The European Securities and Markets Authority published a discussion paper to solicit comments on distributed ledger technology – a more generic term for what is sometimes referred to as the “Blockchain.” (The Blockchain, however, is more appropriately regarded as a form of DLT associated with Bitcoin – one form of digital currency.) Generally, DLT refers to records or ledgers of electronic transactions that are maintained on a shared network of participants and not by a single entity. There is no central validation of such transactions. Security is maintained throughout the system using computer-based encryption techniques. Whereas the Blockchain is an open system where all participants can contribute to the system’s validation, DLT developed for financial markets would most likely be restricted only to authorized persons. According to ESMA, DLT could be used to “speed the clearing and settlement of certain financial transactions by reducing the number of intermediaries involved and by making the reconciliation process more efficient.” ESMA also observed that DLT could be used to record ownership of securities and the safekeeping of assets while so-called “smart contracts” could be linked with DLT to automate the processing of corporate actions or to automate certain contractual terms (e.g., payment on the occurrence of certain conditions). Among other things, ESMA seeks to understand potential uses for DLT in connection with securities and derivatives transactions (not with digital currencies); potential technological issues (e.g., how DLT might interface with fiat currency ledgers and existing market infrastructures); potential regulatory and legal issues; potential governance and privacy issues; and potential risks, including security and cyber risks, fraud and money laundering. ESMA will accept comments through September 2.
Helpful to Getting the Business Done: ESMA’s discussion paper is a very succinct primer on DLT and should be reviewed by all finance industry professionals who wish to acquire a basic understanding of the subject. Although ESMA takes no view on a possible need to regulate DLT, it identifies a number of potential legal and regulatory issues. Among other things, ESMA observes that “[t]he capacity of the DLT to fit into the existing regulatory framework may limit its deployment.” ESMA specifically wants feedback on the legality and enforceability of records maintained on the DLT, and how a specific DLT application might be supervised, given its cross-border nature and the differences in privacy, insolvency and other requirements across countries. ESMA’s desire to learn more in commendable, but it should keep in mind CFTC Commissioner J. Christopher Giancarlo’s cautionary advice to all regulators in thinking about DLT, mainly to “do no harm” in order not to impede the development of this new technology. To accomplish this, US and foreign regulators should “coordinate to create a principles-based approach for DLT oversight in order to provide the flexibility, certainty, and harmonization necessary for this technology to flourish,” Mr. Giancarlo stated a few months ago. (Click here for further insight into Mr. Giancarlo’s thinking in the article, “CFTC Commissioner Calls for Regulators to 'Do No Harm' in Development of Distributed Ledger Technology; Other Regulators Weigh in Too” in the April 3, 2016 edition of Bridging the Week.)