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Tokenization and Distributed Ledger Technology (DLT): European financial markets to enter a new era in 2023

9 February 2023

Regulatory News Alert

New regulatory regime to unlock significant opportunities for existing financial institutions and new entrants

European markets have been eagerly awaiting a new law regarding the issuance, trading and settlement of digital financial instruments to go live, and the wait is almost over. On 23 March 2023, the so-called DLT Pilot Regime Regulation will apply—alongside many beneficial exemptions from traditional financial services laws—to allow both regulators and financial market participants to test and experiment with this new technology – distributed ledger (DLT).

Once the DLT Pilot Regime goes live, DLT trading and settlement systems will be able to request exemptions from specific EU legislation requirements — notably the Markets in Financial Instruments Regulation and Directive (“MiFIR”/”MiFID II”) and the Central Securities Depositories Regulation (“CSDR”) — provided they comply with certain conditions and any potential compensatory measures imposed by the relevant competent authority.

However, permissions issued under the DLT Pilot Regime do not replace authorizations under MiFID II or CSDR. Therefore, this specific license can only be granted to firms authorized as CSDs, investment firms or operators of a regulated market, or to new entrants meeting the relevant MiFIR, MiFID II and CSDR requirements, except those for which the applicant requests an exemption.

For more information on the DLT Pilot Regime and the legislation’s main features and implications, please consult our previous newsletter on the topic.

The foundation for the tokenized financial instrument market

The DLT Pilot Regime is moving from theory to practice. European market players are increasingly exploring how to harness this new framework to their advantage by offering new products, developing new market segments, diversifying their service offerings or innovating their operating models. More and more are taking concrete steps to implement digital (“tokenized”) assets in their strategy by obtaining licenses under this new framework.

Therefore, the so-called tokenization of assets, i.e., the representation of traditional assets on DLT, is a long-term trend that offers significant opportunities for both market participants and investors. This regulatory framework and much-needed legal certainty provide the foundation to build this new market in Europe, scale existing pilots and proofs-of-concept, and begin distributing innovative tokenized securities to a wider and more diversified investor base.

In addition, and clearly recognizing this trend, ESMA honored its mandate stemming from the DLT Pilot Regime and came up with detailed guidelines and clarifications on how to apply for such a specific permission to operate a DLT system.

Those financial firms wishing to obtain such a license should therefore start by analyzing information they have to submit to their competent authority for this purpose. No better way to begin this process but to screen these new ESMA Guidelines on standard forms, formats and templates to apply for a license under the DLT Pilot Regime.

As different exemptions apply to different market players, ESMA distinguishes between the information required by applicants that are (or intend to be) authorized as investment firms and those that are (or intend to become) CSDs.

Competent authorities will grant permissions for a period of up to 6 years. The Guidelines will apply from 23 March 2023, the same time as the DLT Pilot Regime.

In addition to the Guidelines, ESMA regularly updates its Q&A on the DLT Pilot Regime, which provides essential clarifications regarding the practical application of regulatory data reporting, trading and settlement under the DLT Pilot Regime.

Why DLT?

The main benefits for financial firms already deploying or considering implementing this new technology include:

  • Transparency: public ledgers provide information to all participants in a distributed ledger (subject to the ledger’s specific rules), allowing transactions to be traced throughout the security’s life cycle, and can act as a register of ownership.
  • Data integrity: data stored on the ledger has a high level of integrity, as consensus among participants is needed to alter data blocks (subject to the ledger’s specific rules).
  • Disintermediation: DLT-based solutions can foster direct access to primary and secondary markets with peer-to-peer models, decreasing the need for intermediation and, in turn, reducing costs and counterparty risks.
  • Efficiency: DLT can boost listing, trading and settlement efficiency through decentralization, improved access to information and real-time transaction execution, and by easing payment processing, fund transfers and the exercise of contractual rights.

How can Deloitte help you?

Forward-thinking financial institutions understand that now is the time to fully embrace the digital age and ultimately reap the benefits. Nevertheless, keeping track of the complex and ever-evolving legislative environment around emerging technology is not an easy task.

Deloitte can help you navigate this new environment, understand and define your digital strategy and assist you in applying for the DLT Pilot Regime’s specific permission.

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Deloitte’s regulatory watch team closely follows digital finance developments and helps you stay ahead of the regulatory curve.

For all things DLT and how to leverage this new technology, including best use cases in financial services and growing market trends, please check out our webinar series.

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