This final report presents regulatory technical standards to define highly liquid financial instruments in the reserve of assets of issuers of asset-referenced tokens. It stipulates that these instruments must have minimal market, credit, and concentration risk, and be quickly liquidable to meet redemption requests from token holders. The report aims to harmonize and clarify eligible investments in the reserve of…
This document is the final report of the European Banking Authority (EBA) published in June 2024, entitled "Final report on draft RTS to specify the highly liquid financial instruments in the reserve of assets." It is a 57-page regulatory standard (only the first 37 pages are provided) which specifies the highly liquid financial instruments with minimal risks (market, credit, concentration) that may compose the asset reserve of issuers of asset-referenced tokens (ART) and electronic money institutions (EMT) according to Regulation (EU) 2023/1114. The scope covers regulatory aspects, liquidity risks, the definition of eligible assets, concentration limits, and reserve management requirements for the current period.
The report addresses the specification of highly liquid financial instruments with minimal risks that issuers of asset-referenced tokens (ART) and electronic money institutions (EMT) must hold in their asset reserve, pursuant to Article 38(5) of Regulation (EU) 2023/1114 (p. 3). This topic is crucial to ensure financial stability and the issuers' capacity to meet redemption requests from token holders, including under stress conditions (p. 3, 5). The main findings are: (i) the reserve must consist of liquid financial instruments, quickly transferable with minimal price impact, (ii) sufficient correlation must exist between the assets referenced by the tokens and the instruments held to limit value mismatch risk, (iii) liquidity and concentration requirements draw from the LCR (Liquidity Coverage Ratio) framework and UCITS limits, (iv) an unwinding mechanism is necessary for collateralized financing operations, (v) specific limits are set: maximum 35% for level 1 sovereign bonds, 35% for high-quality covered bonds, and 5% for other securities or crypto-assets (p. 3, 10, 16, 18). The conclusions are that including high-quality covered bonds (up to 35%) is essential to allow issuers in all official currencies to meet requirements without excessive concentration on bank deposits (p. 25-26). The recommendation is to adopt the proposed RTS, which harmonize and clarify eligibility criteria, concentration limits, and valuation methods, while providing for rapid communication in case of non-compliance of held instruments (p. 20, 36-37). These RTS will be submitted to the Commission, then to the European Parliament and the Council before official publication (p. 3).
The document responds to the regulatory obligation arising from Regulation (EU) 2023/1114 which requires issuers of asset-referenced tokens (ART) and electronic money institutions (EMT) to establish an asset reserve covering their liabilities towards token holders (p. 4). This reserve must include liquid and safe assets to guarantee redemption capacity at any time, including under stress (p. 5). The EBA is mandated by Article 38(5) of the Regulation to define eligible highly liquid financial instruments, considering the types of assets referenced by the tokens, the correlation between these assets and the reserve, LCR framework requirements, UCITS concentration limits, as well as risks related to asset custody (p. 4-6). The objective is to ensure financial stability by limiting liquidity, market, credit, and concentration risks, while harmonizing eligibility criteria at the European level (p. 22-23). The scope excludes non-liquidity related aspects and does not address operational management modalities beyond regulatory requirements (p. 12-13).
- Definition of highly liquid financial instruments: The EBA relies on the legal definition of financial instruments under MiFID II and CRR, including transferable securities, money market instruments, fund units, and derivatives linked to these assets (p. 6-7). Instruments must meet the general and operational criteria of delegated Regulation (EU) 2015/61 related to the LCR, without benefiting from exemptions granted to sovereign bonds in this framework, due to quantitative limits imposed in the reserve (p. 7, 28-30).
- Composition of the asset reserve: For tokens referenced to official currencies, at least 30% (non-significant) or 60% (significant) must be held as bank deposits (p. 4-5). The remainder may be invested in highly liquid financial instruments, notably level 1 sovereign bonds (capped at 35%), very high-quality covered bonds (capped at 35%), and other financial instruments linked to the referenced assets (p. 10, 16, 25-26).
