4.03 DLT Pilot Regime

The Regulation of the European Parliament and of the Council on a pilot regime for market infrastructures based on distributed ledger technology allows DLT market infrastructures to be temporarily exempted from certain legal obligations of the current regulatory system.

 

Contents

• What is DLT Pilot Regime?
• What are the main objectives of the regulation?
• What are the expectations regarding the tokenization of financial instruments?
• What kind of definitions are used?
• Subject matter and scope
• Exemptions
• Specific permissions
• Next steps

 

What is DLT Pilot Regime?

The Regulation of the European Parliament and of the Council on a pilot regime for market infrastructures based on distributed ledger technology was published in the Official Journal on 2 June 2022. Most of these rules will be applicable from March 23rd, 2022.

DLT pilot regime is a part of the digital finance package, which also includes regulations covered in previous lessons:

• MiCA (regulation on crypto-asset markets)
• DORA (regulation on operational digital resilience)

 

What are the main objectives of the regulation?

The goal is to allow DLT market infrastructures to be temporarily exempted from certain legal obligations of the current regulatory system.

The regulation implements a so-called "sandbox" system, which is a test environment with a temporary exemption from certain legal obligations of the existing regulatory regime, which is expected to ensure a high level of financial stability, market integrity, transparency and investor protection at the same time. 

Existing EU regulations for financial sector services were not designed for the situation of the growing importance of technologies such as DLT and crypto-assets, so the pilot regime is intended to allow regulators to remove regulatory constraints that may inhibit the development of DLT market infrastructures. This could enable the transition to tokenised financial instruments and DLT market infrastructures.

The regulation applies to crypto-assets that qualify as financial instruments within the meaning of Directive 2014/65/EU of the European Parliament and of the Council (as opposed to the MiCA regulation, which applies to crypto-assets not covered by existing financial services regulations).

 

What are the expectations regarding the tokenization of financial instruments?

The so-called tokenisation of financial instruments, that is to say, the digital representation of financial instruments on distributed ledgers or the issuance of traditional asset classes in tokenised form to enable them to be issued, stored and transferred on a distributed ledger, is expected to open up opportunities for efficiency improvements in the trading and post-trading process.

What kind of definitions are used?

• Distributed ledger technology (DLT) – means a technology that enables the operation and use of distributed ledgers.
• Distributed ledger – means an information repository that keeps records of transactions and that is shared across, and synchronised between, a set of DLT network nodes using a consensus mechanism.
• DLT market infrastructure – means a DLT multilateral trading facility, a DLT settlement system or a DLT trading and settlement system.
• DLT financial instrument – means a financial instrument that is issued, recorded, transferred and stored using distributed ledger technology.
• DLT multilateral trading facility (DLT MTF) – means a multilateral trading facility that only declares trading DLT financial instruments.
• DLT settlement system (DLT SS) – means a settlement system that settles transactions in DLT financial instruments against payment or against delivery, irrespective of whether that settlement system has been designated and notified in accordance with Directive 98/26/EC, and that allows the initial recording of DLT financial instruments or allows the provision of safekeeping services in relation to DLT financial instruments.
• DLT trading and settlement system (DLT TSS) – means a DLT MTF or DLT SS that combines services performer by a DLT MTF and a DLT SS.

 

Subject matter and scope

The regulation sets requirements for market infrastructures based on distributed ledger technology, that is, for:

• DLT MTF (multilateral trading facility) 
• DLT SS (settlement system) 
• DLT TSS (trading and settlement system)

These requirements concern:

• granting and withdrawing specific permissions to operate DLT market infrastructures;
• granting, modifying, and withdrawing exemptions related to specific permissions;
• mandating, modifying, and withdrawing the conditions attached to exemptions and in respect of mandating, modifying, and withdrawing compensatory or corrective measures;
• operating DLT market infrastructures;
• supervising DLT market infrastructures; 
• cooperation between operators of DLT market infrastructures, competent authorities and the European Securities and Markets Authority (ESMA).

There are also limitations, as financial instruments that can be handled by DLT include only:

• shares;
• bonds;
• units in collective investment undertakings covered by Directive 2014/65/EU.

More detailed limits are also specified in this regard, as well as in reference to the total market value of all financial instruments handled by DLT.

Additional requirements for DLT market infrastructures are:

• establishing a clear and detailed business plan;
• making publicly available up-to-date, clear, and detailed documentation that defines the rules under which the DLT market infrastructures and their operators are to operate;
• providing their members, participants, issuers, and clients with clear and unambiguous information on their website regarding how the operators carry out their functions, services, and activities;
• having in place specific operational risk management procedures for the risks posed by the use of distributed ledger technology and crypto-assets and for how to address those risks if they materialise;
• segregating the funds, collateral, and DLT financial instruments of the members, participants, issuers, or clients using the DLT market infrastructure, and the means of access to such assets, from those of the operator as well as from those of other members, participants, issuers and clients;
• establishing a detailed and publicly available transition strategy to exit a specific DLT market infrastructure.

 

Exemptions

• The regulation provides a list of exemptions that DLT market infrastructures can apply for  (for example, it allows them to obtain a temporary exemption from using intermediary services).
• However, the granting of exemptions is conditioned on the fulfillment of certain requirements that they are required to meet in order to be covered by such exemptions (further described in Articles 4, 5 and 6 of the regulation).
• DLT market infrastructures shall demonstrate that the exemptions they apply for are proportionate to and justified by the distributed ledger technology.

 

Specific permissions

A legal person who is authorised as:

• an investment firm, or authorised to operate a regulated market may apply for specific permission to operate a DLT MTF;
• a CSD may apply for specific permission to operate a DLT SS;
• an investment firm, or authorised to operate a regulated market may apply for specific permission to operate a DLT TSS. 

Applying for these permissions should include, among other things:

• a business plan, 
• general IT and cybersecurity arrangements, 
• where applicable, a description of the safekeeping arrangements for clients’ DLT financial instruments,
• a transition strategy, 
• any exemptions requested by the applicant.

Specific permission shall be valid throughout the Union for a period of up to six years from the date of issuance.

Next steps

​​By March 24, 2026, ESMA is to submit a report to the Commission on, among other things, the functioning of DLT market infrastructure across the Union, any risks, vulnerabilities or benefits, and costs of using distributed ledger technology.

On the basis of this report, the Commission is to submit a report to the European Parliament and the Council, which should include a cost-benefit assessment of the pilot system.

The pilot regime is therefore intended to allow ESMA and the relevant authorities to learn from the use of the pilot regime and gain experience with regard to the opportunities as well as the risks associated with the use of crypto-assets that qualify as financial instruments and the technology on which they are based.