New rules for ETPs and derivatives with crypto-asset underlyings

Director, Legal FS Regulatory & Compliance Services, PwC Switzerland

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On 15 February 2024, SIX Swiss Exchange published new rules which are applicable to issuers of exchange traded products (ETPs) and derivatives with crypto-asset underlyings. The new rules aim to protect investors by defining new eligibility criteria for underlying crypto-assets, imposing requirements to disclose specific information in the prospectus, and by requiring that either the issuer, the guarantor or the custodian is prudentially supervised.

Background

ETPs and listed derivatives with crypto-asset underlyings are a convenient way for investors to gain exposure to cryptocurrencies. The products can be bought and sold like blue chip stocks via a broker and can be held in a standard securities account. This makes the products easily accessible to both institutional and retail investors.

The Swiss Financial Market Authority (FINMA) and SIX have now identified a need to strengthen regulatory governance relating to listed derivatives and ETPs. The new rules of SIX are designed to address these shortcomings and to meet the requirements of FINMA.

The most impactful requirement is the one mandating that crypto-asset collateral is kept with a prudentially supervised custodian. Issuers of ETPs are typically not prudentially supervised, collateralise the ETPs with the underlying crypto-assets and keep the collateral at custodians that are not always prudentially supervised. Such issuers have to onboard a custodian which meets the new SIX requirement.

Eligible custodians under the new rules are namely Swiss banks, persons according to art. 1b of the Swiss Banking Act (i.e., fintechs) or equivalent non-Swiss institutions. Besides the costs and time necessary to introduce a new custodian into an existing ETP structure, issuers will have to re-assess the cost structure of their products, since prudentially supervised custodians are expected to charge higher fees than non-supervised custodians.

Whilst the new rules are an aggravation for many ETP issuers, they also have the potential to generate new business for custodians which meet the SIX requirements.

The sections below set out the requirements imposed by the new rules of SIX, consisting of the new Directive on Crypto-Assets as an Underlying Instrument (DCA), the revised Additional Rules for the Listing of Derivatives (ARD), the revised Additional Rules for the Listing of Exchange Traded Products (ARETP) and the revised Directive Procedures Exchange Traded Products (DPETP).

New requirements for issuers of ETPs with crypto-assets as underlyings

Today, most issuers of ETPs are not prudentially supervised and neither are many of the custodians of the underlying crypto-assets. The new rules are about to change this situation.

Both the old and new rules require ETPs to be fully collateralised with either exchange-traded financial instruments, cash balances, precious metals, futures on the underlyings or with the underlying crypto-assets. Most issuers opt for the latter option.

The new rules require that the custodian of the crypto-asset collateral is prudentially supervised unless the issuer itself or the guarantor of the ETP is prudentially supervised. Most ETP structures do not involve a guarantor. Further, most issuers of ETPs are unlicensed special purpose vehicles, and as such are not prudentially supervised. In such constellations, the issuer has to appoint a prudentially supervised institution as custodian. Eligible custodians are namely Swiss banks, securities firms, DLT trading facilities, fintechs or non-Swiss institutions with equivalent supervision.

Appointing a prudentially supervised custodian will not only impose significant legal and operational tasks on ETP issuers but will also impact their business. The running costs of an ETP structure will be significantly higher, since prudentially supervised custodians will charge the issuers higher fees than unregulated service providers.

The new rules also set out that custodians must keep the crypto-assets ready for the issuer at all times and that the assets must be allocated individually to the issuer or be kept in an omnibus wallet. In the latter case, it must be clear what share of the assets the issuer is entitled to.

This requirement will be relevant for ETP issuers intending to deploy staking, automated market making, lending or other protocols in the strategy of the ETP. This requirement will need to be addressed with the designated custodian.

Finally, the issuer must submit a compliance declaration to SIX stating that the points above are met and that the collateral qualifies as legally enforceable real security in favour of the investors.

Eligibility criteria for crypto-asset underlying derivatives or ETPs

The old rules of SIX only permitted as underlyings the top 15 crypto-assets based on their market capitalisation in USD. In contrast, the new rules set out that crypto-assets must have a minimum market capitalisation of at least USD 500 million, a daily liquidity of at least USD 50 million over 30 days and have a trading history of at least 180 calendar days.

Data from coinmarketcap.com, coingecko.com or cryptocompare.com may be used as a reference. The new rules will therefore allow significantly more crypto-assets as underlyings than the old rules (currently approx. 50).

The other eligibility criteria for crypto-assets as underlyings remain the same. These criteria exclude privacy tokens and (hybrid) asset tokens, impose requirements related to the blockchain of the crypto-assets, require a transparent pricing of the crypto-asset in a fiat currency and impose marketplace requirements. These criteria will, however, be met by most crypto-assets above the required market cap, liquidity and track record.

Suspension of trading and de-listing by SIX

Under the new rules, SIX may temporarily suspend trading of ETPs or derivatives at the request of the issuer or on their own initiative, but only if this is deemed necessary in exceptional circumstances. This rule is designed to prevent ongoing trading activity in ETPs or derivatives in cases of suspected market abuse or other criminal activity in the market of the underlying crypto-assets. If the reason for the trading suspension prevails for more than three months, the ETP or derivatives are delisted.

Prospectus and other requirements

Most ETPs do not have a fixed maturity but are open-term. The new rules require that investors in such ETPs must have a right to return their units and that the issuer may terminate and redeem the ETP. These rights and the corresponding processes are already covered in most ETP prospectuses in the sections governing the redemption processes.

The new rules also require that the prospectus or another product documentation for ETPs or derivatives must summarise the key differences between fiat currencies and crypto-assets and describe the resulting risks. Furthermore, a risk disclosure for other crypto asset-specific risks is required. Such crypto asset-specific risks are e.g., hacker attacks, volatility, lack of liquidity or risks resulting from trading on unregulated online exchanges.

The risk of trading suspension and delisting in the event of exceptional circumstances such as suspected market manipulation in the underlying market must also be disclosed in the prospectus.

Timeline

The new rules will enter into force on 1 April 2024. Issuers of ETPs and derivatives with crypto-asset underlyings that are already listed on SIX have to fulfil the new requirements within six months.

This deadline is tight. By 1 October 2024, issuers have to:

Supplement the prospectus and/or change product documentation according to the new rules (impacts both issuers of ETPs and derivatives)
Issue a compliance declaration on either the issuer or the guarantor of the ETP being a bank, insurance company, a securities firm or on a compliant collateralisation set-up (impacts issuers of ETPs)
Onboard a prudentially supervised custodian (applicable to issuers of ETPs which are collateralised with the underlying crypto-assets)