The European Securities and Markets Authority (ESMA) has published a letter to the European Commission, the Parliament, and the Council (ECOFIN) which highlights the challenges related to the implementation of the DLT Pilot Regime.
The DLT pilot regime applied in the EU as of 23 March 2023. This regime establishes the legal framework for trading and settling transactions involving crypto-assets meeting the criteria of financial instruments under Mifid II.
ESMA has noted that the DLT Pilot Regime in Europe is facing several significant challenges, with the first being the absence of central bank digital currencies and how it poses a hurdle in finding innovative solutions for cash settlement.
Despite the potential use of cryptographically secured settlement options like tokenised commercial bank money or e-money tokens, timing mismatches with regulatory authorisations have complicated the process.
ESMA also commented that the regulatory landscape surrounding custody services within DLT market infrastructures, particularly concerning “self-hosted wallets” under MiCA, lacks clarity. Defining the roles and responsibilities of various entities involved in custody services needs further elaboration to prevent possible overlaps with existing regulations under MiCA or Mifid.
Ensuring interoperability between DLT market infrastructures and traditional counterparts presents another hurdle, said ESMA, with the difficulty arising in finding authorised DLT service providers and accessing traditional Central Securities Depositories (CSDs), especially in meeting regulatory requirements under CSDR.
Moreover, ESMA said that balancing investor protection with direct access for retail investors under the DLT pilot regime is challenging. Identifying compensatory measures to safeguard investors while facilitating access requires careful consideration and collaboration among regulatory authorities.
ESMA also pointed out that the competitiveness of the DLT pilot regime compared to similar regimes in non-EU jurisdictions is under massive scrutiny. Uncertainty surrounding the duration of the regime and thresholds for DLT financial instruments affects market participation. Clarification on the extension of the regime and adjustments to thresholds could enhance competitiveness and encourage more applications.
The financial regulator noted that addressing these challenges will be crucial in maximising the potential benefits of the DLT Pilot Regime in Europe.
The DLT pilot regime aims to facilitate the establishment of new market infrastructures, including the DLT multilateral trading facility, DLT settlement system, and DLT trading and settlement system.