Recent developments on the application of the DLT to the issuance of securities tokens

On 12 February 2021, a webinar was held between the Italian Authority and some of the main players in the financial market in order to explore the interest of issuers to conduct an experiment in securities token offerings and develop the related regulatory framework. Consob's initiative is particularly important in view of recent developments, both at European level and at the level of certain Member States:

1. the publication by the European Commission of the draft regulation to implement the so-called pilot regime, aimed at creating the first European sandbox allowing the issuance of financial instruments through distributed ledger technology (DLT), by way of derogation from certain EU regulatory provisions; and
2. the adoption by Luxembourg of the Blockchain II Act 2021 in order to recognise the use of DLT for the issuance and settlement of financial instruments, allowing the direct issuance of dematerialised instruments in tokenised form.

The initiative adopted by Consob could be the first step towards the adoption in Italy of a legal and regulatory framework that favours the use of DLT as a method of issuing financial instruments.

Background

On 12 February 2021 Consob announced that a webinar was held between the Italian regulator and some of the main players in the financial market with the aim of sounding out the interest of issuers in conducting an experiment in securities token offerings and developing the relevant regulatory framework (the Press Release). The initiative concerns the new technologies based on distributed ledgers (distributed ledger technologies or DLT)1 on which the Italian regulator, like other European authorities, has long expressed a favourable opinion, while urging the study and analysis of possible legal and regulatory implications2. More recently, the Italian regulator opened a consultation on the application of DLT to Initial Coin Offerings (ICOs), as a result of which it published a report entitled "Initial Coin Offerings and Cryptocurrency Exchanges".

The webinar is part of ongoing discussions at Italian and European level on the compatibility of the issuance of financial instruments through DLT and the applicable legal and regulatory framework. In this regard, the European Commission in September 2020 presented a proposal for a regulation introducing a "pilot regime", part of a package of measures aimed at supporting the potential of digital finance in terms of innovation, competition, and risk mitigation. The purpose of this pilot regime is to allow DLT Market Infrastructures (MTFs and securities settlement systems) to be temporarily exempted from certain specific requirements under EU financial services legislation that might otherwise prevent them from developing solutions for the trading and settlement of transactions related of financial instruments issued with DLT. In addition, the “pilot regime” should also enable the competent authorities to gain experience on the opportunities and specific risks created by crypto-assets that qualify as financial instruments, and by their underlying technology. In other words, this is the first European sandbox for DLT, along the lines of what happened a few years ago in the United Kingdom with the Financial Conduct Authority (FCA).

In this context, the recent initiative described in Consob's Press Release, which could lead to the development of a regulatory framework alternative3 or parallel to the discipline of the “pilot regime”, with the aim of also allowing the application of new technologies to the capital market in Italy, is particularly relevant.

The DLT and the issuance of financial instruments

One of the issues raised by the application of DLT to the issuance of financial instruments in Italy is that of its compatibility with the regime of form and circulation of financial instruments provided for by Italian law and, with particular regard to securities traded on trading venues, by Regulation (EU) No 909/2014, the CSDR(cfr. E. La Sala, L’applicazione della Distributed Ledger Technology agli strumenti finanziari di debito, Le Società, n. 6/2019, pp. 715 e ss.). At the EU level, initiatives aimed at managing the conflict with the existing discipline applicable to financial instruments, including the CSDR, have led to the proposal of the so-called pilot regime.

The European Commission's proposal for a pilot regime

In September 2020, the European Commission published a proposal for a European regulation containing a “pilot regime”5 to allow operators of DLT Multilateral Trading Facilities and DLT Securities Settlement Systems (together the DLT Market Infrastructures) to trade, register, take custody of and settle financial instruments. The proposal aims to provide legal certainty and flexibility to market participants wishing to operate an infrastructure operating through DLT.

This “pilot regime” establishes the basic requirements for the operation of DLT Market Infrastructures and allows them to be temporarily exempted from certain specific requirements of EU financial services legislation that might otherwise hinder the development of solutions for the trading and settlement of transactions through DLT. Indeed, EU financial services legislation was not designed with DLT and crypto-assets in mind, and there are provisions that may preclude or restrict the use of DLT in the issuance, trading and settlement of tokenised financial instruments. The “pilot regime” also aims to fill certain regulatory gaps by imposing certain additional requirements in order to address the risks arising from the use of DLT such as, but not limited to, those relating to transparency, data protection and cybersecurity.

Scope of application

With the aim of enabling innovation while preserving financial stability, the scope of the pilot regime was limited to certain securities considered eligible as illiquid6.

Main measures

The main measures set out in the proposed regulation include:

• introduction of the definitions of "DLT MTF", "DLT securities settlement system" and "DLT securities";
• introduction of requirements and exemptions applicable to DLT Market Infrastructures;
• introduction of the procedure for the specific permission to operate a DLT MTF and a DLT securities settlement system respectively and include details on the information that must be submitted to the competent authority;
• arrangements for cooperation between the DLT Market Infrastructure, competent authorities and ESMA; and
• duration of the pilot regime (five years) and possible extension or modification and application of the new regime 12 months after its entry into force.

Conclusions

Pending the entry into force of the new pilot regime, some European countries, such as Luxembourg, have considered the possibility of introducing an ad hoc regime for issuing financial instruments using DLT technology7. The initiative adopted by Consob could be the first step towards the introduction in Italy of a legislative and regulatory framework that favours the use of DLT as a method of issuing financial instruments.