Yesterday, the International Securities Lending Association (ISLA) announced that he was appointing Ashurst to perform a preliminary legal analysis of its Global Master Securities Lending Agreement (GMSLA) in the context of digital assets. Recent events, including the Celsius bankruptcy, have highlighted several legal gray areas regarding title to digital assets, particularly when pledged as collateral.
Ashurst’s work will explore transfer of title and security over pledged securities. In terms of digital assets, ISLA said the focus is on traditional tokenized assets, native digital securities, and forms of digital cash. This doesn’t seem to include cryptocurrencies, but we asked for clarification as this is the area with the most pitfalls. And much of the rest of this article focuses on crypto issues.
“Ashurst’s appointment to help us navigate our way through this landscape ensures that the GMSLAs issued by ISLA and used for securities lending activities globally are able to support the ability of our members to take advantage of these new opportunities,” said David Shone, Market Director. Infrastructure and technology at ISLA.
The bankruptcy of Celsius highlights a delicate subject
Ten days ago, a deposit regarding the bankruptcy of crypto lender Celsius highlighted the difficult legal issues related to digital assets used as collateral and cryptocurrencies in particular.
All activity within 90 days of bankruptcy is reviewed to ensure certain creditors are not disadvantaged over others. An $841 million transaction between Tether and Celsius is under review.
The infamous Celsius has borrowed money from stablecoin firm Tether with an $841 million balance still owed in relation to the crypto crash in May. Tether requested additional guarantees in May and June, which Celsius was unable to provide. He therefore agreed that Tether could liquidate the existing cryptocurrency collateral with a loss of around $97 million.
It appears to be a legitimate transaction. However, due to the new legal situation of cryptocurrencies, it is possible that Celsius could recover the funds turning Tether into an unsecured creditor. This is because it is unclear if Tether was entitled to the warranty.
In the United States, many of these transactions are governed by the Uniform Commercial Code (UCC), which is adopted by all states, at least in part. New UCC Rules relating to digital assets which address many issues are about to come into force. Until then, there are challenges as cryptocurrencies such as Bitcoin are considered general intangible assets.
To secure crypto title, Tether would need to have:
- has filed a UCC-1 financing statement with the Secretary of State where the debtor is located for ‘perfect’ one’s safety in digital assets, or
- transform digital assets from intangibles to investment property by having a guardian take care of the keys.
In addition to the Tether scenario, another potential pitfall is that digital assets carry prior privileges. This was highlighted in a document written by Tim Swanson (page 36) in 2015. In other words, even if someone innocently buys Bitcoin, if it was pledged to someone else, the buyer is out of luck. .
The UK is also reviewing digital asset laws
At the end of July, the Law Commission of England and Wales opened a consultation on digital assets as personal property. This includes addressing the last point – if someone buys digital assets in good faith, ignoring another party’s claim, they will retain ownership of the token.
The UK currently recognizes two types of personal property, things in possession (tangible objects) and things in action (things that can be claimed in a legal action or proceeding). He suggests creating a third category, “data objects”.
It also covers liens on digital assets, requiring them to be written down.
How does this fit into the Basel III rules?
Banks must comply with Basel III rules to protect their balance sheets from volatile events. The treatment of crypto-assets is currently under review, and cryptocurrencies are treated as the highest possible risk. The first proposal did not take hedging into account. In other words, if a bank had a long position in a crypto-asset and a put option, they would both be considered risks rather than offsetting them.
However, last month’s Basel proposal makes it possible to compensate in the event of hedging.
If there are legal title issues, particularly with collateral, some offsets may not reduce risk as intended, resulting in increased risk to a bank’s balance sheet.
We wondered about the murky legal situation of digital assets, so we looked at the Basel wording. It is up to the banks to establish legal clarity.
Is the issue of legal title to digital assets on anyone’s radar?
When the FinancialTimes highlighted the Celsius/Tether topic, we reached out to a handful of organizations to see if these issues were on their radar. They included banks, custodians and industry bodies (not ISLA). Judging by the response, we would conclude that these particular legal risks have not been sufficiently considered. But the commissioning of Ashurst by ISLA means that this is changing.