James Field
The Association for Financial Markets in Europe (AFME), an industry advocacy organization that represents wholesale market participants in Europe, has published a series of papers on digital finance and distributed ledger technology (DLT), including a roadmap for the scaling of DLT capital markets with eight policy suggestions.
On August 1, the AFME released a general paper on digital finance outlining priorities for “fostering resilient, innovative, and competitive financial market.”
One key priority was addressing regulatory issues affecting tokenization, not least that central securities depositaries (CSDs)—institutions that holds financial instruments, including equities, bonds, money market instruments, and mutual funds—are currently required for listing securities and collateral eligibility.
The AFME followed up on this paper on August 2 by publishing a policy roadmap to “scaling DLT” in capital markets for the EU and the U.K. The roadmap contains four key principles to consider and an eight-point policy plan.
The four key principles were achieving full technological neutrality, achieving economic equivalence between DLT-based securities and traditional formats, balancing technology’s benefits with new risks, and enabling innovation.
When it came to the policy suggestions, some proposed solutions were relatively straightforward and widely advocated for, such as making available a broad array of cash settlement solutions, including wholesale central bank digital currency (wCBDC), and allowing banks to explore the use of permissionless blockchains “provided they have robust governance, controls, and risk mitigation solutions.”
However, half of the eight proposals were related to the Central Securities Depositories Regulation (CSDR), the EU rules governing securities settlement, and CSDs.
Currently, securities in the EU need to be registered by the CSD in ‘book-entry’ form, a method of tracking ownership of securities where no physically engraved certificate is given to investors. Since both a central system and digital tracking are required, securities that use blockchain technology (or DLT) can’t be used as collateral for loans or other financial purposes.
The AFME requested regulatory clarity on whether DLT qualifies as a digital tracking and argued for an approach more aligned with Switzerland, where DLT securities can be used as collateral.
Additionally, the AFME suggested that it should be possible to operate a DLT settlement system within the EU DLT Pilot Regime—a legal framework for trading and settlement of transactions in digital assets that began on March 23 but has yet to provide any notable solutions—without full authorization as a CSD.
Finally, the paper noted a lack of legal and regulatory consistency in the rules governing the custody of DLT-based securities between EU member states, which it argued impedes connectivity to DLT platforms, and therefore also impacts investor access to DLT-based instruments.
To address this, the AFME recommended that EU and national authorities promote harmonization in national custody legislations and regulatory guidance so that the same rules are provided for DLT-based securities as for traditional securities.
“The origination and distribution processes for DLT-based issuances do not differ in any significant way from those for traditional issuances, as underlying economic risks of issues are the same,” argued the paper.
“However, the use of DLT can offer transformative and tangible benefits compared to traditional infrastructures. These include innovation in capital markets through the possibility of programmable settlement, more cost-effective management of issuances through the automation of work flows and corporate actions, as well as reduction of single-point-of-failure risk in financial market infrastructures.”
In this context, the AFME summed up its publication by encouraging European issuers to consider the opportunities of shaping the capital market transformation towards DLT while appealing to policymakers to provide a regulatory framework that “fully supports the deployment of DLT where appropriate in the financial sector by reviewing current obstacles across the security lifecycle and supporting digital cash solutions.”
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