Contributions on the topic of security tokens often invoke liquidity as a very important advantage of tokenising assets. They offer the possibility of injecting liquidity into illiquid assets such as real estate, by, for example, trading the corresponding tokens after they have been issued. In theory, this is undoubtedly correct. However, practice has proved different so far. The European Union in particular has almost no trading platforms on which the corresponding security tokens are (allowed to be) traded. As a result, there is no corresponding secondary market, although such a market would be indispensable for strong trade and thus liquidity. This situation is mainly due to the current legal position. This position is characterised by a series of very strict requirements and restrictions that corresponding platforms are subject to.
Specifically, the current legal provisions for the operation of crypto exchanges provide for comprehensive regulatory requirements. Crypto exchanges in which buyers and sellers of securities (including security-like transferable security tokens) based on “distributed ledger technology” (DLT) are brought together without the exercise of discretion through internal operating procedures qualify as a so-called “MTF”, or multilateral trading facility. Under Austrian law, the operation of an MTF requires a licence under the Securities Supervision Act, the obtaining of which requires initial capital of EUR 730,000 and involves complex compliance requirements.
According to the current legal situation it is also essential that the participation of investors in the crypto exchange or trading system without the prescribed characteristics (such as securities firms and credit institutions) is not permitted. This provides for a duty of mediation regarding market participation by a legally authorised person. Furthermore, the transaction requires the involvement of a central securities depository, which operates certain settlement systems (securities delivery and settlement systems) for the transactions and on whose securities account the respective security must be booked for the settlement of the transaction. These prerequisites already pose great challenges to project developers at the beginning of a crypto project and have so far prevented the establishment of corresponding trading venues.
In addition to the planned EU regulation entitled “Markets in Crypto-Assets Regulation” (MiCAR), the new DLT Pilot Regime Regulation should also help overcome previous regulatory hurdles and facilitate access to the crypto market.
Because this regulation provides for an exemption from the previously applicable and strict regulations if certain conditions are met, a kind of “regulatory sandbox” is to be created for the trading and settlement of financial instruments based on DLT. The DLT Pilot Regime is primarily aimed at investment firms, market operators and central securities depositories and regulates the requirements in relation to so-called DLT market infrastructures. These are (i) DLT multilateral trading facilities (DLT-MTF), (ii) DLT settlement systems (DLT-SS) and (iii) DLT trading and settlement systems (DLT-TSS). These correspond to familiar regulatory infrastructures, but are specifically tailored to DLT-based securities.
In principle, the same legal provisions apply to the a forementioned DLT market infrastructures as are already applied to the classic MTFs and settlement systems of the central securities depositories. In order to promote the establishment of such systems, however, the DLT pilot regime now provides for temporary exemptions from certain requirements and restrictions if certain conditions are met. Amongst other things, this will allow that the aforementioned brokerage obligation is not bound to a limited time period, in contrast to the current legal requirements for classic MTF trading platforms or for the operation of a DLT-MTF. Prospective investors will therefore now be able to access the crypto exchange or the respective trading venue directly.
The operation of a DLT-SS requires a licence and may only be carried out by central securities depositories, but will now also be facilitated by the DLT pilot regime upon application. For example, the requirement to book DLT securities on the securities account of the central securities depository may be waived. The possibility of operating a DLT-TSS (DLT trading and settlement system) is, however, entirely new. Accordingly, this can either be a DLT-MTF, where the services of a DLT-MTF are combined with those of the DLT-SS, or a DLT-SS, where in turn the services of a DLT-SS are provided with those of a DLT-MTF. In this way, investment firms and market operators could partially provide services of a CSD and vice versa. This should greatly facilitate the settlement of DLT transactions.
In conclusion, while the current provisions will remain in place, developers will be offered the possibility, at least in certain respects, to take advantage of exemptions to speed up and simplify project implementation. The ordinance, which will come into force on 23 March 2023, will be valid for three years, although this can be extended after assessing the costs and benefits. In any case, the introduction of this regulation promises to become a real “game changer” for the importance of security tokens and their emissions.