Last week the European Parliament and Council finalized the legislation for the EU’s pilot regime for tokenized securities. These are defined as crypto-assets that qualify as financial instruments, such as stocks, bonds, money market securities and funds. That’s in contrast to cryptocurrencies and stablecoins covered by the EU’s MiCA legislation. The size limits for stock issuance mean this program won’t be suitable for unicorns to raise funds other than through bonds.
The new law comes into force on 23 March 2023 for three years, with the possibility of another three-year extension. It allows some temporary exemptions to certain securities regulations.
The European Securities and Markets Authority (ESMA) has the bulk of the operational responsibilities, including authorizing DLT exchanges (DLT MTF) and settlement systems (DLT SS) or platforms that perform both tasks (DLT TSS).
Both new players and incumbents are expected to participate, although any new player will have to be an authorized investment firm at a minimum.
Direct access for retail investors
Securities laws have numerous limitations that make using distributed ledgers tricky. Generally regulated exchanges don’t allow access to retail participants who are expected to go through intermediaries. If ESMA grants permission, the DLT pilot regime waives this on condition that the exchange or settlement system operator offers consumer compensation if something goes wrong.
However, there are some limitations on these retail or non-regulated participants. For example, they are expected to have “a sufficient level of trading ability, competence and experience, including knowledge of the functioning of distributed ledger technology.” And they can’t be a market maker or algorithmic trader.
Single trading and settlement entity
Current legislation also separates trading and post-trade, so an exchange can’t also be a central securities depository (CSD). The new legislation allows a single entity to operate the trading and post-trade settlement, although it also supports the separation.
As part of its aim to be technology neutral, at least one element supports public blockchains through an exemption from the rules on settlement finality. However, compensation must be offered if something goes wrong.
Another area where rules are relaxed is the CSD preference for settling in central bank money. For the DLT Pilot regime, commercial bank money and e-money tokens (stablecoins) are acceptable for payment.
Size limits
For any DLT platform, there’s an overall volume limit of €6 billion ($6.4bn) of securities issuance or a market capitalization of €9 billion ($9.6bn).
DLT equity issuance is limited to companies with a market capitalization of less than €500 million ($534m).
Bond issuance limits focus on the issuance size of less than €1 billion ($1.07bn). And not only bonds are allowed, but other securitized debt such as depositary receipts and money market securities without any derivative elements.
For funds, the assets under management should be less than €500 million.
Meanwhile, other jurisdictions seem interested in this approach to experimenting with security tokens. In April, the United Kingdom announced plans for a sandbox for DLT financial market infrastructures. And we wouldn’t be shocked to see something similar in the United States.
