ESMA plans no changes to blockchain securities rules ahead of start of DLT pilot regime – Ledger Insights

Yesterday, the European Securities and Markets Authority (ESMA) announced that there is no need for new regulatory technical standards (RTS) before the start of the EU’s DLT pilot regime in March 2023. The pilot regime aims to reduce the regulatory burden to allow blockchain-based securities trading and settlement to be trialed on a large scale and create legal certainty. It is open to both established and newcomers.

Tokenized stocks, bonds and funds (UCITS) fall under the DLT pilot regime and have monetary limits. For example, a maximum of EUR 9 billion can be traded or settled on a platform, and funds and bonds are intended for smaller market capitalizations of up to EUR 500 million for equities and UCITS and EUR 1 billion for bonds.

One of ESMA’s tasks under the pilot regime legislation is to assess the need for new RTS provisions, which is why it held a consultation and workshop.

The accompanying 64-page report provides initial indications of where clarification or new standards may be needed and where legislation may need to be changed.

One of the identified gray areas is over-the-counter (OTC) trading, particularly as much of the legislation is aimed at exchanges or multilateral trading facilities (MFTs). If an exchange hits the €9 billion pilot limit, some expect additional trades to be made bilaterally. On the other hand, others wanted to clarify whether OTC trading is allowed under the DLT pilot regime. ESMA said it would develop further guidance as needed.

How tokenized securities differ

There are several areas where tokenized securities present differences. In some cases it is about technology, in others it is about direct access.

The current regulations do not provide for this Liquidity Pools. With automated market making protocols, humans provide assets in liquidity pools and an algorithm determines the price. “While on-chain liquidity pools provide significant pre-trade visibility, a no-bid, no-offer system is not foreseen in RTS 1 and 2,” the ESMA report reads.

The immutability of blockchains raises questions such as the ability to do so Cancel or amend trades. In all cases, there would have to be a new blockchain transaction. This in turn raises the question of who pays the gas fees for the corrections. If the error is due to the trading or post-trade platform, ESMA considers that it should pay the fees.

One of the big bugbears of conventional trading is the need to report to regulators. ESMA initially envisaged that this could be averted if Regulatory authorities gain access to the blockchain data.

Existing legislation assumes that the exchange has to do with transactions only Intermediaries, not with natural persons. The DLT pilot regime expressly waives the requirement for this intermediary role. Therefore, the national identity number is recorded from individuals.

However that Personal data is not recorded on the blockchain. The data that needs to be reported to regulators is covered by RTS 22.

“ESMA understands that a blockchain cannot be viewed as a database. For this reason, ESMA considers that most DLT MTFs store limited transaction data in the block where the transaction is executed, while the remaining RTS 22 fields are appended to the transaction as payload or metadata. The payload or metadata is stored off-chain and associated with the on-chain transaction.”

While regulators can access nodes on the blockchains, a key challenge for them is overseeing different types of DLTs. So they asked questions interoperability. Proposals include setting up standards, APIs, automated workflows and complying with the ISO 20022 and FIX protocol for DLT.

Meanwhile, ESMA also held a consultation on the application process for the DLT pilot regime. And the Danish regulator recently got the ball rolling, announcing its first sandbox entrant for security tokens.

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