The European Securities and Markets Authority (ESMA) has published a speech given by Patrick Armstrong, Senior Risk Analysis Officer, ESMA Innovation and Products Team, on regulation and distributed ledger technology (DLT). In his speech, Mr Armstrong comments on how ESMA approaches the topic of financial innovation and the attendant regulatory challenges. Points of interest in the speech include:
- the issue of DLT and the regulatory response is a critical topic for both the regulators and market participants. The challenge is to identify when a regulator should step in, also called the regulatory “tipping point”, which is a point between “too small to care” and “too large to ignore”;
- when confronted with a financial innovation, a regulator can roughly take one of the three approaches: (i) ban or restrict products or processes, (ii) take a ”wait and see” approach; and (iii) actively facilitate and regulate the product or process. ESMA and member states will have the power to ban a financial product once the MiFID II regime becomes effective on 1 January 2018. Until then, ESMA believes that until a harmful tipping point has been reached, it can take measures such a issuing warning or statements;
- the “wait and see” approach is largely the approach that ESMA has taken towards DLT. This should not be interpreted as ESMA taking a passive approach, instead, it is actively trying to learn more about the innovation, but doing so while its objectives are not placed at risk by not taking action. At the same time, by waiting to see how the innovation develops, ESMA does not risk stifling a potentially socially or economically useful product or process;
- actively facilitating and regulating the product or process approach, is one that ESMA will take when it believes an innovation has matured or becomes too large to ignore. ESMA notes that this approach has its merits, as it may reduce regulatory uncertainty around DLT, and may also lead to more rapid development in ways that are responsible. However, if technology fails to develop as anticipated, the approach could lead market participants to suggest that the regulator acted impetuously or disrupt a socially and economically useful phenomenon from evolving;
- ESMA is using the feedback received to its June 2016 Discussion Paper: The distributed ledger technology applied to securities markets to develop a position on the use of the technology in securities markets and assess whether a regulatory response to the DLT may be needed. ESMA’s view is that DLT could bring a number of benefits to securities markets, including not exclusively to post-trade processed. However, a number of challenges will need to be addressed before these benefits may materialise. ESMA also realises that while DLT may at once reduce or mitigate certain risks, it may also create or exacerbate other; and
- in analysing the responses to its discussion paper, ESMA has not identified major impediments in the current EU regulatory framework that would prevent the emergence of DLT. However, a number of concepts as principles, such as the legal certainty attached to DLT records or settlement finality, may require clarification as DLT develops. ESMA also realises that beyond pure financial regulation, broader legal issues such as contract law, insolvency law or competition law, may impact on the deployment of DLT.
View ESMA speech on regulation and DLT, 22 November 2016