Digital Token Identifier (DTI) Foundation April 2023 Regulatory Updates
Table of Contents
EU Regulatory Updates
1. EU’s Digital Finance Package
In September 2020, the EU introduced its Digital Finance Package with the objective of making the EU fit for a digital age. This package included:
- a digital finance strategy;
- a legislative proposal on digital resilience, known as Digital Operational Resilience Act (DORA);
- a legislative proposal on cryptoassets, known as Markets in CrytoAssets (MICA) Regulation; and
- a Regulation on a pilot regime for distributed ledger technology (DLT) market infrastructure.
See below sections for more information on DORA, MICA and the DLT Pilot.
The digital finance strategy sets out four main priorities:
- removing fragmentation in the Digital Single Market;
- adapting the EU regulatory framework to facilitate digital innovation;
- promoting a data-driven finance; and
- addressing the challenges and risks with digital transformation, including enhancing the digital operational resilience of the financial system.
2. EU Markets in Cryto-Assets (MiCA) Regulation
The European Commission (EC) first issued a proposal for a new regulation which would set transparency and disclosure requirements for the issuance and admission to trading of cryptoassets in September 2020 under its Digital Finance Package. MiCA establishes harmonised rules for cryptoassets at EU level, with the aim of providing legal certainty for cryptoassets not covered by existing EU legislation.
MiCA identifies ‘cryptoassets’ broadly as “a digital representation of a value or a right that uses cryptography for security and is in the form of a coin or a token or any other digital medium which may be transferred and stored electronically, using distributed ledger technology or similar technology” and captures:
- asset-referenced tokens (ART);
- electronic money (‘e-money’) tokens (EMT); and
- other crypto-assets not covered by existing EU law.
On 20 April 2023 the European Parliament voted in favour of the MiCA Regulation (Level 1) with the next step being for the Council to formally endorse MICA. MICA is expected to come into force in June 2023 and will apply 18 months after this date, in January 2025. ESMA plans to publish consultations on MiCA guidelines and technical standards in Q3 2023, Q4 2023 and Q2 2024, (however, these timings are tentative and linked to Level 1 adoption).
3. The EU Digital Ledger Technology (DLT) Pilot Regime
The EU DLT Pilot went live on 23 March 2023, a key milestone in the EU’s Digital Finance Package.
The aim of the DLT Pilot is to develop the trading and settlement environment for tokenised securities in a controlled environment and to enable EU regulators to draw lessons in order to identify possible proposals for a suitable regulatory framework, given the current EU legislation for financial services does not cater for DLT and crypto-assets.
The DLT Pilot Regime applies to market infrastructure, in particular Multilateral Trading Facilities (MTFs) and Central Securities Depositaries (CSDs) to operate DLT financial market infrastructure. Under the pilot regime, there are three categories of DLT market infrastructure: (1) DLT MTFs, (2) DLT settlement systems (DLT SS) and (3) DLT trading and settlement systems (DLT TSS) – a DLT specific type of market infrastructure which combines the two services of trading and settlement. The creation of a DLT TSS is innovative, in particular, given that under the current rules, the combination of these activities is not envisaged. However, the EU authorities recognise the potential benefits of DLT in combining trading and settlement.
Given this is a pilot scheme, there are limits on the instruments which can be traded on DLT market infrastructure and market value thresholds are in place. Broadly speaking, the DLT Pilot is limited to:
- Shares of an issuer with market capitalisation of less than EUR 500million
- Bonds with an issue size of less than EUR 1 billion
- UCITS where market value of assets under management is less than EUR 500million
There are also thresholds in place to manage the scale of assets trading:
- DLT financial instruments on DLT market infrastructure should not exceed EUR 6 billion at the point of admission / initial recording of a new DLT financial instrument
- Where the aggregate market value of all DLT financial instruments on a DLT has reached EUR 9 billion, a “transition strategy” must be activated to reduce the aggregate value.
It should be noted that EU national regulators can set lower thresholds than these if they wish.
