The European Commission published its new Digital Finance Strategy on 24 September 2020 (DFS 2020). At the core of this strategy lie the legislative proposals for an EU regulatory framework on crypto-assets, consisting of both the proposal for a new Regulation on Markets in Crypto-Assets (MiCAR) as well as a new proposal for a Regulation on a Pilot Regime for Market Infrastructures Based on Distributed Ledger Technology (known as PilotR). The latter is the focus of our working paper on ‘The DLT Sandbox under the EU Pilot Regulation’.
As already discussed here on the Oxford Business Law Blog in a post by Professor Wolf-Georg Ringe and Christopher Ruof, the PilotR will introduce a so-called ‘sandbox’ approach. This means that PilotR creates a controlled space with temporary derogations from existing rules to facilitate innovation and give regulators an opportunity to gain experience in DLT-based market infrastructures. Even though several EU Member States have already adopted a sandbox approach in various aspects of financial markets regulation, concerns over deviating from mandatory EU financial law and putting the main privilege of EU membership (ie the ‘EU Passport’) at risk have limited the space for experimentation. Hence, there is a need to take action at EU level.
In our working paper we analyse the PilotR Proposal in light of the international discussion on regulatory sandboxes and its application to Distributed Ledger Technology. We identify the implications of the new PilotR in the context of EU securities law and assess to what extent the PilotR delivers on the DFS 2020 ambitions. We conclude with some suggestions how the draft PilotR could be improved in the ongoing EU legislative process.
When we compare PilotR to other regulatory sandboxes, we find, on the pro-innovation side, that PilotR operates with longer timelines than most sandboxes. Exemptions are valid for up to six years, compared to the typical 6-24 months (plus extensions) we find in sandbox regulations. However, this long duration comes at the price of a relatively narrow set of available exemptions for companies under the weight of heavy regulatory requirements. In particular, the PilotR restricts access to the Piloting Regime to licensed entities and allows for exemptions only with regard to a detailed list of requirements.
PilotR’s narrow set-up is partly a consequence of its greatest benefit, namely the ‘EU Passport’ that allows firms to expand across the Single Market, which should enable more firms to participate in the pilot regime and facilitate, consequently, more competition and more innovation, and eventually more learning on the side of both firms and regulators, provided that the learning is shared across competent authorities. To achieve this, PilotR stands out from other sandboxes in providing an elaborate process for such knowledge-sharing across regulators in the EU/EEA, with ESMA assuming a central coordination role.
However, the PilotR does not allow ESMA to issue binding rules. In order to ensure a harmonized set of rules as a precondition for the EU passport, the EU regulators decided in favour of a tight-knit list of mandatory regulation, in an effort to prevent a ‘race to the bottom’ where Member States compete to have the most lenient (instead of the best) rules for DLT market infrastructure.
Notwithstanding the former, PilotR is characterized by an innovative ‘Business Plan Approach’ where the DLT operator defines governance functions and liabilities of entities operating, and connected to, the DLT market infrastructure, while the Competent Authority reviews this Business Plan to avoid, or limit at least, externalities. Through this Business Plan Approach, PilotR promotes innovation while demanding business-specific risk mitigation, avoiding one-size-fits-all approaches. This bold regulatory move, however, prompts legal questions regarding the enforceability of business-induced rules vis-à-vis the nodes that do not qualify as operators as well as third parties.
Overall, the PilotR Proposal constitutes a significant step towards a future-proof EU fintech framework. However, to fully meet the ambitions laid down in the DFS 2020, we believe that the PilotR Proposal would benefit from widening its scope to include non-licensed entities as well as a number of technical improvements, as further outlined in our paper.
Dirk A. Zetzsche is Professor of Law, ADA Chair in Financial Law and Inclusive Finance, Faculty of Law, Economics and Finance, University of Luxembourg.
Jannik Woxholth is a PhD student and a Senior Scientist under the ADA Chair in Financial Law (Inclusive Finance), University of Luxembourg.