1. ESMA DLT Report Key findings 30 May 2017
FSB Financial Innovation Network
Patrick Armstrong

2. 2013 : ESMA starts looking at investments using VCs
Background
2013 : ESMA starts looking at investments using VCs
April 2015 : Call for Evidence on VCs and DLT
Oct 2015 : DLT Task Force composed of 9 NCAs; EC, EBA and ECB as observers
June 2016 : Discussion Paper on DLT
Positive feedback from a wide range of stakeholders (>70 responses)
Feb 2017 : Report on DLT

3. Overview of key findings (1/2)
A number of potential benefits
But risks as well
Some important challenges lie ahead – still unsure whether and how DLT may address those challenges
More likely scenario : improvement of existing processes under the current market infrastructure
First target : least efficient market segments with relatively limited volumes, e.g., syndicated loans, private equity shares

4. Overview of key findings (2/2)
No major impediment in current EU rules
But potential issues at national level, e.g., corporate law
A number of concepts/principles will require clarification, e.g., settlement finality or legal ownership in a DLT environment
Also, some new rules may be needed to address new/heightened sources of risk or to regulate new roles/functions, e.g., the management of private keys
Some adjustments to supervisory practises may also be required from regulators through time – need to build technology savvy teams

5. Need to monitor developments closely as market is evolving quickly
ESMA’s stance
Regulatory response pre-mature at this stage, considering that technology is still at an early stage
Need to monitor developments closely as market is evolving quickly
Balanced and pro-active approach
Engage with industry
Consider possible ways to address risks and barriers to potential benefits
European and international cooperation is needed

6. Key findings

7. More efficient post-trade processes
Potential benefits
More efficient post-trade processes
Faster clearing and settlement
Enhanced safekeeping and record-keeping of ownership
Smart contracts
Enhanced reporting and supervision
Enhanced collection, consolidation and sharing of information
Enhanced KYC and AML processes
Greater security and availability
Reduced counterparty risk and enhanced collateral management
Reduced costs

8. Main Challenges
Interoperability
Use of common standards
Network effect
Access to central bank money
Scalability
Governance
Privacy issues

9. Fraud and money laundering Operational risks High
Sources of risks
Cyber risk
Fraud and money laundering
Operational risks
Potentially lower with DLT but could take new forms
High
Obsolescence of encryption
Systems running in parallel
Distorted competition
Market manipulation
New/heightened sources of risk
Low
Market volatility
Interconnectedness
Potentially low in the short term (applications limited in scope)

10. Interaction with the EU regulatory framework Clearing activities
EMIR and MiFIR clearing obligation
EMIR : certain classes of OTC derivatives need to be cleared through CCPs ; others are subject to risk mitigation techniques
MiFIR : exchange-traded derivatives need to be cleared through CCPs
DLT needs to qualify as CCP or to accommodate risk mitigation techniques
Other assets
MiFID securities, securities lending, repurchase agreements, collateral deposits and non-MiFID derivatives and instruments
No prescription on the form or governance of DLT

11. Interaction with the EU regulatory framework Settlement activities
CSDR and SFD
CSDR applies to Central Securities Depositories (CSDs) operating securities settlement systems and to the settlement of transactions in financial instruments as defined by MiFID
SFD applies to payment and securities settlement systems (designated by Member States based on systemic importance)
Implications for DLT
Transferable securities, issued by issuers established in the Union, traded on trading venues, or transferred following a financial collateral arrangement need to be recorded in book-entry form with a CSD -> DLT would need to be a CSD -> CSDR applies
If DLT is designated as a securities settlement system -> DLT needs to qualify as a CSD ->SFD and CSDR apply
If DLT acts as a settlement internaliser under CSDR (settling transactions outside a securities settlement system operated by a CSD) -> CSDR reporting requirements apply

12. Interaction with the EU regulatory framework Safekeeping and record-keeping of ownership
Legal framework
No harmonised definition at EU-level
Different entities fulfil this role: CSDs, custodian banks, registrars, notaries, depositaries
Need to distinguish between issuer level and investor level
CSDR: notary and central maintenance functions -> integrity of securities issue
MiFID/MiFIR, UCITS, AIFMD: requirements at investors’ level
Certain aspects of securities issuance or the rights attached to securities are defined by national rules, including the Civil Law and Corporate Law
Implications for DLT
CSDR, MiFID/MiFIR, UCITS, AIFMD requirements may apply depending on the type of assets
Need to account for national rules

13. ESMA’s Way Forward
ESMA will continue to monitor market developments around DLT to assess whether regulatory action may be needed.
Meanwhile, a number of concepts or principles, e.g., the legal certainty attached to DLT records or settlement finality, may require clarification.
ESMA believes that the industry should work towards solutions to the issues the technology poses