Options for DLT financial instruments – single pilot regime

The use of distributed ledger technology (DLT) and blockchain in financial markets has increased significantly over the last five years, and one of the main applications of DLT in financial markets is crypto-assets, including crypto-assets that qualify as financial instruments.

Today, companies raise capital not only through the traditional approach of issuing financial instruments and listing them on a stock exchange, but also through the opportunities offered by new technologies – DLT and blockchain – to create financial instruments in the form of crypto-assets. This includes security tokens and tokenised securities, which are relatively new terms that have been used for some time in the financial industry to refer to crypto-assets and which may become even more popular in the future.

From theory to practice

Crypto-assets classified as financial instruments are generally subject to the same regulatory framework as traditional financial instruments. However, the current regulatory framework of the financial instrument market imposes a number of restrictions that preclude taking advantage of the opportunities offered by DLT and blockchain in relation to the issuance of crypto-assets, trading and settlement of crypto-assets that qualify as financial instruments.

In view of this technological aspect and in order to facilitate the development of crypto-asset financial instruments, the European Union (EU) has created a special pilot regime for trading such digital financial instruments. Regulation (EU) 2022/858 of the European Parliament and of the Council on a pilot regime for market infrastructures based on distributed ledger technology, and amending Regulations (EU) No 600/2014 and (EU) No 909/2014 and Directive 2014/65/EU entered into force in March 2023 and, along with this Regulation, the term DLT financial instrument was introduced in the financial instruments regulation: a financial instrument that is issued, recorded, transferred and stored by means of distributed ledger technology.

The pilot regime allows participants operating in the financial instruments market to test how financial instruments can be issued and traded using blockchains and how the trading and settlement process for such instruments can be organised with fewer intermediaries compared to the issuance, trading and settlement of traditional financial instruments, e.g. a customer will be able to access trading of DLT financial instruments directly without using brokerage services.

Such a single EU pilot regime allowing market infrastructures (trading and settlement providers) to use DLT and blockchains in their operation is an important step for authorities of Member States to gain practical experience in DLT financial instruments, explore the possibilities and identify the risks associated with this type of crypto-assets and new technologies.

What is covered by the regime

Only DLT financial instruments are admitted to trading or recording in the distributed ledger under the pilot regime. Moreover, this option will apply both to cases where the financial instrument is initially issued, recorded, transferred and stored using the distributed ledger technology and to cases where the existing traditional financial instrument is tokenised or converted into a DLT financial instrument.

The pilot regime is not applied to all DLT financial instruments but only to shares, bonds or other forms of securitised debts, units (shares) of collective investment funds with quantitative limits set by regulation regarding the issue amount, capitalisation of the issuer or the value of the assets under management.

This Regulation creates a new type of market infrastructure, the DLT market infrastructure, comprising the DLT multilateral trading facilities, the DLT settlement system, the DLT trading and settlement system, which combines trading and settlement in an innovative way. 

A licensed investment firm (IF) or regulated market organiser may apply for authorisation to organise or maintain a DLT multilateral trading facility or a DLT trading and settlement system, while a licensed central securities depositary may apply for authorisation to maintain a DLT settlement system or a DLT trading and settlement system.

The Regulation also provides that new market participants which have not previously been licensed as an IF, a regulated market operator or a central securities depositary may apply for a licence to operate as an IF, a regulated market operator or a central securities depositary simultaneously submitting an application for authorisation to maintain a DLT infrastructure under the pilot regime subject to any requirements of the relevant regulation for which exemption has not been requested under this Regulation.

Companies wishing to obtain authorisation to maintain a DLT infrastructure under the pilot regime and having additional questions about this EU pilot regime are invited to contact Latvijas Banka's Innovation Hub. You can apply for advice by filling in the application form on Latvijas Banka's website.

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