The DLT sandbox under the pilot-regulation

The European Commission published its new Digital Finance Strategy on 24 September 2020 (DFS 2020). One of the centerpieces of the Strategy is the draft regulation on a pilot regime for market infrastructures based on distributed ledger technology (known as PilotR). The PilotR Proposal foresees a regulatory sandbox approach for the European Single Market, offering firms a set of exemptions from EU financial law allowing them to test distributed ledger technologies (DLTs) in certain activities related to trading, clearing, and settlement. Besides offering room for experiment, the PilotR Proposal supports the education of EU regulators about DLTs in this context, which may come to form the basis for foundational changes to EU law. The PilotR Proposal constitutes a significant step towards a future-proof EU fintech framework. We appreciate the European scale of PilotR, with an ‘EU Passport’ and ongoing cooperation across competent authorities and the ESMA. PilotR is characterized by an innovative ‘Business Plan Approach’ where the DLT operator defines governance functions and liabilities of entities operating, and connected to, DLT. Through this Business Plan Approach, PilotR promotes innovation while demanding business-specific risk mitigation, avoiding one-size-fits-all approaches. This bold regulatory move, however, prompts legal questions regarding the enforceability of business-induced rules vis-à-vis the nodes that do not qualify as operators as well as third parties. Furthermore, the PilotR Proposal would benefit from three amendments: First, EU legislators should articulate a clear link between the priorities laid down in the DFS 2020 and PilotR, along with an explanation of how PilotR fits into a broader set of measures to support innovation. Second, PilotR is characterized by a narrow scope with a relatively long timeline for testing, thereby the degree of mutual learning will be reduced. Third, being limited to authorized MiFID firms and CSDs only, regulatory leniency will be reserved for incumbents only – despite PilotR’s expressed objective to benefit innovative start-ups