On 23 March 2023, EU Regulation 2022/858 that creates a pilot regime for market infrastructure based on distributed ledger technology came fully into force, representing the first piece of EU legislation that explicitly provides for regulation of distributed ledger technology (DLT). This regime is expected to play a leading role in the creation of financial instruments in tokenised form, the development of a secondary market for these assets, the supervision of this market infrastructure, and the cooperation between operators and competent authorities.
The six-year pilot regime established under this Regulation will allow market infrastructure providers to use DLT for the issuance, trading, and settlement of digital assets that qualify as in-scope financial instruments. The DLT Regulation will facilitate the granting of authorisation to successful applicants for the operation of DLT market infrastructure, including the granting of exemptions from certain existing requirements under the following financial services legislation where such legislation potentially constrains the use of DLT:
• Markets in Financial Instruments Regulation (MiFIR);
• Markets in Financial Instruments Directive II (MiFID II); and
• Central Securities Depositories Regulation (CSDR).
Core features of the DLT pilot regime
The pilot regime provides that DLT Multilateral Trading Facilities (DLT MTF) operators can apply for a temporary exemption from the obligation to admit only investment firms, credit institutions, and other entities that have a sufficient level of trading capacity and expertise to provide direct access to non-professional investors. This exemption is subject to adequate investor protection measures, specific conditions for non-professional investors, and compliance with any additional investor protection measures required by the competent authority.
In parallel, Central Securities Depositories operating a DLT Settlement System (DLT SS) may request a temporary exemption from the provision to use central bank money in the settlement of cash payments, enabling the use of commercial bank money or e-money tokens. These specific authorisations and exemptions are valid only for a maximum period of six years from the date of the grant and only for the duration of the pilot scheme.
The pilot regime places limitations on the DLT financial instruments that can be admitted to trading, such as shares of issuers with a market capitalisation of less than EUR 500 million, bonds, and other forms of securitised debt with issues of less than EUR 1 billion (excluding debt securities with derivative components), and units of collective investment undertakings with assets under management with a market value of less than EUR 500 million.
DLT market infrastructure operators are required to adopt and document rules for the operation of their DLT system, including rules on access, participation of the validation nodes, conflict of interest, and risk management to ensure investor protection, market integrity, and financial stability. They must also have adequate IT and cyber arrangements associated with the use of their DLT and ensure the continuity, availability, reliability, security, integrity, and confidentiality of their services and stored data.
Implications of the DLT pilot regime in Bulgaria
In response to the Regulation, Bulgaria has proposed draft legislation amending and supplementing the Markets in Financial Instruments Act, and the Commission for Financial Supervision (CFS) and its Oversight of Capital Activity department will likely be responsible for the supervision of these market infrastructures. Companies in Bulgaria will be able to take full advantage of the benefits of the Regulation, and the CFS will be able to recognise regulatory obstacles to the development of processes while accumulating invaluable knowledge on the operation of DLT in practice.
Regarding the granting of specific authorisation for operating, the fees for application are relatively low for Bulgaria.
Given that the Regulation introduces measures that allow experimentation with DLTs for EU financial services on the basis of a single passport, regulating the use of DLTs in Bulgaria would allow Bulgarian financial service providers to continue to be competitive in the EU market. The introduction of the pilot legislation in Bulgaria will allow experience to be gained on how the current financial legislation applies to market DLT-based infrastructure and its limitations in this respect.
DLT use cases
DLT has many other areas of application and has potential to remodel a lot of traditional economic and legal processes. Some of these areas include the energy sector, data protection and financial services. DLT can enable peer-to-peer energy trading as well as transparently track energy production and consumption. Moreover, DLT can help protect and secure personal data through the creation of digital identities, which can be used for authentication and access control, thus allowing citizens to access services securely. In addition, DLT enables efficient cross-border payments, improves security and transparency of transactions, facilitates faster settlements, and streamlines the Know Your Customer (KYC) process. DLT could make payment systems faster, cheaper and more secure.
How would companies benefit?
Market-based DLT systems are generally functional in serving Small and Medium Enterprises (SMEs) looking to diversify their financing sources. SMEs may find it advantageous to finance their investments by issuing tokenised shares or bonds directly in the DLT markets, through Security Token Offerings. This can enable SMEs to attract a wide range of investors to asset classes that have not been previously present in their portfolios. It can help to attract individuals who have previously invested in crypto assets with no connection to real or financial assets as alternative forms of investment. By dealing with established types of financial instruments, the pilot regime has the potential to create conditions that bring dispersed financial resources back into the real economy.
It is essential to overcome the operational obstacles that currently separate segments of the financial system and lead to geographic fragmentation of markets for raising funds for SMEs and trading financial instruments. DLT and the tokenisation of financial assets for SMEs offer the possibility of counteracting liquidity dispersion in multiple markets and facilitating clear access to information on SME issuers, thereby promoting wider investor participation.
For more information on this Regulation and how it could effect your business, contact your CMS client partner or local CMS experts.
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