In terms of benefits, the DLT Pilot allows for some exemptions from the EU’s MiFIR/MiFID II and CSDR regimes to make it easier for market participants to trial DLT when trading and settling tokenised securities. However, if granted any exemptions from certain MiFID II/MiFIR/CSDR requirements, the DLT market infrastructure will have to comply with certain conditions, known as ‘compensatory measures’, to meet the objectives of those requirements.
ESMA recommends use of Digital Token Identifier (DTI) in DLT Pilot as a compensatory measure
ESMA recommended that DLT market infrastructure use the ISO 24165 Digital Token Identifier standard (DTI) as a compensatory measure in its report on the DLT Pilot, published on 27 September 2022 (page 54).
In its DLT Pilot Q&A, (last updated in March 2023 to include a question on how should the tentative market capitalisation of DLT shares be calculated), ESMA also recommends that trading venues, investment firms and approved publication arrangements (APAs) complement the ISIN by including the DTI when publishing post-trade information under Table 3 of Annex I of RTS 1 (equity and equity-like instruments), and Table 2 of Annex II of RTS 2 (non-equities).
ESMA is required to develop further guidelines relating to the DLT Pilot, expected in 2025. ESMA is also required to prepare a report in 2026 assessing the DLT Pilot Regime which will assist the EU in its proposals regarding next steps: these steps could range from extending the Pilot for another 3 years, extending the scope of DLT financial instruments under the Pilot, amending the Pilot Regime, terminating it or making it permanent.
4. EU Digital Operational Resilience Act (DORA)
The Digital Operational Resilience Act (DORA) aims to harmonise provisions relating to digital operational resilience across the EU financial sector with particular focus on managing ICT-related risks and incidents.
DORA entered into force on 16 January 2023 and applies from 17 January 2025. The European Securities Authorities (ESMA, EBA and EIOPA) will need to deliver technical standards to the European Commission (EC) in early 2024 and ESMA has stated it plans to publish its consultations on DORA guidelines and technical standards in Q2 and Q4 of 2023, along with a Feasibility Study in Q4 2023.
5. Bank for International Settlement (BIS) opens Innovation Hub Eurosystem Centre
On 28 March 2023, the BIS Innovation Hub Eurosystem Centre, a joint effort by the BIS and Eurosystem central banks, opened. The BIS states: “the Centre has offices in Frankfurt and in Paris, hosted and supported by the Deutsche Bundesbank and the Banque de France. The European Central Bank (ECB) coordinates the interactions of the Eurosystem with the Centre. The Centre’s project focus areas are decentralised finance, wholesale CBDC, cyber security and green finance.“
The project on decentralised finance (DeFi) is called Project Atlas, with. BIS’s project partners being the Deutsche Bundesbank and De Nederlandsche Bank. Together, they will consider what is the economic significance of cryptoassets and DeFi, noting these markets often lack transparency and present new risks. The BIS will develop a data platform to provide reliable insights into the macroeconomic relevance of DeFi and cryptoasset markets, tailored to the needs of central banks under Project Atlas.
UK Regulatory Updates
6. FCA/Bank of England Joint Data Transformation Programme
In 2021, the FCA and BoE started their multi-year Joint Data Transformation Program with the vision to …”get the data they need to fulfil their mission, at the lowest possible cost to industry“. The BoE and FCA have set up a multi-year, multi-phased, transformation programme with 3 key reforms in mind:
- Defining and adopting common data standards that identify and describe data in a consistent way throughout the financial sector. These common standards should be open and accessible for use by all who need them.
- Modernising reporting instructions to improve how reporting instructions are written, interpreted and implemented. There are a range of steps involved, from setting up better Q&A processes to potentially rewriting instructions as code.
- Integrating reporting to move to a more streamlined, efficient approach to data collection. This reform includes making data collection more consistent across domains, sectors and jurisdictions, and designing each step in the data collection process with the end-to-end process in mind.
