ESMAs call for evidence on the DLT pilot regime

On 4 January, ESMA issued a call for evidence on the DLT pilot regime and a related review of MiFID transparency and reporting requirements.

ESMA is aware that it lacks experience with the use of DLT for trading and settlement, as do the national competent authorities and market participants. This call for evidence is intended to allow ESMA to gather expertise and perspectives from stakeholders in order to understand the challenges it presents and the modifications that are likely to be required to the current framework.

The paper seeks input from various stakeholders on the need to amend specific aspects of the regulatory technical standards (RTS) made under MiFIR to ensure the transparency and reporting requirements are appropriate for instruments traded and settled on DLT systems.

The call also raises general questions about how common aspects and definitions (such as the concepts of execution and order transmission) might need to be reinterpreted or amended in light of DLT transactions and securities. These points are likely to be of wider interest and may indicate the future direction of travel for the regulation of such decentralised systems.

Background: The EU's DLT pilot regime

On 24 November 2021 the European Parliament and the Council reached a political agreement on a proposal for a DLT pilot regime. The DLT pilot regime aims at allowing firms to develop systems for the trading and settlement of 'tokenised' securities (digital representations of traditional securities) using DLT technology.

Under the pilot, investment firms, CSDs, regulated market operators and some new entrants will be able to establish three new types of DLT market infrastructure: DLT Multilateral Trading Facilities (DLT MTF), DLT Trading and Settlement Systems (DLT TSS) and DLT Settlement Systems (DLT SS). Firms operating these DLT infrastructure will be exempt from certain MiFID/R and CSDR requirements which could otherwise inhibit the issuance, trading and settlement of tokenised securities using DLT. The DLT operators would instead comply with alternative conditions, which will be set out in the pilot regime regulation.

Permission to operate DLT market infrastructure under the pilot will last for up to six years and the regime is expected to be available from early 2023. The regime is limited to certain DLT financial instruments and subject to limits on the value of instruments which may be admitted to trading (each limit may be lowered by the national competent authority):

• Shares, the issuer of which has a market capitalisation of less than EUR 500m;
• Bonds or other forms of securitised debt with an issuance size of less than EUR 1bn; and
• Units in certain collective investment undertakings with an AUM of less than EUR 500m;

There is also an overall limit on the total market value of instruments admitted to trading of EUR 9bn.

The DLT pilot draft regulation includes a requirement for ESMA to review the data reporting and transparency RTS made under MiFIR to ensure they can apply effectively to financial instruments issued on DLT.

Reporting, record keeping, regulatory access

The DLT pilot proposes that operators of DLT trading venues could be exempted from MiFIR transaction reporting, provided that they give the regulator direct and immediate access to the underlying ledger by admitting the regulator as a 'regulatory observer participant'. ESMA invites views on what arrangements would be required to facilitate this. It is possible this hints at a future where the regulator has real-time "observer" capacity within market infrastructure.

ESMA questions what types of details are relevant to report for transactions in DLT financial instruments. For example certain reporting actions, such as modifications and cancellations of transactions, may not be possible on a DLT system which uses an immutable ledger. ESMA invites views on these points and asks whether alternative actions or statuses would be appropriate.

Transparency

ESMA also requests views on transparency issues, such as whether or not the current waivers and transparency levels within MiFIR remain fit for purpose. Again, this indicates no radical change in thinking and the approach appears to be "how do we shave off the edges of a square peg to fit within a round hole?".

Common aspects and definitions

The call also raises questions regarding MiFID concepts and definitions which may have wider importance in the context of DLT. For example, ESMA asks how the definition of "execution of a transaction" should apply to a DLT transaction process (does this occur upon the initial broadcast of a transaction to the network, upon verification of the digital signature, on the agreement of a network consensus, or the broadcasting and updating of participant records?). ESMA also asks whether orders can be meaningfully "transmitted" between entities within a DLT network.

Next steps

The consultation is open until 4 March 2022; responses can be submitted via ESMA's website. ESMA will then consider the feedback and whether amendments to the RTS are necessary. If they are, it will consult on any subsequent proposals before submitting a final draft RTS to the European Commission.

The DLT pilot is expected to begin in early 2023.