The EC proposal 2020/0267 (COD) on a pilot regime for market infrastructures based on distributed ledger technology introduces the possibility for certain types of EU financial market participants to operate a market infrastructure (MI) based on distributed ledger technology (DLT) with clear and uniform requirements. The aim of the European Commission is to remove regulatory hurdles to issuance, trading and post-trading of financial instruments in crypto-asset form. The proposed text provides for a so-called “pilot regime” for interested stakeholders to gain experience on the use of DLT for MIs, by making use of temporary derogations from existing rules.
The proposed Pilot Regime Regulation:
- Proposes derogations from rules on the trading and settlement of MiFID financial instruments. An example of impediments to DLT innovation are the requirements for the use of a central securities depository (CSD) in post-trading of securities, which can inhibit the decentralised setup that characterises blockchain technologies. The Pilot Regime Regulation would empower supervisors to exempt DLT market infrastructures from certain CSD requirements. As such, the regulation could lead to efficiencies in the trade and post-trade areas, and drive down costs to the benefit of investors.
- Establishes the conditions for acquiring permission to operate a DLT market infrastructure, sets limitations on the transferable securities that can be admitted to trading, and frames the cooperation between the DLT market infrastructure and competent authorities.
- Provides the basis for a secondary market with relevant post-trading features required to foster and strengthen the entire infrastructure(s) backbone of the industry. The ABBL welcomes the Proposal as a necessary and useful complement to the EC proposal 2020/0265 on markets in cryptoassets and amending Directive (EU) 2019/1937 (MiCA), which intends to create a primary market for cryptoassets,
- Should be able to ensure that the technological advances are factored into the overall European financial markets, by creating a pilot regime which allows mature market participants to test-run their solutions in a safe environment with immediate feedback by industry participants and supervisory authorities without putting at risk the systemic importance and stability of EU financial markets.
Against this background and in light of the recent Luxembourg legislative adaptations in the context of the circulation and issuance of securities on DLT basis, it is worth to have a look at some of the key characteristics of the proposed regime for the DLT-based market infrastructure, which shares the characteristics of a sandbox, as it imposes clear limits on operators and grants regulatory exemptions within these limits; moreover, it has a maximum duration of six years.
The proposed pilot regime distinguishes between two types of DLT market infrastructures: a DLT multilateral trading facility (MTF) and a DLT securities settlement system (SSS). The DLT MTF needs to be operated by a market operator regulated by the Markets in Financial Instruments Directive II (MiFID II). The DLT SSS needs to be operated by a central securities depository regulated by the Central Securities Depositories Regulation. National competent authorities (NCAs) grant the permissions to operate a DLT market infrastructure for a period of up to six years. The permission comes as an addition to the authorisation as CSD or investment firm. The EC shall issue a recommendation to the European Council and Parliament regarding its future, five years from establishing the pilot regime.
In principle, DLT market infrastructures—be it MTF or SSS—are subject to all requirements applicable to traditional MTF or SSS under the current financial regulations. However, the proposed regulation foresees several exemptions for DLT market infrastructures, which must be requested at the NCA, while also imposing a few restrictions on their operations. DLT market infrastructures are subject to specific requirements covering the business plan, functioning of the DLT, IT/cyber arrangements, safekeeping arrangements, disclosure obligations, and exit strategy. Finally, the market infrastructures need to report on a semi-annual basis to the NCA the European Securities and Markets Authority (ESMA), in their oversight function, may require corrective measures and may even withdraw the authorisation.
The EU financial services legislation contains several specific requirements that would prevent a DLT market infrastructure from developing, if not lifted. Thus, a DLT MTF should notably have the possibility to be exempted from the book-entry requirement and the recording with a Central Securities Depository (CSD), provided it ensures recording on a DLT solution, segregates the securities on a client basis, and grants robust settlement procedures and custody arrangements. A DLT SSS may be exempted from several provisions, including those concerning transfer of orders, securities accounts, and recording of securities, provided it demonstrates the incompatibility of such provisions with the use of its particular DLT solution and ensures segregation of securities on client basis—among other requirements. Any DLT market infrastructure should also be allowed to use the so-called settlement coins to clear transactions and be able to request an exemption from the obligation of intermediation (to provide direct access to retail clients).
The DLT market infrastructure should only be able to admit DLT transferable shares of issuers with a market cap of less than EUR 200 million, and bonds with an issuance size of less than EUR 500 million. No sovereign bonds can be admitted/recorded by DLT market infrastructures – this point is however under heavy industry discussion and likely to change in the coming months, as some other contentious points in terms of scope restrictions. The infrastructure must finally not record securities with a value exceeding EUR 2.5 billion.
From a Luxembourg perspective, there are a number of opportunities that can be identified as part of the Proposal, in terms of service offering for existing and new players, as well as a push for several product lines, especially in the less liquid space, such as:
- International debt instruments (where Luxembourg already has a strong global footprint in financial markets)
- ESG / Green Finance (strong potential and already strong global presence via LGX)
- Alternative fund industry where Luxembourg lacks market infrastructures.
Finally, it should also be noted that the pilot regime has the potential to disintermediate the entire value chain of securities processing (in terms of shortening the securities transaction timeline, which may be brought down to real-time settlement), which has a significant impact on the entire securities industry in Luxembourg, as well as key industry players such as CSDs, securities services providers as well as existing market infrastructures.
By Gilles Walers