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 pilot DLT regime in March 2023. The pilot regime aims to reduce the regulatory burden to enable blockchain-based technology. securities trading and settlement will be tested at scale and provide legal certainty. It is open to starters and newcomers alike.

Stocks, Bonds and Tokenized Funds (UCITS) fall under the pilot DLT regime and have monetary limits. For example, a maximum of €9 billion can be traded or settled on one platform, and funds and bonds are for smaller market capitalizations of up to €500 million for shares and UCITS and €1 billion for bonuses.

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

The accompanying 64-page report begins to hint at where clarifications or new standards may be needed, and where the laws need to be changed.

One of the gray areas identified is over-the-counter (OTC) trading, particularly given that a significant portion of the legislation targets exchanges or multilateral trading facilities (MFTs). When an exchange reaches the €9 billion pilot limit, some expect additional transactions to be executed bilaterally. On the other hand, others wanted clarification on whether OTC trading is allowed within the pilot DLT regime. ESMA said it would develop further guidance if necessary.

How Tokenized Securities Are Different

There are several areas where tokenized values ​​make a difference. In some cases, it is related to technology and in others, it is direct access.

The current regulations do not contemplate liquidity funds. With automated market making protocols, people make assets available in liquidity pools and an algorithm determines the price. “While on-chain liquidity pools offer significant pre-trade transparency, a no-bid, no-bid system is not envisioned in RTS 1 and 2,” the ESMA report says.

The immutability of blockchains raises issues such as the ability to cancel or modify operations. In all cases, there would have to be a new blockchain exchange. In turn, that raises the question of who pays the gas fees for the fixes. If the error is due to the trading or post-trading platform, ESMA believes that they should pay the fees.

One of the big problems with conventional trading is the need to inform regulators. ESMA originally foresaw that this could be ruled out if regulators have access to blockchain data.

Existing legislation assumes that exchanges only deal with intermediaries, not with natural persons. The pilot DLT regime specifically mentions the requirement for this intermediary role. Therefore, the national identity number of the persons will be registered.

However, that personal data will not be recorded on the blockchain. The data that must be reported to regulators is covered by RTS 22.

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

Although regulators can access nodes on blockchains, a key challenge for them is monitoring different types of DLTs. Therefore, they raised questions about interoperability. Suggestions include establishing standards, APIs, automated workflows, and adhering to the ISO 20022 and FIX protocol for DLT.

For its part, ESMA also conducted a consultation on the application process for the DLT Pilot regime. And the Danish regulator recently got the ball rolling and announced its first sandbox participant for security tokens.