The Association for Financial Markets in Europe (AFME) published a series of papers on digital finance and distributed ledger technology (DLT). Last week we wrote about its more general paper on digital finance, which included a section on tokenization. It subsequently published two policy roadmaps to scale DLT in the capital markets for the EU and the UK.
DLT projects are now moving beyond the experimentation phase, but current regulations are obstructing the potential to scale DLT usages.
Half of the eight AFME proposals relate to the Central Securities Depositories Regulation (CSDR).
The DLT Pilot Regime commenced in March 2023, but so far no solutions have launched. While some organizations are working on applications, most large incumbents have no plans to use it because the limits are too small and there’s no commitment to finalize new laws. AFME wants to see both these points addressed. Clearstream’s Jens Hachmeister recently compared the DLT Pilot Regime to requesting the adaptation of an aircraft carrier to support the landing of Cessna aircraft, but only for a handful of flights.
Additionally, AFME believes that it should be possible to operate a DLT settlement system (DLT SS) within the Pilot Regime without full authorization as a central securities depository (CSD).
CSDR changes
On a related point, beyond the DLT Pilot Regime, currently CSDR legislation only supports centralized settlement systems. A move towards decentralized settlement systems might see the functions of notary, account maintenance and settlement services performed by separate entities.
Another CSD related issue is the need for securities to be registered by the CSD in ‘book-entry’ form. AFME requests regulatory clarity on whether DLT qualifies.
Because there’s a need for both a CSD and book-entry form, DLT securities aren’t eligible to be used as collateral. That contrasts with Switzerland, where they are.
The CSDR contains settlement finality rules which ensure legal enforceability, binding transfer and netting even when a participant becomes insolvent. However, the securities settlement system currently has to be run by a CSD. AFME wants to see similar protections for DLT-based platforms.
On chain payment
Currently the European Central Bank is conducting wholesale DLT settlement trials, with three central bank money solutions, one of which is a wholesale CBDC (wCBDC). The trials end in November but AFME requests that at least one of them be made permanently available.
Additionally, on the digital money front it wants to see regulatory clarity around the use of tokenized commercial bank money, approved stablecoins and private alternatives to central bank money (similar to Fnality).
AFME notes the latest update to the Basel Committee rules on crypto-assets now assigns the highest risk weighting (1250%) to securities issued on permissionless blockchains. When transposing this into EU law, it argues that the EU should take risk mitigation solutions into account.
Finally, the paper notes that custodial services in Europe are governed by national legislation, which is creating a fragmented environment for cross border issues. Hence, it would like to see the harmonization of custody rules.
The paper splits the actions into steps that are needed in the near term versus those that could be delayed a little longer. While the EU appeared to be a first mover with the DLT Pilot Regime, other jurisdictions are catching up.
