The Swiss Financial Market Supervisory Authority (FINMA) has published a guidance on the risks associated with the custody of crypto-based assets. In it, the authority sets out requirements designed to protect the interests of the investors of these asset types.
The guidance highlights risks associated with third-party custodians. Should these third parties become insolvent, the segregability of the cryptoassets cannot be guaranteed. If the custodian is also located abroad, the legal complexity increases. In particular, the report states, “The risk increases significantly if the third-party custodian is not subject to prudential supervision and does not have to comply with any supervisory standards for custody. Findings from FINMA’s supervision show that these risks were not always adequately taken into account by the supervised institutions in the past.”
The guidance covers investment management in three areas – individual portfolios, collective assets, and structured products or crypto exchange-traded products (ETPs).
Individual portfolios
Institutions involved in individual portfolio management must ensure that the assets they manage are held in safekeeping, segregated per client, with a bank, securities firm, DLT trading facility, or other institution “that is subject to supervision equivalent to that in Switzerland”. Institutions compliant with the Markets in Crypto-Assets Regulation (MiCAR) in the EU, for example, may qualify.
The guidance cautions, “It is the responsibility of the institutions to ensure appropriate custody of crypto-based client assets in accordance with the aforementioned requirements. Custody arrangements that do not meet the regulatory requirements must be adjusted in the interests of client protection.” Exceptions to this rule may be permitted if certain conditions regarding client education and transparency are met.
Collective assets
For Swiss collective assets, direct investments must be held in custody at a Swiss custodian bank. It is possible to delegate custody to “an equivalently supervised third-party custodian” if that custodian is “is subject to equivalent prudential supervision and equivalent bankruptcy protection rules for crypto-based assets exist in this regard”.
Structured products
The issuing of structured products to retail investors by special purpose entities is permitted based on two conditions: the products must be offered by prudentially supervised institutions, and the issuer must provide a legally enforceable guarantee from a prudentially supervised financial intermediary, in lieu of which, a legally enforceable real security must be provided in favour of the investors.
The guidance acknowledges that risk exists “when offering structured products in the crypto sector with regard to the custody of the underlying crypto-based assets pledged as security”. “Real” security will therefore require legal protection “in the event of the insolvency of the custodian of the security”.
