EU’s ‘DLT Pilot’ to Trade Tokenized Securities Wins Political, Regulatory Support

The European Parliament (EP), the European Securities and Markets Authority (ESMA) and the industry are backing the EU’s efforts to create a pilot regime for financial market infrastructures based on distributed ledger technology (DLT) (“the DLT Pilot”). This pilot regime aims at developing the trading and settlement of “tokenized” securities.

This regime will create a testing ground for the use of blockchain technology in the field of financial instruments for three years, which may be extended for another three years. This time limitation, though, has caused concerns among some members of the industry as they argue that the uncertainty around the regime’s future limits investment in building an infrastructure based on DLT for this pilot.

From a regulatory perspective, the project recently achieved two milestones. First, on March 24, 2022, the plenary of the European Parliament approved the regulation needed to implement this pilot regime in the 27 member states. Once the regulation is published in the official journal, which is expected to happen in the next weeks, member states will have nine months to pass legislation at national level and start applying the pilot regime. Thus, companies should be able to test the DLT pilot at the beginning of 2023.

The second development is the positive feedback that ESMA received from the industry regarding the regulatory technical standards (RTS) for the DLT Pilot. ESMA closed the consultation on March 4, and it recently published the comments received. From these comments, we observe that the industry has generally welcomed ESMA’s efforts and, although there are minor concerns and a few suggestions, the RTS won’t likely be subject to many changes. This means that ESMA could publish a final proposal for the RTS before the DLT Pilot starts applying in 2023.

One topic that comes up in several submissions from different actors is the interoperability between platforms across Europe and elsewhere — interoperability from a jurisdictional and a technical point of view, as DTL platforms and services are global in nature and tokenized instruments can be traded globally.

Notably, some participants also refer to the benefits of having a central bank digital currency (CBDC) to facilitate the functioning of the DLT value chain, and in particular the settlement of tokenized securities. The use of CBDC was not part of the consultation, but some participants note that CBDCs will play a key role to support settlements in a DLT environment.

“To fully realize the expected benefits of tokenized securities, such as reduced counterparty risk and (near) instant settlement, there is a need for credible digital currencies available on DLT to implement on-chain delivery versus payment (DvP) mechanisms. Ideally, this would be in the form of Central Bank Digital Currency (CBDC), and/or other forms of digital cash such as tokenized commercial bank money or stablecoins,” said the International Capital Market Association in its submission.

For others, not any form of digital money is as useful as CBDCs. “We consider that the critical issue is not e-money tokens but the use of CBDCs, to fully complement the DLT value chain,” said the Association Française de la Gestion financière in its comments.

The DLT pilot is part of a series of measures proposed by the European commission to support the potential of digital finance. Two other important instruments are the Markets in Crypto-assets Regulation (MiCA) and the Digital Operational Resilience Act (DORA).

The European Union is betting strongly on the use of blockchain technology and DLT because regulators see this technology as a trigger for other innovations. After losing the competition for cloud computing and online platforms, which has been dominated by U.S. firms, EU policymakers have seen in blockchain the opportunity to gain a competitive leg up in another important technological race.

Read More: EU Securities Regulator Sees Competitive Advantage from Blockchain in Financial Markets