The EU Regulation 2022/858 (the “DLT Pilot Regulation”) opened up opportunities for efficiency improvements in the trading and post-trading process for tokenised financial instruments (i.e. the digital representation of financial instruments on distributed ledgers (DLT) or the issuance of traditional asset classes in tokenised form) to enable them to be issued, stored and transferred on a DLT.
Specifically, the DLT Pilot Regulation - applicable from 23 March 2023 - allows certain tokenised financial instruments to be admitted to new market infrastructures specifically authorized for the purpose (the "DLT market infrastructure” including DLT multilateral trading facilities (DLT MTF), DLT settlement systems (DLT SS) and DLT trading and settlement systems (DLT TSS)) and to be traded as an exception to the application of the obligation of representation in book entry form with a central depository prescribed by the so-called CSDR regulation which requires investors to hold their financial instruments through the "centralized management system", a pyramidal structure assuming the presence of "intermediaries" and which culminates in the central depository. The DLT Pilot Regime Regulation would, in the presence of certain conditions, disapply the obligation to use an intermediary which is currently envisaged by the EU legislation both as regards to access to trading venues and the regulation or settlement of transactions.
In this context, Law Decree No. 25 of 17 March 2023 (the “Decree”) containing urgent provisions on the issuance and circulation of certain financial instruments in digital form in accordance with the provisions of the DLT Pilot Regime Regulation was published in the Italian Official Gazette No. 65 of 17 March 2023 with the aim to introduce a new type of issuance and circulation of financial instruments in DLT to permit from the domestic civil law perspective the issuance and circulation of financial instruments in DLT market infrastructures and to simplify the Italian Regulatory sandbox.
Issuance and circulation of certain financial instruments in digital form
The scope of application of the issuance or circulation regime under the Decree includes shares, bonds, debt securities issued by limited liability companies, other debt securities issued in accordance with Italian law, depositary receipts - relating to bonds and other debt securities of non-domiciled issuers - issued by Italian issuers, money market instruments regulated by Italian law, money market instruments regulated by Italian law, shares or units of Italian UCIs and other instruments identified pursuant to Article 28, paragraph 2, letter b) of the Consolidated Financial Act.
The DLT Pilot Regulation imposes limits on the extent of individual issuance and volume of total assets registered or traded on DLT market infrastructures. These limitations do not, apply to issuances and market infrastructures which do not intend to make use of the related optional regime.
The Decree attributes to Consob, in agreement with the Bank of Italy, a regulatory power for the purposes of the potential further extension of the scope of application, also by way of derogation from the provisions in force relating to the form and circulation of these instruments. This will allow, among other things, the opening of the new circulation regime to the units of limited liability companies (srl), in particular to standardized units of srl-PMI.
In line with the DLT Pilot Regime Regulation, the Decree sets out certain requirements which are the preconditions for a "register" that uses DLT technology to support the new issuance and circulation regime and which are designed to ensure, among other things, the production of effects equivalent to the non-reproducibility of the "title" and the exclusivity of possession which are typical of the issuance and circulation of financial instruments in paper form and which have also been transposed in the scriptural world of centralized management.
One added value of the DLT Pilot Regime is , that similarly to a centralized management system, all the risks associated with loss destruction and theft of the documentary support are avoided. Moreover, it is possible to create an efficient and secure circulation system, with an automated payment flow management system, without however having to use a model which necessarily implies the involvement of the central depository and the opening of an account with an intermediary by the investor.
In the new issuance and circulation system, digital instruments can, but do not necessarily have to, be held directly by investors, i.e. without recourse to an "intermediary" who stands between the investor and the registry, due to the features of the DLT technology. This should also decrease costs to investors.
The issuance and transfer of digital financial instruments are carried out through entries on a digital circulation register (the “Digital Register”) kept by (i) a registry manager, (ii) the manager of an SS DLT or TSS DLT, (iii) by the Bank of Italy or by the Ministry of the economy and finance, as well as by (i) other entities to be possibly identified by means of a dedicated regulation.
The Digital Register must ensure the integrity, authenticity, non-opposition, non-duplicability and validity of the records certifying the ownership and the transfer of digital financial instruments and related constraints, the possibility of identifying at any time the subjects in favor of whom the recordings are made, the type and number of digital financial instruments held by each person, as well as the possibility of making their transfer possible.
The Digital Register manager and the manager of the SS DLT or TSS DLT must guarantee the compliance of the Digital Register with the characteristics prescribed by the Decree and the related implementing provisions, as well as the correctness, completeness and continuous update of the information relating to the issue of the digital financial instruments.
In case of financial instruments not recorded on a SS DLT or TSS DLT, the issuance of digital financial instruments is allowed only on a Digital Register kept by a Digital Register manager. Each issuance is recorded on a Digital Register only and each Digital Register has only one Digital Register manager. For each issuance, the issuer must notify Consob and provide specific information to the investors.
The following entities can be a Digital Register manager: (i) banks, investment firms, market managers established in Italy, (ii) financial intermediaries under Art. 106 of the Consolidated banking Act, payment and e-money institutions, asset managers and insurance or reinsurance companies established in Italy provided that the activity is carried out exclusively with reference to digital financial instruments issued by them or by members of the group to which they belong established in Italy, (iii) issuers with registered office in Italy, other than those referred to in the previous letters, who intend to carry out the activity of register manager exclusively with reference to digital instruments issued by them, (iv) other entities established in Italy different from those mentioned before and (v) other entities identified with a specific regulation. A specific liability regime is also set out for Digital Register managers.
The Decree does not clarify if entities having a registered office in Italy only can be a Digital Register manager or if also Italian branches of the entities mentioned above may be considered as “establishments” in Italy. This is a point that should be clarified in the context of conversion of the Decree into law.
Digital Register managers must be authorised by Consob and the latter has 90 days to resolve on the complete application (after an initial 20 day-term in which the regulator has to assess the completeness of the application) to be drafted on a proportional basis (e.g. more information and documents are to be provided by entities not already regulated), in agreement with the Bank of Italy. Digital Register managers must promptly notify Consob of the start of the activity. In the case of subjects supervised by the Bank of Italy or by IVASS, the notification must also be addressed to these Authorities.
Changes to Italian Regulatory sandbox
Finally, the Decree contains measures aimed at facilitating access to the so-called "Regulatory sandbox”, which is, as known, an experimental and temporary technical-regulatory space for companies in the financial sector operating in the Fintech sector, set up and operating exclusively on a national level. The first application of the rules governing the Regulatory sandbox has highlighted some rigidities which may not promote innovation. In particular, a number of experimental proposals would have implied the exercise of a reserved financial activity (the provision of investment services or activities) and which therefore, based on the applicable regulatory framework, would have required the applicant to submit, as part of the application for admission to the Regulatory sandbox, also the application for authorization to carry out the reserved activities. Now the Decree allows the performance, for a limited period of time, as part of the sandbox and in compliance with the limits established by the admission measures, of activities that fall within the scope of investment services without, however, the need to request the authorization required by law for the usual performance of the same activities. This removes one of the biggest hurdles to the development of the sandbox in Italy.
The Decree will have to be converted into law in the 60 days after the publication in the Official Gazette and amendments will be possible.
Authored by Jeffrey Greenbaum and Claudia Colomba.