Pilot regime on DLT market infrastructure

With a recent legislative package, the EU Commission proposes to establish a pilot regime for distributed ledger technology (DLT) market infrastructures for financial instruments. Under the pilot regime, traditional MTF operators and CSDs will be permitted to operate DLT-based trading facilities and settlement systems at small scale and, for MTFs, with direct un-intermediated investor participation.

On 24 September 2020 the European Commission published (i) a new draft regulation comprised by a draft pilot regime on distributed ledger market infrastructure, which sets out the requirement on multilateral trading facilities and securities settlement systems using DLT (so-called 'DLT market infrastructures') (the "Pilot Regime") and (ii) a draft directive for a proposal to amend to the existing definition of 'financial instruments' pursuant to directive 2014/65/EU ("MiFID II").

The proposed Pilot Regime will allow certain market participants (including authorised investment firms and market operators) to be licensed to operate DLT multilateral trading facilities ("MTF") and for central securities depositories ("CSD") to operate DLT securities settlement systems.

As a starting point, the Pilot Regime subjects DLT MTFs and DLT CSDs to the existing regulation of multilateral trading facilities and securities settlement systems. The Pilot Regime will thus only be available to entities already holding a license to operate MTFs or as a (traditional) CSD, respectively. However, and most importantly, the Pilot Regime allows for MTFs and CSDs licensed to operate DLT multilateral trading facilities and securities settlement systems, to apply for exemptions from the existing rules to the extent that such rules are incompatible with the use of the particular DLT. Such exemptions include the possibility for DLT MTFs to (i) use settlement coins (i.e. commercial bank money in a tokenised form) when performing the settlement of transactions in DLT transferable securities and (ii) be exempted from the obligation of intermediation in order to provide access for retail investors on the DLT MTF. Given that traditional double-entry book keepings securities accounts do not always exist in a DLT system, DLT CSDs may be exempted from the rules relating to the notion of 'securities account' or 'book-entry form'.

The Pilot Regime will only apply to securities meeting certain eligibility requirements designed to ensure that the Pilot Regime will only be operated at small scale. For shares, the market capitalisation or the tentative market capitalisation of the issuer of DLT transferable securities should be less than EUR 200 million and for bonds, less than EUR 500 million in issuance size.

The Pilot Regime is intended to run for a period of five years after which ESMA will prepare a report on the Pilot Regime for the Commission to assess whether the pilot regime should become permanent in its current proposed form or in a modified form.

Amendments to the definiton of financial instruments 

Related to the introduction of the proposed Pilot Regime, the Commission has also proposed an amendment to the definition of financial instruments pursuant to article 4 of MiFID II. Specifically, the Commission has proposed to replace the existing definition set out in article 4(1), point 15 to include such instruments issued by means of DLT. The purpose thereof is to provide certainty as regards crypto-assets and is deemed necessary by the Commission to establish a temporary exemption for multilateral trading facilities.

A new Dawn for the use of DLT?

As the proposal remains subject to review by the European Parliament, the exact scope of the Pilot Regime is unclear. However, it is clear that it is both the opinion and desire of the Commission that DLT will have an increasingly important role within EU financial markets and that the use of DLT in finance has gone from being viewed as a somewhat exotic technology towards a technology of critical importance to ensure the future competitiveness of EU financial markets.   

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