Could regulatory moves be underway that will help unlock the promise around blockchain and distributed ledger technology (DLT)? Too often great new ideas and tools run into a wall of financial sector regulation before they can show their full promise. With the goal of freeing-up innovative potential, the European Commission is working on a new pilot regime for the issuance, trading and post-trading of crypto-assets.
“A regime such as this would give more certainty,” said Emilie Allaert, head of operations and projects at the Luxembourg House of Financial Technology (LHoFT). “Many people are not looking into DLT because they don’t see a way forward, but with a dedicated regime it would help identify potential for different users and so create new opportunities,” she added.
The advantages of DLT systems are numerous: a shared data source, resilience, transparency and traceability with the ability to automate processes to boost efficiency. Applying these to cryto-assets (digital, liquid contracts that represent all or part of real world and virtual assets) would have a major impact across the financial sector, hence the desire to adopt regulation to enable these opportunities to flourish.
Request limited exemptions
The pilot regime for digital security infrastructure, proposed by the Commission last October (2020/0267), would enable regulated institutions to request exemptions from certain regulatory requirements around DLT-based infrastructure in the areas of cross-border trading, custody and settlement of securities in the European Union (EU). This process would serve to identify obstacles and thus could point the way to towards future reform which would facilitate the use of these technologies.
The proposal includes the suggestion for a DLT multilateral trading facility which could be operated by regulated investment firms and market operators, or a DLT securities settlement system to be run by an authorised central securities depository (CSD). Permission to offer these services across the EU would be given by the national regulator in consultation with the European Securities and Markets Authority (ESMA). “Another advantage of these proposals is that at the moment, there is no clear agreement at the European or even sometimes on the national level, about the definition of crypto-token and cryto-assets, whether they really need to be regulated and under which regulation they fall. This is one of the main questions addressed by this proposal,” said Allaert.
Case-by-case decisions
Regulators would then judge which exemptions to apply. These might include no longer needing to record trades with a CSD, as long as they were registered on an approved distributed ledger, on the condition that record-keeping, custody arrangements and settlement procedures are in place. Alternatively, MiFID II rules on having to hold intermediated securities could be waived, enabling investors to be accessed directly. There could also be secondary market structures with relevant post-trading features. Ultimately the goal would be increased efficiencies in trading and post-trade environments, which would cut costs to investors. To prevent these operations competing too strongly and unfairly with existing infrastructure, the range and volume of securities they could handle would be at least initially be limited.
Under the Commission proposal, this regime would run for at least five years from 2024, after which ESMA would write a report on the lessons learned. Then a decision would be taken whether to extend and reform the pilot regime and if EU regulation could be amended.
Potential opportunities for Luxembourg
In a recent website article, the ABBL identified potential avenues for Luxembourg, particularly building on areas in which it is already has expertise. In particular it looked at opportunities for international debt instruments, ESG/green finance (such as the Green Exchange) and the alternative fund industry where Luxembourg currently lacks market infrastructure.
The article added a warning to incumbent players: “the pilot regime has the potential to disintermediate the entire value chain of securities processing” which could have “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 infrastructure.”
This proposal would also add the responsibilities of the regulator. Allaert had praise for the Luxembourg financial regulator the CSSF regarding fintech in general and DLT projects in particular. “They’re really open to discussions. Their approach is to come to have a look at the project and judge whether it needs to be regulated or not,” she said, adding they have dedicated teams working on various aspects of digital finance.
The European Parliament has given a broadly favourable view on the proposal and discussions are on-going within the EU decision-making machinery. It remains to be seen whether a clear proposal with broad acceptance will emerge before the summer break.