Introduction
After almost two years of long and cumbersome EU legislative making process, on 2 June 2022 the Regulation on a pilot regime for market infrastructures based on distributed ledger technology (Regulation (EU) 2022/858 “DLT-Pilot Regime”) was finally published in the EU Official Journal. The DLT Pilot Regime introduces an EU-wide regulatory sandbox within which entities willing to operate securities trading and settlement systems based on DLT (“DLT market infrastructures”), may be exempted from certain requirements applicable under the existing EU regulatory framework, that may hinder deployment of DLT in securities trading. The Regulation was originally published as part of the EU Digital Finance Package alongside the proposal for Regulation on markets in crypto-assets (MiCAR) that aims to create harmonized regulatory framework on crypto assets in the EU.
Pilot Regime
Going live on 23 March 2023, the DLT Pilot Regime will run initially for a period of 6 years, during which regulated investment firms, market operators and central securities depositories (CSDs) willing to operate DLT market infrastructures will be able to apply with their NCAs for exemption from certain requirements applicable under the Markets in Financial Instruments Regulation (MiFIR), the Central Securities Depository Regulation (CSDR) and the Settlement Finality Directive. The permission to operate DLT market infrastructure will also come with the EU passport, enabling operators to provide their services across the EU based on a single permission.
DLT market infrastructures
The DLT Pilot Regime will enable regulated entities to operate DLT market infrastructures that include:
- DLT multilateral trading facility (“DLT MTF”) which is a multilateral trading facility, operated by an investment firm or a market operator, that only admits to trading DLT financial instruments;
- DLT securities settlement system (“DLT SS”) which is a securities settlement system, operated by a central securities depository (CSD), that settles transactions in DLT financial instruments;
- DLT trading and settlement system (“DLT TSS”) which refers to a DLT MTF or DLT SS that combines services performed by a DLT MTF and a DLT SS operated by an investment firm, market operator or alternatively a CSD.
The scope of application of the pilot regime is limited to DLT market infrastructure serving the trading or settlement of financial instruments within the meaning of MiFID II that are issued, recorded, transferred and stored using a DLT (the so called “DLT financial instruments"). In order to enable tokenization of financial instruments, the EU Commission has also separately proposed the extension of the definition of a financial instrument under MiFID II which shall now include financial instruments issued by means of DLT as well.
Limitations
The DLT Pilot Regime will apply solely in relation to the following types of financial instruments:
- shares, the issuer of which has a market capitalisation, or a tentative market capitalisation, of less than EUR 500 million;
- debt securities (bonds, money market instruments, securitized debt excluding instruments that embed derivative or have complex structure) with an issue size of less than EUR 1 billion;
- units in collective investment undertakings the market value of the assets under management of which is 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. Where this threshold is surpassed, the operators 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.
Exemptions from existing requirements
The Regulation allows NCAs to grant operators of DLT MTFs, DLT SSs and DLT TSS targeted exemptions from regulatory requirements applicable under existing securities trading regulations that would represent potential impediments to deployment of DLT in securities markets.
Operators of DLT MTFs will be able to apply for exemption from requirements under Article 26 MiFIR on transaction reporting under MiFIR as well as to apply for a temporary derogation from the obligation to hold securities on an intermediated basis (i.e. by authorized investment firms) with the aim of granting retail clients a direct access to DLT based trading venues.
CSDs operating DLT SSs will be able to apply for an exemption from the book entry requirement under Article 3 of the Central Securities Depository Regulation (CSDR) which would enable admission to trading of securities that are not registered with a CSD, but instead automatically recorded on the DLT based ledger. Further exemption will also be possible from requirements on mandatory cash settlement which is intended to use of settlement coins or e-money tokens for securities settlement purposes. Operators of DLT TSSs will be able to request the same exemptions as those available to operators of DLT MTFs and of DLT SSs.
Compliance with minimum requirements
In order to benefit from targeted exemptions from requirements applicable under existing regulations, prospective operators of DLT market infrastructures will need ensure compliance with minimum requirements laid down in the new Regulation. To that end, they will (among other) need to:
- establish clear and detailed business plans describing how they intend to carry out their services and activities and to inform their participants, members, issuers and clients with information on how services that they provide based on DLT differ from those performed by service providers not utilizing DLT;
- make publicly available up-to-date, clear and detailed written documentation that defines the rules under which the DLT market infrastructures and their operators are to operate;
- ensure that the overall IT and cyber arrangements related to the use of their distributed ledger technology are proportionate to the nature, scale and complexity of their businesses;
- have in place specific operational risk management procedures for the risks posed by the use of distributed ledger technology and crypto-assets.
Outlook
Deployment of DLT in securities trading can provide for a better cost, time and organizational efficiency that could eventually enable European financial markets to enter 21st century by leaving behind existing securities settlement and clearing processes that were developed decades ago. To that end, with this Regulation, the EU sends a clear signal to the market that it is more than aware of the benefits that DLT based systems can have for the financial services industry in general and that is ready to allow European financial institutions to explore the potential that this technology can offer.
By 24 March 2026 ESMA shall prepare a report on functioning of the DLT Pilot Regime, based on which the EU Commission shall make recommendations to the EU Parliament and the Council on whether the regime shall be extended for a period of up to 3 years, made permanent, amended, extended to other types of financial instruments or eventually terminated.
