A former Bermuda financial regulator has called for a halt to the licensing of crypto currency exchanges until they resolve issues of corporate structure and client asset protections.

Writing an opinion in a recent edition of The Financial Times, the one time boss of the Bermuda Monetary Authority, Matthew Elderfield, said cryptocurrency exchanges will be forced to prove their validity in the wake of the spectacular collapse of FTX.

Mr Elderfield was the chief executive of the BMA for two years from July 2007 and is also the former deputy governor and head of financial regulation at the Central Bank of Ireland.

His FT article said that the FTX saga is only evidence of the need for high industry standards, as he opined on how to supervise a crypto exchange, suggesting regulators will have to make hard decisions on granting licences if firms are not ready for new rules coming in the European Union and the United Kingdom.

He discussed how the Financial Services and Markets Bill is winding its way through parliament in the UK, with a broad definition of crypto assets that will be subject to regulation.

And he says: “In the EU, the Markets in Crypto Assets Regulation (Mica) was agreed this summer and will come in force by 2024. With the aftershocks from the collapse of the crypto exchange FTX reverberating, a new question comes into focus: how to supervise a crypto exchange?

“Mica sets admirably tough standards for crypto asset service providers, covering exchanges. Exchanges will now need a licence from one country in order to gain a passport to do business across the whole of the EU.

“Two big changes are coming. First, corporate structure. The service providers will need to have robust corporate governance and controls, an EU legal entity and, crucially, a corporate structure with jurisdictions that do not prevent effective supervision.

“FTX’s failure highlights the importance of these standards. But it is hard to give the other exchanges good marks. The largest, Binance, will still not say where it is headquartered, for example.

“As the Bank of England’s Jon Cunliffe explains, part of the problem is that these are not really “exchanges” but rather provide multiple, bundled services that would be separated in traditional finance for conflict of interest, prudential and consumer protection reasons.

“Mica unhelpfully appears to allow such bundling of multiple services in a single legal entity. Some guardrails will be needed in detailed rules set during the run-up to implementation.

“Second, Mica will impose client asset protection rules on service providers.”

The allegation that FTX used client assets to fund its trading arm has left creditors waiting to discover their losses – without a clear understanding if that includes 100,000 or a million creditors.

Mr Elderfield said this has left other exchanges scrambling to demonstrate the validity of their proof of reserves, the assets that back customer positions.

He notes how Binance has commissioned a report from the accounting firm Mazars.

But his FT opinion article said: “But the report is limited in scope on the crypto assets it covers, unconvincing about how customer liabilities are calculated and lacks comment on the effectiveness of internal controls. Mazars announced at the end of last week that it had stopped providing proof of reserve reports entirely and painstakingly qualified past ones as not being an assurance exercise.

“Client asset segregation was a big non-crypto problem in the failure of Lehman Brothers and the broker dealer MF Global. This led to a crackdown in the UK and elsewhere, with big fines, detailed new regulatory requirements and increased personal senior manager liability.”

Mr Elderfield points out that specialised crypto rules need to be quickly put in place and regulators will have tough decisions to make on granting licences if exchanges are not ready in time for the new EU and UK rules.

He foresees that exchanges submitting licence applications will first need to make changes to their business models. And Mica has other challenging requirements.

He said: “Exchanges will have to vet each crypto asset’s suitability for customer trading based on the ‘reliability of the solutions used’ and the potential association with financial crime.

“They will also need to disclose the adverse environmental and climate-related impact of the mining required for each crypto asset. Liability for losses from hacking of customer wallets will kick in. And tougher risk warnings for crypto investments will come into force in both the EU and UK.

“Supervisors themselves have tight deadlines to make licensing decisions under Mica. The risk is that the race to be the crypto hub of Europe will sway decisions – likewise the new UK imperatives for supervisors to consider competitiveness.

“Binance, by far the largest exchange, is the key test case. The French regulator, the Autorité des Marchés Financiers, raised eyebrows by registering Binance under pre-Mica rules, despite Binance being fined by Dutch supervisors and the UK’s Financial Conduct Authority saying it was unsupervisable.

“What will happen in the (re) licensing process? Supervisors need the resources and political cover to refuse licences until corporate structure and client asset problems are sorted.

“The best way to supervise crypto exchanges? Start by not licensing them until they have got their act together.”