In November/December 2022, EY, commissioned to perform a data standards review on further development and adoption of standards under this programme, asked a series of questions to which the DTI responded, advocating the use of ISO as a universal template for international financial services standards. The FCA and BoE have said that they expect work on the resulting report to conclude ‘in the coming weeks’ and in March published an update on the progress of the programme.
7. HMT: Future Financial Services Regime for Crytoassets Consultation
On 1 February 2023 HM Treasury (HMT) published a consultation and call for evidence on its plans to regulate cryptoassets used within financial services, given most cryptoasset activities are not currently subject to broader financial services regulation in the UK. Using the principle of “same risk, same regulatory outcome”, HMT intends to put in place commensurate safeguards where cryptoassets present similar risks to traditional financial instruments.
HMT is pursuing a phased approach to regulating cryptoassets. Phase 1 comprised putting in place an anti-money laundering and counter terrorist finance regime (AML/CFT) for cryptoassets which has been in place since January 2020 and proposals focused on fiat-backed stablecoins and the financial promotion of cryptoassets. This consultation sets out proposals for Phase 2: the UK government’s approach to regulating broader cryptoasset activities, such as the trading of and investment in cryptoassets.
HMT’s proposed policy approach is to bring cryptoasset activities into the UK regulatory perimeter, using the UK’s existing Financial Services and Market’s (2000) Act (FSMA) rather than create a bespoke regime, and the FCA will be given powers to write tailored rules. Proposals are centred around a number of important cryptoasset activities – including exchange activities, custody activities and lending activities.
Whilst a definition of cryptoassets is included in the Financial Services and Markets Bill, drawn broadly so as to capture all current types of cryptoasset, and very similar (although not identical), to that in MICA, HMT’s intention is that that the activities will be regulated, rather than the asset itself. Consequently, HMT plans to create a number of new regulated or designated activities tailored to the cryptoasset market. It is also worth noting that HMT proposes to capture cryptoasset activities provided in or to the UK i.e. activities provided by UK firms to persons based in the UK or overseas (natural and legal), as well as those provided by overseas firms to UK persons (natural or legal).
Etrading Software’s DTI Foundation (DTIF) welcomes the UK Government’s consultation and has responded, highlighting that the DTI ISO standard has been designed for the specific purpose to improve transparency within the cryptoassets market, assisting regulators and market participants manage some of the risks identified in the consultation. The DTI enables regulators to:
- Understand the impact on market participants and the market in the event a blockchain suffers an operational outage or event through identification of the financial instruments at risk and individual trades at risk;
- Detect market abuse through the identification of market activity and irregular suspicious patterns; and
- Detect AML activities through facilitating the tracking of bridged cryptoassets.
The consultation closes on 30 April 2023 and HMT will use responses to inform its proposals.
8. FCA Business Plan: 2023/24
On 5 April the FCA published its Business Plan for 2023/24 which sets out the work it will do over the next 12 months. The FCA will focus on four commitments, one of which is “Strengthening the UK’s position in global wholesale markets” and will entail “shaping digital markets to obtain good outcomes“.
The FCA notes cryptoassets is a focus for 2023/04. The UK Treasury is currently consulting on proposals for a broader future regulatory regime for cryptoassets (see item above) and in preparation, the FCA states it will be investing in additional skills to enable it to deliver on, and make changes to, the systems and procedures needed for the relevant firms, as well as the necessary changes to systems and procedures for the firms who fall within the scope of these proposals.
9. FCA Executive Directors speak about digital assets at City Week 23
The FCA recently published two speeches given at City Week 23 by Sarah Pritchard (Executive Director of Markets and Executive Director of International) and Emily Shepperd (Chief Operating Officer and Executive Director of Authorisations).
Highlights from Sarah Pritchard’s speech entitled “Regulation of Digital Assets” in the UK, are:
- Regulation may be able to mitigate some of the harm, but it will not be able to stop all risk in relation to crypto – in particular risk of financial loss. Consumers who buy crypto must be prepared to lose all their money.
