The European Commission introduced in September 2020 a proposal for a European Union (EU) regulation on a pilot regime for market infrastructures based on distributed ledger technology (DLT), commonly referred to as the DLT Pilot Regime. It is part of the European Commission’s digital finance strategy, whose purpose is to enable and support the development of digital finance through innovation and competition while mitigating associated risks.
About the DLT Pilot Regime
The DLT Pilot Regime consists in the development of harmonised requirements for market participants in scope that allow them to benefit from regulatory exemptions and disregard certain rules applicable under existing EU financial services legislations.
Objectives of the DLT Pilot Regime
The DLT Pilot Regime, the Markets in Crypto-Assets Regulation (MiCA), and the Digital Operational Resilience Act (DORA) are core components of the EU digital finance package. As such, they share the same objectives:
- Achieving legal certainty
- Supporting innovation
- Protecting consumer rights
- Ensuring financial stability
In addition, the DLT Pilot Regime specifically seeks to facilitate experimentation through derogation for the use of distributed ledger technology in the trading and post-trading of crypto-assets. The experimentation phase will last 6 years, which will help identify obstacles in the regulation and gather valuable knowledge about the application and development of the associated technology.
EU Digital finance package: get the full picture
Scope of the DLT Pilot Regime
Assets in scope of the DLT Pilot Regime
The material scope of application of the DLT Pilot Regime is limited to a specific category of assets. Contrary to the Markets in Crypto-Assets regulation, which concerns crypto-assets other than those qualifying as financial instruments under MiFID II, the DLT Pilot Regime concerns assets qualifying as financial instruments under MiFID II (the “DLT Financial Instruments”).
DLT Financial Instruments
In order to be eligible, DLT Financial Instruments shall satisfy certain conditions.
- DLT Financial Instruments consisting of shares: the issuer of these securities shall have a market capitalisation of less than EUR 500 million
- DLT Financial Instruments consisting of bonds or money market instruments shall have an issuance size of less than EUR 1 billion. Corporate bonds issued by issuers whose market capitalisation did not exceed EUR 200 million at the time of their issuance shall be excluded from the calculation of the threshold
- DLT Financial Instruments consisting of units in collective investment undertakings shall have a market value of the assets under management of less than EUR 500 million
In addition, the aggregate market value of all the DLT financial instruments that are admitted to trading on a DLT market infrastructure shall not exceed EUR 6 billion at the moment of the admission to trading or initial recording of a new DLT financial instrument.
Once the aggregate market value of all the DLT financial instruments that have been admitted to trading or recorded on a DLT market infrastructure has reached EUR 9 billion, the operator of the DLT market infrastructure will be required to activate a special transition strategy with the aim of reducing the trading activity on their platform.
DLT Market Infrastructures
The sandbox offered by the DLT Pilot Regime allows certain market infrastructures to apply for exemptions from different EU financial services legislations, notably MiFID II and CSDR.
Eligible DLT market infrastructures allowed to benefit from the sandbox temporary regime (“DLT Market Infrastructures”) may be:
- a DLT multilateral trading facility (“DLT MTF”) consisting in a multilateral trading facility operated by investment firms or market operators authorised under MiFID II, subject to the rules notably laid down in Article 4 and 7 of the DLT Pilot Regime;
- a DLT securities settlement system (“DLT SSS”) consisting in a securities settlement system operated by a central securities depository conducting securities settlement operations under CSDR, notably subject to the terms of Article 5 and 8 of the DLT Pilot Regime;
- a DLT trading and settlement system (DLT TSS) operated by an investment firm, a market operator or a CSD and which combines activities of both a DLT MTF and a DLT SSS.
In order to give effect to the sandbox regime, DLT Market Infrastructures are entitled to apply for a temporary exemption of certain rules that are not compatible with the use of DLT in the trading and post-trading phases.
Concretely and if certain conditions are satisfied, the exemption regime allows DLT Market Infrastructures to limit incompatible obstacles with a DLT. For example, a DLT MTF shall be entitled to disregard Article 3(2) of CSDR to allow the admission to trading of DLT transferable securities which are not recorded in a CSD. A DLT SSS shall have the possibility to benefit from operational exemptions for certain obligations existing under CSDR (e.g. recording of securities, integrity of the issue, segregation of assets, settlement finality). Exemptions shall be proportionate and limited to the specific use of the DLT described in the DLT Market Infrastructure’s business plan.
Industry implications of the DLT Pilot Regime
The exploratory regime promoted by the DLT Pilot Regime will help authorities identify risks and gather experience on opportunities created by crypto-assets and the underlying technologies.
DLT Pilot Regime: role of national competent authorities
National competent authorities have a central position and shall have an active role in this context. Exemptions allowing the DLT Pilot Regime to be operational depend on the ability of national competent authorities to facilitate its implementation. This may also imply an adjustment of existing national legal frameworks in order to facilitate the use of the DLT Pilot Regime. ESMA is also involved in ensuring effective convergence, financial stability, market integrity as well as proportionality of exemptions granted by national competent authorities.
Securities Services’ view
We welcome this initiative as well as the general orientation adopted by the European Commission in shaping the EU digital finance strategy and in particular the DLT Pilot Regime.
The launch of a temporary test phase is evidence of the need to design, in a pragmatic and prudent manner, new rules facilitating the development of distributed ledger technology. Leveraging on existing rules to create a new framework appears to be an appropriate method to avoid inconsistencies with pre-existing regimes and develop a sustainable model.
Business models are undoubtedly likely to have to be adapted. The ability of financial market participants to take a role in this disruptive approach will essentially depend on their capacity to adapt their service offer to the newly created digital standards (also considering potential regulatory technical standards to be further developed). This also presupposes that they gain sufficient technical knowledge in a short timeframe.
Key dates of the DLT Pilot Regime
4 January to 4 March 2022 – ESMA’s call for evidence for potential amendment of RTS developed under MiFIR relative to pre- and post-trade transparency and data reporting in order to be applied to securities issued, traded and recorded on DLT
13 January 2022 – ECON voted the draft legislation after the trilogue
24 March 2022 – Adoption by the EU Parliament
2 June 2022 – Publication in the Official Journal of the Regulation (Eu) 2022/858 of the European Parliament and of the Council on a pilot regime for market infrastructures based on distributed ledger technology, and amending Regulations (EU) No 600/2014 and (EU) No 909/2014 and Directive 2014/65/EU
23 March 2023 – Entry into application of the DLT Pilot Regime
Note: this article was first published on 14 April 2022. It was last updated on 13 April 2023.