When creating the legal framework for regulations in the financial sector, the European legislator had primarily traditional financial services in mind. As a result, novel technologies and products, in particular distributed ledger technologies ("DLT") and crypto-assets, are not satisfactorily regulated.
On the one hand, this may have the effect of unnecessarily hampering innovation in finance, and on the other hand, novel developments may pose previously unknown risks.
Therefore, as part of the Digital Finance Package, in order to promote digital finance, the EU legislator adopted Regulation (EU) 2022/858 of 30 May 2022 on a pilot regime for market infrastructures based on distributed ledger technology (DLT pilot regime), which was published in the Official Journal of the European Union on 02 June 2022, which enters into force today (22. June 2022) and which will apply as of 23 March 2023.
Aim of the DLT pilot regime
Under the DLT pilot regime, certain DLT market infrastructure operators are exempted from some provisions of the current regulatory regime (in particular Directive 2014/65/EU (MiFID II)) to provide trading and/or settlement services for financial instruments using DLT and blockchain technology in a test environment (Sandbox).
The aim is to promote the development of DLT in the financial environment while maintaining standards for investor protection, market integrity, financial stability, and transparency. It also aims to identify and remove legal barriers to the adoption of blockchain and DTL. The lessons learned will then be used by the EU legislature in the decision-making process for novel regulation in the financial sector.
Who and what is in scope?
The DLT pilot regime essentially lays down requirements in respect of granting and withdrawing of the permissions to operate DLT market infrastructures under the DLT pilot regime; operating DLT market infrastructures; supervising DLT market infrastructures; and cooperation between operators of DLT market infrastructures and the competent authorities.
DLT-based market infrastructures covered by the regulation are namely multilateral trading facilities (DLT MTF), settlement systems (DLT SS), and trading and settlement systems (DLT TSS).
DLT financial instruments are crypto assets that qualify as financial instruments and are issued, transferred, and stored in a distributed ledger. In this regard, the DLP pilot rule is limited to
- shares, the issuer of which has a market capitalisation, or a tentative market capitalisation, of less than EUR 500 million;
- bonds, other forms of securitised debt, or money market instruments, with an issue size of less than EUR 1 billion;
- units in collective investment undertakings with a market value of assets under management of less than EUR 500 million.
Both operators of existing DLT market infrastructure and market participants wishing to enter the market for the first time can apply to the competent national authority to be included in the pilot regime in order to make use of the exemption provisions. The DLT pilot regime is optional, i.e. market participants are not forced to apply for permission to enter the pilot regime, but are free to decide whether they want to be subject to the regulation or to the currently applicable regulatory framework.
When does it apply?
The DLT Pilot regime will apply from 23 March 2023. From this date it will be open to market participants to apply for a relevant permission under the DLT pilot regime. Until then, the European Securities and Markets Authority (ESMA) will develop guidelines to establish standard forms, formats and templates for the purposes of the application.
The pilot regulations will allow both market participants and government agencies to become familiar with new technologies and the challenges associated with them. With the high risks that can arise in the context of financial services, it seems more than appropriate to create a dedicated ecosystem for a test run. While the establishment of DLT technologies is still in its infancy in Europe and Germany, it seems only responsible to renew the somewhat dusty legal framework in the area of finance in view of the rapid technological progress of recent years. The extent to which practical experience will ultimately really flow into future legal regulations remains to be seen.