- The FCA expects crypto promotions to be treated on a par with other high-risk investments and failure to comply will be a criminal offence.
- The FCA wants industry’s input to make sure it gets the future regulatory regime for cryptoassets right. It will discuss with policymakers, investors and consumers about the limits of regulation and the appetite for risk.
Highlights from Emily Shepperd’s speech entitled “How Regulation can help the UK lead in Fintech”, are:
- Regulators can help firms innovate by setting firm foundations on which they can grow. The sooner firms get a handle on regulatory issues, the sooner they can thrive and grow.
- The FCA has helped firms foster innovation through its Sandboxes, Innovation Pathways and Early and High Growth Oversight schemes.
- The UK remains the most attractive destination for financial technology investment in Europe, and is globally second only to the United States.
Global Regulatory Updates
10. FSB Proposed Framework for International Regulation of Cryptoasset Activities
The Financial Stability Board (FSB) consulted on its proposed framework for the international regulation of cryptoasset activities from Oct 2022 to December 2022. In the consultation, the FSB described the key issues and challenges it sees in developing a comprehensive and consistent regulatory approach that captures all types of cryptoasset activities that could give rise to financial stability risks. It also set out the FSB’s proposed approach for establishing a comprehensive framework.
Etrading Software’s DTI Foundation agrees with the FSB’s recommendations and responded to question 8 of the consultation: “Have the regulatory, supervisory and oversight issues and challenges as relate to financial stability been identified accurately? Are there other issues that warrant consideration at the international level?”, noting that the Digital Token Identifier (DTI) can help with the following recommendations:
- Recommendation 1: by providing a common international tool to uniquely identify digital assets;
- Recommendation 3: by facilitating efficient and consistent information sharing between the authorities;
- Recommendation 6: by providing authorities with access to quality reference data on crypto assets; and
- Recommendation 8: by providing a link between crypto assets and traditional securities through a link to ISINs and Legal Entity Identifiers (LEIs) to simplify linkage of the different identifiers by market participants and public authorities.
The FSB plans to publish the final report in July 2023.
11. FSB 2023 Work Program: digital innovation a priority area
On 30 March 2023, the FSB issued its Work Program for 2023 which includes its planned work, and indicative timeline of main publications. “Harnessing the benefits of digital innovation while containing its risks” is a priority area with the FSB committing to continue to monitor developments in crypto-asset markets and advance its work on the global regulatory and supervisory framework for crypto-asset markets and activities.
The FSB’s focus is to:
- Assess the implications of crypto-assets for financial stability, including through ongoing monitoring, analysis of emerging themes or material incidents, and deep-dives on crypto-asset firms that vertically integrate different functions (“multifunction crypto-asset intermediaries”) and on the tokenisation of assets.
- Finalise its recommendations on global stablecoin arrangements and for crypto-asset activities and markets and conduct follow-up work to promote the effective and timely implementation of the recommendations across FSB and non-FSB jurisdictions.
- Analyse the financial stability implications of decentralised finance (DeFi) and conduct follow-up policy work, as appropriate, on addressing risks from DeFi and multifunction crypto-asset intermediaries.
12. IOSCO Work Program 2023-2024: addressing new risks in fintech is a priority
On 4 April 2023, IOSCO published its work program for 2023-2024 with five proposed priority workstreams one of which is “Addressing new risks in sustainability and fintech”. There are two workstreams: Crypto and Digital Assets (CDA) and Decentralised Finance (DeFi), both focusing on identifying, assessing and responding to market integrity and investor protection concerns in the sector. IOSCO expects to deliver the following:
- a consultation report with recommendations for the regulation of CDA in H1 2023 and final recommendations in 2023.
- a consultation report with recommendations for the regulation of DeFi in Q3 and final policy recommendations by year-end 2023.
Disclaimer: The content of this Regulatory Update is for general information only and does not constitute legal or other professional advice.