A couple of weeks ago the European Securities and Markets Authority (EMSA) published a letter on the outcomes of the 1st year of the EU’s DLT Pilot Regime. This is a groundbreaking regulation from the EU; however, it has shown mixed results. Let us look at this story step-by-step.
What is the DLT Pilot Regime and what purpose does it have?
The regulation allows the operators of capital market infrastructure to experiment with the application of distributed ledger technology during the trading and settlement of tokenized securities.
DLT has been identified as a promising technology due to its transparency and efficiency. The latter is reached through the exclusion of financial intermediaries without whom the settlement of security transactions can be conducted instantly and at a much lower cost.
How are things going?
So far, the market is not exactly booming with DLT-based capital market infrastructure. ESMA attributes this to the novelty of the regime. The present state of capital markets does not appear to be streamlined, fast and cost-efficient enough, which may keep major players from investing significantly in DLT if they believe the industry is not ready (or not open) to applying the technology.
Also, while DLT has promising aspects, most of these have not been validated through actual deployments by key players.
ESMA has received 4 applications from market participants with 8 more applications being expected throughout 2024. The uptake may not be significant at this point, but this year might yet bring additional momentum. For that to happen, some obstacles will need to be tackled.
What are the key challenges identified?
💸 Innovative solutions for cash settlement: DLT-based infrastructure requires innovative solutions for cash settlement that cannot include traditional cash. There are several options (e.g., tokenized commercial bank money, e-money tokens) but few providers offer these.
🔑 Custody through self-hosted wallets: further clarification is needed regarding the roles and responsibilities of different entities in the case of self-hosted wallets, where the owner of the wallet controls the corresponding private key completely.
🤝 Interoperability: interoperability needs to be ensured between traditional and DLT-based market infrastructure, and different types of DLT-based infrastructure as well, for reasons related to efficiency and regulatory compliance.
🔒 Investor protection: in certain cases, the DLT Pilot Regime allows retail investors to directly access the DLT market infrastructure. However, further clarification is needed to identify the appropriate measures required for this access to ensure continued protection.
🆚 Competitiveness vis-á-vis third-country regimes: for the pilot regime to retain its attractiveness compared to similar initiatives in other jurisdictions, the European Commission should confirm that it will be extended beyond 2026 as uncertainty regarding this question keeps interested providers from committing to the application process.
Where does Dorsum come into the picture?
At Dorsum, we have been working on a platform for the tokenization of investment units for a while and have experienced most of the challenges highlighted by ESMA ourselves. DLT-based market infrastructure will not suddenly take over the global capital markets one day.
Instead, we expect a gradual shift (taking decades), where those use cases for which the advantages of the technology clearly outweigh the costs will eventually move over to a DLT-based infrastructure.
If you and your company would like to play a role in forming the future of capital markets, or simply have some questions regarding DLT, blockchain or digital assets, do not hesitate to reach out to us.
Authors: Péter Kanti, Botond Bátorfi
Sources: ESMA, European Crypto Initiative, Elizaveta Palaznik
