EU’s Pilot Regime for Distributed Ledger Technology in Market Infrastructures

Further to our Tweet of 2 June 2022, while everyone is hopefully aware of the European Union’s MiCA (i.e. regulation on Markets in Crypto Assets) let’s not forget about the EU’s Regulation for a pilot regime for market infrastructure based on distributed ledger technology (the Pilot Regime) which was published yesterday (2 June 2022) and will apply from 23 March 2023 – see Article 19 for application dates of the different parts of the Regulation. 

The Pilot Regime introduces a ‘regulatory sandbox’ across the 27 European countries that make up the economic and political union that is the EU. Separately from the Pilot Regime, some EU countries have already amended their securities laws to allow for DLT implementation e.g. Germany, Italy, and France.  Worldwide, there are currently over 50 countries that have implemented comparable ‘sandboxes’.  

‘The pilot DLT regulation will contribute to strengthening our innovation and competitiveness in the field of digital finance. It will help deliver the benefits of digital finance for businesses and citizens while protecting consumers and preserving financial stability.’

Andrej Šircelj, Minister of Finance of Slovenia

We previously reported on ESMA’s (i.e. the EU’s equivalent of the SEC) call for evidence on the DLT pilot regime and some of the responses that were received to that consultation including that of the Association of Financial Markets in Europe, and the International Capital Markets Association. 

The Pilot Regime allows certain entities (called ‘eligible market participants’) with exemptions to certain EU financial services regulations (namely the Markets in Financial Instruments Directive (MiFID) and the Central Securities Depository Regulation (CSDR)) so they can experiment with distributed ledger technology, particularly for use cases in the trading and post-trading of securities in the EU (under legislation called MiFID II) in a ‘tokenized’ form. 

Notably given that the technology is DLT, eligible market participants are highly centralized entities being: 

1. a DLT multilateral trading facility (DLT MTF) consisting of a MiFID II authorized and supervised MTF;
2. a DLT securities settlement system (DLT SSS) consisting of a securities settlement system operated by a central securities depository conducting securities settlement operations under the EU’s Central Securities Depository Regulation (CSDR); and
3. a DLT trading and settlement system (DLT TSS) operated by a MiFID II investment firm, a market operator or a Central Securities Depository (CSD) which combines activities of both a DLT MTF and a DLT SSS.  

The scope of the DLT Pilot Regime covers only assets that are so-called ‘financial instruments’ under MiFID II, broadly all types of securities and bonds (the ‘DLT Financial Instruments’). In contrast, the scope of MiCA covers the new class of assets known as ‘crypto-assets’ which are not MiFID ‘financial instruments’.

To be eligible for the Pilot Regime the DLT Financial Instruments be either:

1. shares with a market capitalization of less than EUR 500 million; 
2. bonds, other forms of securitized debt, including depositary receipts, or money market instruments, with an issue size of more than EUR 200 million but less than EUR 1 billion, excluding those that embed a derivative; or 
3. units in mutual funds (i.e. collective investment undertakings) with assets under management which is less than EUR 500 million.

Eligible market participants seeking to experiment with DLT in the sandbox provided by Pilot Regime will shortly be able to submit their plans to ESMA for approval, but exemptions allow the DLT Pilot Regime to be operational depending on the ability of national authorities in a given EU Member State facilitating its implementation. This may also imply an adjustment of existing national legal frameworks in order to facilitate the use of the DLT Pilot Regime.

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The experimentation phase under the DLT Piot Regime will last for 6 years and aims at helping to identify obstacles in existing securities regulation to the application and development of the DLT. At the end of the period, ESMA will report feedback to the  European Commission, who will then decide whether to extend the pilot period, or whether to propose targeted amendments to EU financial services law.  

However, it currently remains unclear how a successful business model can be operationalized immediately after the pilot regime expires.