SEC, OCC flag heightened risks from crypto bankruptcies

Noting there has been “widespread disruption” in the crypto asset market recently, the SEC’s Division of Corporation Finance issued a sample letter Thursday urging companies to “evaluate their disclosures with a view towards providing investors with specific, tailored disclosure about market events and conditions, the company’s situation in relation to those events and conditions, and the potential impact on investors.”

The Division of Corporation Finance’s letter provided a sample list of concerns about a public company’s incomplete or missing disclosures related to its exposure to the crypto asset market. The agency would like to understand through a company’s disclosures:

• Material connections that exist between the business and the crypto asset market.
• Related to recent crypto asset company bankruptcies, how the “downstream effects of those bankruptcies have impacted or may impact your business, financial condition, customers, and counterparties, either directly or indirectly” and whether any of the firm’s assets might be lost or misappropriated.
• Direct or indirect exposures to “other counterparties, customers, custodians, or other participants in crypto asset markets” known to have filed for bankruptcy, experienced excessive withdrawals or redemptions, lost a portion of their crypto assets, or experienced material corporate compliance failures.
• Steps the firm has taken to protect its customers’ crypto assets, including policies and procedures that prevent self-dealing, conflicts of interest, and comingling of assets.
• Whether the firm has experienced excessive redemptions or withdrawals or has suspended redemptions or withdrawals of crypto assets.
• Whether the firm’s crypto assets are being used as collateral for a loan, margin, rehypothecation, or other similar activity.
• Whether crypto assets under the firm’s control serve as collateral for any other person’s loan, margin, rehypothecation, or other similar activity and whether the current crypto asset market disruption has affected the value of the underlying collateral.
• Material risks posed by “excessive redemptions, withdrawals, or a suspension of redemptions or withdrawals” of crypto assets.
• Material risks posed by potential reputational harm the firm might face because of recent disruptions in the crypto asset market.
• Material risks posed by “unauthorized or impermissible customer access to your products and services outside of those jurisdictions” and the steps the firm has taken to limit such access.
• Material risks posed by pending crypto asset legislation or the assertion of jurisdiction by U.S. or foreign regulators or government entities over the crypto asset market.
• Material risks posed to the firm because of disruption in the crypto asset market that would cause depreciation in the firm’s stock price; loss of customer demand; financing risk, including equity and debt financing; increased losses or impairments; legal proceedings; and price declines or price volatility of crypto assets.

The OCC, in its semiannual risk perspective published Thursday, warned financial institutions that risk management practices within the crypto asset market “are not yet robust.”

Market participants “appear unprepared for the stresses and surprises that have taken place this year, resulting in substantial losses for millions of consumers,” the agency said. The report noted stablecoins, which are crypto assets supposedly pegged to fiat currencies, “may be unstable” and that the risk of a failure of one crypto asset business could negatively affect many others.

Regulators’ cause for concern has spiked following the collapse of FTX, a Bahamas-based cryptocurrency exchange once valued at $32 billion that filed for bankruptcy Nov. 11. The sudden implosion roiled the cryptocurrency market generally, with other large firms, like BlockFi, collapsing in the aftermath.

Representatives from the Commodity Futures Trading Commission have also called for heightened oversight of cryptocurrency following the FTX and BlockFi bankruptcies.