Key Takeaways
- • McCarthy Tetrault partner Greg Winfield argues that the failures of crypto lenders and exchanges, including entities caught up in the collapse of FTX, have chilled institutional interest in digital assets and prompted tighter regulatory scrutiny.
- • Winfield identifies five core crypto risks for pension plans: custody, anti-money laundering and sanctions, securities regulation, tax, and investment risk, with crypto described as highly speculative and extremely volatile.
- • Winfield contends that larger private and public-sector pension plans should build crypto expertise now, since they may be exposed through pooled funds, service-provider payments, or member requests even without a direct allocation.
- • Recommended steps include organizing expertise, reviewing the statement of investment policies and procedures (SIPP), documenting decisions, and starting with a modest initial position.
Summary
The last six months have been difficult for pension plans and other institutional investors considering cryptocurrencies, according to Greg Winfield of McCarthy Tetrault LLP. The bankruptcies of several crypto lending businesses, some tied to the collapse of the exchange FTX, have dampened market sentiment and led governments and regulators to scrutinize market participants more closely, tighten certain requirements, and impose new disclosure obligations.
Winfield argues that digital assets are unlikely to disappear from the commercial world and that the current downturn offers public-sector and larger private-sector pension plans an opportunity to learn about the asset class, identify risk areas, and develop standards for managing them. He describes cryptocurrencies as blockchain-based stores of value in which a private key controls transfers, and notes that a coin or token is essentially software code recording the value held at a blockchain address. He identifies custody risk, anti-money laundering and sanctions risk, securities regulatory risk, tax risk for non-tax-exempt entities, and investment risk as the main concerns. Because crypto does not represent a payment obligation or a participating interest in an issuer's net assets, Winfield notes it is difficult to value with traditional techniques and is highly speculative and extremely volatile.
Winfield argues that ignoring an asset class entirely can be as imprudent as investing without understanding it. He suggests that smaller plans may reasonably deprioritize the topic, but that larger private and public plans should make greater efforts to understand crypto, since exposure may arise indirectly through pooled funds paying crypto dividends, service providers requesting crypto payment, or members asking for crypto distributions. Investors can gain exposure directly through crypto or crypto-linked ETFs, or indirectly through crypto-linked businesses, and can use funds or managed accounts to limit direct handling. Winfield stresses that due diligence should cover the applicable regulatory regime, such as US registered RIA/CPO, EU AIFM, MiFID, or Canadian PM/IFM rules, along with the manager's risk mitigation, counterparty diversification, and valuation methods.
He outlines a sequence of steps: assembling expertise, often through outside advisers; deciding whether a "go" decision is warranted; reviewing and, if needed, amending the SIPP, including how crypto is characterized as a commodity, security, or currency and whether valuation language is adequate; and documenting the decision-making, due diligence, and sell conditions. He also suggests keeping an initial investment modest relative to plan size and reviewing the position regularly against the plan's assets and liabilities.
Winfield argues that digital assets are unlikely to disappear from the commercial world and that the current downturn offers public-sector and larger private-sector pension plans an opportunity to learn about the asset class, identify risk areas, and develop standards for managing them. He describes cryptocurrencies as blockchain-based stores of value in which a private key controls transfers, and notes that a coin or token is essentially software code recording the value held at a blockchain address. He identifies custody risk, anti-money laundering and sanctions risk, securities regulatory risk, tax risk for non-tax-exempt entities, and investment risk as the main concerns. Because crypto does not represent a payment obligation or a participating interest in an issuer's net assets, Winfield notes it is difficult to value with traditional techniques and is highly speculative and extremely volatile.
Winfield argues that ignoring an asset class entirely can be as imprudent as investing without understanding it. He suggests that smaller plans may reasonably deprioritize the topic, but that larger private and public plans should make greater efforts to understand crypto, since exposure may arise indirectly through pooled funds paying crypto dividends, service providers requesting crypto payment, or members asking for crypto distributions. Investors can gain exposure directly through crypto or crypto-linked ETFs, or indirectly through crypto-linked businesses, and can use funds or managed accounts to limit direct handling. Winfield stresses that due diligence should cover the applicable regulatory regime, such as US registered RIA/CPO, EU AIFM, MiFID, or Canadian PM/IFM rules, along with the manager's risk mitigation, counterparty diversification, and valuation methods.
He outlines a sequence of steps: assembling expertise, often through outside advisers; deciding whether a "go" decision is warranted; reviewing and, if needed, amending the SIPP, including how crypto is characterized as a commodity, security, or currency and whether valuation language is adequate; and documenting the decision-making, due diligence, and sell conditions. He also suggests keeping an initial investment modest relative to plan size and reviewing the position regularly against the plan's assets and liabilities.
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