- Liquidity risks and financial stability: The reserve must be quickly liquidatable with minimal price impact to meet redemption requests, including under stress. Excessive concentration on bank deposits or a single issuer could lead to systemic risks, notably bank runs and fire sales destabilizing markets (p. 5-6).
- Correlation between referenced assets and reserve: The EBA emphasizes the importance of sufficient correlation between the value of assets referenced by the tokens and that of instruments held in reserve to limit value mismatch and de-pegging risk (p. 11-12, 30-33). It proposes including in the reserve financial instruments or derivatives linked to the referenced assets, without setting minimum or maximum thresholds, leaving risk management to the issuer (p. 12, 55).
- Concentration limits: Drawing from the UCITS framework, the EBA sets a general 5% limit per issuer for securities other than sovereign and covered bonds, a 35% limit for level 1 sovereign bonds, and a 10% limit for very high-quality covered bonds (p. 10, 33-35). These limits aim to ensure sufficient diversification while allowing issuers in non-euro currencies to meet reserve requirements (p. 34).
- Unwinding mechanism: To avoid overestimation of the reserve related to collateralized financing operations (repos, swaps), an unwinding mechanism is provided, aligned with that of the LCR, taking into account cash inflows and outflows over a 5 business day horizon (p. 8-10).
- Custody and asset concentration: The EBA recommends issuers implement measures to limit concentration of assets in custody with entities of the same group, even if it does not set precise thresholds, due to market constraints (p. 12-13).
- Operational requirements: All instruments must be unencumbered, easily valued, traded on recognized markets, diversified, and accessible without legal or practical impediments (p. 28-30).
- Public consultation: Responses mostly supported the proposals, with requests for clarifications notably on concentration limits for government bonds in USD and management of cases where an instrument ceases to meet criteria (p. 36-37).
- Established facts:
- Eligible financial instruments must meet LCR criteria, notably be level 1 with 0% haircut, and respect precise concentration limits (5%, 10%, 35%) (p. 16, 18, 33).
- The reserve must contain at least 30% to 60% bank deposits depending on the nature and size of the tokens (p. 4-5).
- Inclusion of high-quality covered bonds up to 35% of the reserve is necessary to ensure diversification and compliance in all official currencies (p. 25-26).
- Assumptions:
- Sufficient correlation between referenced assets and the reserve limits de-pegging and excessive volatility risk (p. 11, 30).
- Application of an unwinding mechanism over 5 business days allows correct reflection of the real liquidity of assets in the reserve (p. 8-10).
- Interpretations:
- The EBA interprets that LCR exemptions for sovereign bond requirements should not apply in this context due to imposed quantitative limits (p. 28-30).
- The absence of LCR haircuts in asset valuation is compensated by a minimum overcollateralization requirement (p. 56).
- Uncertainties:
- The risk of increased volatility linked to inclusion of volatile referenced assets in the reserve remains to be managed by issuers (p. 54).
- Concentration of assets in custody with entities of the same group may pose unquantified risks (p. 12-13).
- The impact of future market developments and international regulatory frameworks on these standards remains to be monitored (p. 8, 16).
The EBA concludes that the definition of highly liquid financial instruments must rely on level 1 assets with 0% haircut under the LCR framework, complemented by very high-quality covered bonds capped at 35% of the reserve, and financial instruments or derivatives linked to the referenced assets without mandatory thresholds (p. 25-26, 30-33). It recommends applying concentration limits inspired by the UCITS framework (5% general, 35% for sovereign bonds, 10% for covered bonds) to ensure adequate diversification while allowing issuers in all official currencies to meet regulatory requirements (p. 33-35). The EBA proposes an unwinding mechanism aligned with the LCR to reflect the real liquidity of assets in the reserve (p. 8-10). It stresses the necessity for issuers to have risk management procedures, notably for asset concentration in custody, and provides for a rapid communication obligation to the competent authority in case of non-compliance of held instruments (p. 12-13, 20, 36-37). These RTS must be adopted by the European Commission, then validated by the Parliament and the Council before official publication (p. 3, 20).
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