On June 22nd, 2022, the European Union (EU) — wide Regulation on a Pilot Regime for market infrastructures based on distributed ledger technology (DLT Pilot Regime) came into force, applying from March 23rd, 2023. This Regulation is part of the EU Digital Finance Package introduced by the European Commission in 2020 and forms within this Package together with the Regulation of Markets in Crypto-Assets (MiCa) the legal framework for crypto based assets. To determine which Regulation applies to a particular crypto based asset, it has to be established whether it qualifies as a financial instrument as defined in Directive 2014/65/EU (MiFID II): Crypto based assets that qualify as financial instruments remain subject to the existing EU legislation with the addition of the newly introduced DLT Pilot Regime, while MiCa will apply to those crypto based assets that do not qualify as financial instruments (for an introduction to MiCa, see our previous article).
To understand why this DLT Pilot Regime was introduced, some background information is needed: The existing EU financial services legislation was introduced before considerations regarding DLT and crypto based assets were integrated in drafting processes and thus contains provisions that may inhibit or limit the use of DLT in the issuance, trading and settlement of crypto based assets that qualify as financial instruments. Consequently, the DLT Pilot Regime was designed with the intent to facilitate the development of DLT and crypto based assets that qualify as financial instruments and ultimately to foster innovation. To achieve this, specific permissions to operate DLT financial market infrastructure will be granted for DLT Multilateral Trading Facilities (DLT MTF) and DLT Securities Settlement Systems, when they fulfill the requirements outlined in the Regulation. These permissions then allow the accredited entities to request exemptions from certain existing provisions and come with the so-called EU passport, which authorises these entities to provide their services across the EU.
A second objective of the DLT Pilot Regime is to allow legislators and relevant authorities, notably the European Securities and Markets Authority (ESMA) to gain experience with the opportunities presented by crypto based assets that qualify as financial instruments as well as the posed risks, and to identify obstacles in the Regulation. Consequently, the DLT Pilot Regime is designed as a testing environment (sandbox). The Pilot is foreseen to run for 6 years with the permissions and subsequently the exemptions also being granted temporarily.
In line with this, Article 10 outlines that ESMA has to present a report to the EU Commission after five years containing information about the functioning of the DLT Pilot Regime, the type of requested exemptions and the benefits as well as risks presented by the use of DLT, among other aspects. On the basis of this assessment, the EU Commission will analyse whether the Pilot Regime should be maintained as it is, amended or terminated; whether it should be extended to new categories of financial instruments; and whether targeted amendments to EU legislation should be considered.
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