Yesterday the European Securities and Markets Authority (ESMA) published the final format for the application process to participate in the EU’s DLT Pilot Regime for digital securities. The program commences in March 2023 and the application forms enable participants to start preparing.
The pilot program allows market infrastructures to use blockchain, either permissioned or permissionless, for the issuance and trading of tokenized stocks, bonds and funds, including money market funds. Participants are allowed some limited exemptions from current legislation.
For example, for exchanges or multilateral trading facilities (MTFs), one of the exemptions is allowing users to trade directly without going through a broker. Another is the combination of a trading and post-trade infrastructure, so a central securities depository (CSD) can also operate an exchange or vice-versa. Or a broker could do both.
Regarding the application process, ESMA conducted a consultation that ended in early September.
One ESMA observation based on the responses is that if an exchange provides DLT-based CSD services or a CSD provides a DLT-based exchange, they still need to comply with most of the existing legislation for any additional role they take on.
How many will participate in DLT Pilot Regime?
The consultation only received ten responses, although it was pretty narrow, focusing on the application forms that national regulators will use.
One of the questions is how many organizations will participate in the pilots. During an October conference, a BNY Mellon executive raised concerns about the caps involved in the regime, which are small for major players.
Securities issued under the DLT Pilot Regime are limited to €6 billion, with market capitalization capped at €9 billion for a single platform. Bigger players could hit these limits in days. Any single issuance of funds or equities (market cap) is restricted to €500 million, with up to €1 billion for bonds.
The legislators don’t want the limits to be higher because they see it as experimental. Some will view the combination of roles within FTX as a major lesson.
If larger incumbents want to press ahead, they must comply with existing regulations, which will inevitably lead to compromises and workarounds. Or there’s another path.
Crossover with in-country projects
One of the respondents to the consultation asked whether they could use an existing national DLT authorization instead of going through the EU application process. ESMA’s view is that it’s not possible because this is a standalone pilot and applies to the whole of the EU. National rules are only likely to replicate the DLT Pilot Regime rules partially. So it’s a separate project.
Some EU countries are more advanced than others in terms of DLT legislative progress. Luxembourg, Germany and France spring to mind.
Returning to the previous point about larger players, some of them might want to cherry-pick these progressive jurisdictions without the size limits to make faster progress.
Meanwhile, many in the industry believe that for blockchain to be adopted in the securities sector requires central bank money on ledger. Hence to support the DLT Pilot Regime, the Banque de France is planning wholesale central bank digital currency (CBDC) pilots.