement of the $3.5 billion-worth of Bitcoin that Terra owned, after it emerged that the transaction that caused Terra's collapse was actually maintained by founder Do Kwon’s Terraform Labs.
RATING AGENCIES WARY
In a report for clients, rating agency Moody's has argued that crypto's tech infrastructure "replaces trust in the 'known other' (other humans, institutions, intermediaries) with trust in the 'unknown other' – code, entities and dynamics – that are hard to see and understand from the outside."
For its part, Standard & Poor’s analysts have paid close attention to the volatility of crypto assets in their approach to rating issuers exposed to them. S&P does not treat crypto assets as cash or cash-like instruments, due to their unpredictability and the uncertainty about how they are or should be regulated.
According to S&P, “stablecoins are only as credible as their issuer and we need to be clear in distinguishing between assets that are more likely to be stable stores of value and those that are more risky and better classified as investment products."
The potential risks of crypto require coordination among policymakers, regulators, and standard setters, said S&P. However, different jurisdictions are taking varying approaches to regulation, making coordination unrealistic at the moment. For example, China has largely banned the private cryptocurrency industry, while rapidly progressing with the development of a digital yuan.
Regulatory and commercial attitudes towards privately issued stablecoins may shift if central bank digital currency (CBDC) initiatives such as the digital yuan make progress, according to rating agency Fitch. In its view, CBDCs could possess some of the functionality of stablecoins, presenting fewer risks to financial systems and users.