Europe’s Crypto Clampdown: Insurers Face 100% Coverage Rule
European regulators are stepping up their scrutiny of the cryptocurrency market, which is famous for its volatility and extreme fluctuations. Cryptocurrencies have been a part of the global economy system for just a few years and are still subject to many unregulated aspects. It would come as no surprise if, as the cryptocurrency world evolves into a regulated market, new and complex forms of regulation and oversight surface.
A Stricter Standard: 100% Capital Requirement
The European Union of Insurance and Occupational Pensions (EIOPA) has suggested a much stricter guideline, seemingly in retaliation to the crypto market’s risky nature. It came to light in March 2023 that insurance companies would be forced to maintain capital backing for their crypto assets proportional to the asset itself. Unlike EIOPA’s expectations, most investments, such as equities and bonds, do not pose these restrictive conditions. Cryptocurrency depicts nothing in crypto value and is of no tangible value, unlike the crypto eco dollar in crypto-pegged currency systems. Cryptos are required to fulfill a backing ratio, which is higher than 50%. As such, the investment will earn positive returns.
EIOPA’s Rationale: Inherent Risks and High Volatility
Despite how harsh these regulations appear, EIOPA heavily bases them on the need to be perpetually on the safe side for what some perceive as the pitfalls of putting capital into the volatile speculative market. As prone as crypto assets are to collapse, it’s hard to argue against them imploding risks.
Filling the Regulatory Gap: MiCA and CRR
EIOPA’s initiative attempts to fill the gap that exists in the interface of the Capital Requirements Regulation and Markets in Crypto Assets Regulation (CRR and MiCA). In the European Union, there is no insurance regulatory framework that adequately covers crypto assets, and this lack is what compels the need for policy change.
Options Considered: A 100% Stress Level
EIOPA identified four options, each one differing in its mix of effectiveness and practicality for enforcement:
Business as usual: No changes to policy.
Moderate limits: Insurers must maintain a capital reserve equal to 80% of their crypto asset exposure.
Full reserves: Insurers must maintain a capital reserve equal to 100% of their crypto asset exposure.
Wider scope for tokenized assets: A broader assessment of the risks related to tokenized assets is urged by the European Commission.
EIOPA’s Preferred Option: A 100% Haircut
EIOPA backs the strongest option, which is also called the third option—the full reserves or 100% stress level. EIOPA considers the approach inexcusably 80% stressful and 100% comforting, while transitional measures under CRR are less risk-sensitive and make more sense.
The Stress Level is 100%. Reasoning: A diversified portfolio is not safe.
The diversification approach outlined by EIOPA does not work at the stress level of 100%, which assumes crypto asset prices can fall to $0. Because risks tend to correlate at the ‘tail’ end of a distribution, there is no real option to diversify meaningfully. Historical data for Bitcoin (BTC) and Ether (ETH) show they both have gotten beaten down in price too, BTC 82% and ETH 91%.
Crypto Assets Maha Marga
As noted above, the suggested capital charge for crypto assets is 100%, which is a much harsher treatment than other financial vehicles receive. Stocks are allocated capital charges of 39% to 49%, while real estate faces a 25% capital charge, according to the Commission Delegated Regulation 2015/35.
Impact on Policyholder Protection: Aim for Better Safety
EIOPA sees no significant burden in imposing a 100% capital charge on the direct insurance and reinsurance linked to crypto assets <some profit> and thinks it improves policyholder protection. The authority thinks that the extra measure with regards to crypto assets will capture overwhelming risk that would breach policyholder protections foremost in case of large losses.
The “Immaterial” Portion Relating to Crypto Assets: A Warning
EIOPA highlights the strikingly low presence of crypto-asset (re)insurance undertakings in relation to all assets in Europe, which stands at a mere €655 million or 0.0068 percent. So diminutive that the authority refers to it as ‘immaterial.’
The Reasoning: Major Risk, Possibility of Complete Loss
No matter the size, EIOPA stresses the importance of focusing on the ‘high-risk’ nature of crypto assets, which can lead to ‘total loss of value.’ This possibility of being completely destitute is what has led the authority to recommend a 100% capital charge, which is the highest possible measure for policyholder protection.
Sweden or Luxembourg: Potentially the Most Hard-Hit
A draft report for Q4 2023 referenced by EIOPA estimates that Luxembourg and Sweden stand the most chance of being disproportionately impacted by the rule. These two countries contributed to 69% and 21% of all crypto asset exposures among (re)insurance undertakings, respectively.
Nature of Crypto Investments: Primarily Through on Behalf of Policyholders
EIOPA indicates that these holdings in crypto assets are more often than not structured within funds, such as ETFs, and are held for unit-linked policyholders.
A Possible New Approach Differentiated By The Future
As explained, EIOPA (the European Insurance and Occupational Pensions Authority) suggests a 100% capital charge for now while reserving the right to use a more “differentiated approach” in the future as the uptake of crypto assets becomes more widely accepted. In other words, the approach may change as the crypto market expands and deepens its integration into the economy.
Conclusion: Regulating Potential Innovational Risks
Once again, Intas’s policy statement seeks to ensure that the purpose behind these policies is to protect clients and policyholders. At the same time, policy framework regulation aims to advance innovation responsibly while minimizing risks. The forecasted regulatory reaction to crypto-assets by EIOPA, resulting in a “volatile” risk categorization of crypto-assets, which requires insurers to hold 100% of their capital, is rather aggressive in adapting to the fast-paced growth of these products. The flexibility observed in policies governing virtual assets indicates the willingness to encourage the use of such assets while aiming to mitigate risks inherently possessed by the volatility of these products in such entities.
