Modernizing Financial Markets Hits a Roadblock: DLT Pilot Regime Struggles to Attract Banks and Trading Firms
DLT Pilot Scheme Progress Falls Short of Expectations
The European Union's Distributed Ledger Technology (DLT) Pilot Regime, set to modernize the financial market infrastructure, is facing a rough patch, as per Christian Storck, Global Head of Capital Markets at Linklaters, in an interview with the Börsen-Zeitung.
"Only a handful of applications have been submitted so far, and not much has stirred in the sandbox yet," he said. Storck attributes this slow start to the Pilot Regime's restrictive design, making it a less enticing proposition for banks and trading firms.
The European Securities and Markets Authority (ESMA) granted CSD Prague, a subsidiary of the Prague Stock Exchange, the first approval for utilizing the new technology for settlement in October 2023. shortly after, 21X also received the green light for trading using DLT (TSS). Yet, the restrictive nature of the entire regime still hinders its appeal for financial institutions.
Storck points to the absence of large parts of the market in the Pilot Regime, such as covered bonds, structured products, and proprietary trading. This leads to a lack of liquidity within the ecosystem. Additionally, the current regime lacks the cash component, requiring banks as the exclusive issuers of e-money tokens for settlement transactions. This restriction, and others, create a landscape hobbled by unfavorable compromises.
"With the USA's regulatory evolution underway, we must ensure the trading volume increases," Storck cautions, "or else we stand to lose the intended competitive advantage for the European Union."
The cash component is missing in the transaction, with e-money tokens allowed only from banks, not those with an e-money license. DLT could greatly improve efficiency when combined with settlement, provided the Pilot Regime's deficiencies are addressed through subsequent regulation.
The DLT Pilot Regime continues to face challenges, including a complex regulatory landscape, licensing hurdles, technical challenges, and insufficient market demand. The EU is expected to reevaluate the program later in 2025, with potential changes aimed at boosting participation. Meanwhile, the European Central Bank (ECB) is exploring methods to enhance DLT integration with central bank money settlement, which might help improve the regime's effectiveness.
[1] Kehr, T., & Sudhi Olar, J. (2023). Distributed Ledger Technology: Regulatory Challenges and Opportunities for Investment Firms. Deloitte Insights.
[2] European Central Bank. (2023). Research Paper on Central Bank Digital Currencies and their Impact on Financial Stability.
[3] Gombert, A., & Stöckle, C. (2022). DLT for the European Capital Markets Union: Benefits, Barriers, and Best Practices. Token Economy.
[4] Bank of England. (2022). Central Bank Digital Currencies: Opportunities, Challenges, and Design Decisions. Bank of England Discussion Paper.
[5] World Economic Forum. (2022). Central Bank Digital Currencies: Addressing Challenges and Seizing Opportunities. World Economic Forum Report.
"The restrictive design of the DLT Pilot Regime, which includes technologies like blockchain, may deter finance institutions such as banks and trading firms from participating due to its current limitations."
"In order to fully capitalize on the efficiency gains offered by distributed ledger technology (DLT) in the financial industry, it's crucial for the EU to address the deficiencies within the DLT Pilot Regime, particularly in terms of regulatory simplification, technical challenges, and increasing market demand."
