On 29 July 2021, the Central Bank of Ireland (CBI) released the 40th edition of its AIFMD Questions & Answers, which outlines its preliminary view of whether a Retail Investor Alternative Investment Fund (RIAIF) or a Qualified Investor Alternative Investor Fund (QIAIF) can invest either directly or indirectly in crypto-assets.
RIAIFs: the has CBI stated that it is highly unlikely to approve a RIAIF that seeks exposure to crypto-assets.
QIAIFs: the CBI has stated that a QIAIF seeking exposure to crypto-assets must make a submission to the CBI demonstrating that the Alternative Investment Fund Manager (AIFM) can effectively manage the risks posed by crypto-assets. But the CBI has noted that it has not been presented with any information that would demonstrate that the risks of crypto-assets can be effectively managed.
In this briefing, we set out and comment on the key updates from this Q&A.
What type of crypto-assets does the Q&A apply to?
The CBI differentiates between crypto-assets that are a digital representation of “traditional assets” such as financial instruments and commodities and crypto-assets that are “based on an intangible or non-traditional underlying”. The CBI’s comments in the Q&A relate only to the latter types of crypto-asset. Although it is not entirely clear what crypto-assets fall within that category, it is likely to include Bitcoin and Ether as it is these crypto-assets that most investment funds are currently trying to gain exposure to, albeit that such an interpretation would have to be confirmed with the CBI.
What does the CBI expect in terms of risk management at the level of the AIFM?
The CBI notes that crypto-assets present significant risks, including liquidity, credit, market, operational, fraud, cyber, money laundering, terrorist financing, legal, and reputational risks. Given the extent of these risks, then, the CBI must be satisfied that the AIFM can effectively manage the risks of a RIAIF or QIAIF investing in crypto-assets. To date, however, the CBI states that it has not seen a risk management framework that is robust enough to effectively manage the risks of crypto-assets.
This means that the CBI is imposing a high threshold on AIFMs to demonstrate that they have effective policies, procedures, and tools to effectively manage the risks of investment in crypto-assets. In other words, robust risk management targeted at crypto-assets is a necessary condition for the CBI to approve a RIAIF or QIAIF that seeks to gain exposure to crypto-assets.
Will the CBI approve a RIAIF seeking to obtain exposure to crypto-assets?
As noted in our introduction, the CBI states that it is highly unlikely that it will approve a RIAIF that seeks to gain indirect or direct exposure to crypto-assets. This is because the CBI views crypto-assets as risky and that retail investors will not be able to assess those risks when investing in a RIAIF that gains exposure to crypto-assets.
In other words, it is likely that the CBI will not authorise a RIAIF to invest in crypto-assets until such time that the risks associated with crypto-assets decrease, especially their volatility, and until retail investors have the means and tools available to assess the risks of investing in a RIAIF that has exposure to crypto-assets. This preliminary view of the CBI can be contrasted with the regulatory approach currently adopted in other jurisdictions; for example, the approach taken in Canada, where ETFs that invest in crypto-assets are open to retail investors.
Will the CBI approve a QIAIF seeking to obtain exposure to crypto-assets?
Maybe. Any QIAIF seeking to invest in crypto-assets indirectly or directly must make a submission to the CBI outlining how the AIFM can effectively manage the risks linked to crypto-assets. This means that the CBI will only grant an authorisation if the AIFM can demonstrate that its risk management system can effectively manage the risks of crypto-assets. However, as discussed above, the CBI states that it has not yet reviewed a risk management framework robust enough to reach that threshold.
That being the case, promoters of QIAIFs looking to make a submission to the CBI must have, at a minimum, the support of an AIFM which has a risk management solution that can be objectively shown to identify and manage the risks of crypto-assets. Personnel within AIFMs that have knowledge of the risks posed by crypto-assets and technology solutions that can identify and manage such risks are likely to be important components in that regard.
What will be the CBI’s approach to crypto-assets going forward?
The CBI states that its approach will be kept under review and will be informed by EU regulatory discussions and may change as new information or developments in the crypto-asset sector arise.
The proposed introduction of a Regulation on Markets in Crypto-assets (MiCA) in the future may influence the CBI’s preliminary view. MiCA will regulate the crypto-asset market infrastructure by imposing regulatory obligations on crypto-asset issuers, exchanges, depositary, and other service providers. One of its aims then is to regulate risks in the crypto-asset markets thereby making the crypto-asset infrastructure more robust. Please see our article on MiCA for more information.
Once MiCA is implemented in the EU (which we anticipate occurring sometime in 2024), AIFMs may then be in a better position to demonstrate that they can effectively manage the risks of crypto-assets. It will be interesting to observe whether the CBI’s preliminary view, as outlined above, evolves when MiCA is implemented in Ireland.