Luxembourg is furthering its efforts to establish itself as the EU hub for distributed ledger technology (DLT) by amending its legal framework to (i) recognize that DLT financial instruments can be subject to financial collateral arrangements and (ii) provide the necessary legal certainty for market infrastructure players to benefit from DLT.
On 9 March 2023, the Luxembourg Parliament adopted the bill of law 8055 (the Bill) (i) amending the Luxembourg act dated 5 August 2005 on financial collateral arrangements, as amended (the Collateral Act 2005)1 and (ii) implementing important concepts in Luxembourg law to accompany the upcoming Regulation (EU) 2022/858 of the European Parliament and of the Council of 30 May 2022, establishing a pilot regime for market infrastructures based on distributed ledger technology (the DLT Pilot Regime Regulation).
Luxembourg provides missing puzzle piece to financial collateral arrangements taken over DLT financial instruments
The Bill explicitly makes financial collateral arrangements over DLT financial instruments possible in accordance with the Collateral Act 2005.
The amendments to the Collateral Act 2005 are significant for financial market participants. The Bill clarifies that the concept of book-entry transferable financial instruments now includes financial instruments registered or existing in securities accounts held within or through the secured electronic registration mechanisms, including distributed electronic ledgers or databases. References in the amended Collateral Act 2005 to book-entry transferable financial instruments will now cover book-entry financial instruments registered or existing in securities accounts held within or through systems using DLT.
This is a welcomed upgrade to the existing Luxembourg DLT legal framework comprising, notably, of Luxembourg act dated 1 August 2001 on the circulation of securities, as amended, and Luxembourg act dated 6 April 2013 on dematerialised securities, as amended. The current legal framework in Luxembourg allows for the native issuance of dematerialised securities and the transfer and safekeeping of fungible securities using DLT. The Bill eliminates the uncertainty on the applicability of the Collateral Act 2005 to book-entry financial instruments located or deemed to be located in Luxembourg and kept via DLT networks.
In other words, the Collateral Act 2005 (as amended by the Bill) will now complete the lifecycle of DLT financial instruments by recognising their native issuance, transfers, safekeeping and collateralisation using DLT.
Luxembourg is currently one of the only jurisdiction that explicitly recognizes financial collateral arrangements over DLT financial instruments, enabling the use of DLT in financial collateral arrangements in a legally certain manner.
That being said, the Luxembourg legislator, by confirming the use of a specific technology, remains technologically neutral - neither favouring nor discriminating against any particular existing or emerging technologies.
The Luxembourg financial ecosystem welcomes the amendment of the Collateral Act 2005, allowing market participants to use, with complete legal certainty, DLT for financial collateral purposes, without amending other provisions of this law, in particular with regard to creation, perfection and enforcement of such collateral arrangements. This allows market players to remain flexible in how to implement financial collateral arrangements without suffering from a prescriptive and cumbersome approach.
This light-touch approach allows the Luxembourg legal framework to avoid becoming obsolete in the long term due to future technology innovation while providing the necessary legal certainty allowing market players to use Luxembourg as their EU hub for their DLT capital market projects.
Refresher on the DLT Pilot Regime
The DLT Pilot Regime Regulation creates the EU DLT Pilot Regime. The EU DLT Pilot Regime allows national competent authorities to grant temporary exemptions to DLT market infrastructures from certain specific requirements imposed by existing EU Regulation. The EU DLT Pilot Regime will be in force for a period of six years and will be applicable from 23 March 2023 onwards.
The EU DLT Pilot Regime introduces three categories of DLT market infrastructures:
- a DLT Multilateral Trading Facility (DLT MTF) which is a multilateral trading facility operated by an investment firm or a market operator that may notably (i) allow for direct retail participation and (ii) be exempt from certain transaction reporting obligations; and
- a DLT Settlement System (DLT SS) which is a securities settlement system operated by a central securities depository (CSD) that may benefit from a number of exemptions regarding settlement system regulatory obligations; and
- a DLT Trading and Settlement System (DLT TSS) that combines services performed by, and benefits from respective exemptions available for, a DLT MTF and a DLT SS. The DLT TSS may be operated by an investment firm, a market operator or alternatively by a CSD. The DLT TSS combines the businesses of a DLT MTF and a DLT TSS which will serve as a one-stop shop for market infrastructure.
The idea behind the EU DLT Pilot Regime is to avoid the situation where operators of DLT market infrastructures are prevented from developing innovative solutions for the trading and settling of transactions in crypto-assets, without weakening the existing requirements and safeguards applicable to traditional market infrastructures.
Importantly, only financial instruments that are issued, recorded, transferred and stored using DLT are in scope of the EU DLT Pilot Regime and these instruments currently include shares, bonds and units in collective investment undertakings subject to certain volume limitations.
What the Bill adds in Luxembourg regarding the DLT Pilot Regime
The amendments introduced by the Bill include, among others:
- the express recognition of instruments issued using DLT in the definition of “financial instruments” under the Luxembourg act dated 5 April 1993 on the financial sector, as amended; and
- the clarification that the definition of “financial instruments” within the meaning given to such term in the Luxembourg act dated 30 May 2018 on markets in financial instruments, as amended (implementing MiFID II in Luxembourg), includes financial instruments issued using DLT.
1The Collateral Act 2005 implements the EU financial collateral directive in Luxembourg and is regarded as a key creditor friendly instrument to structure international financial transactions.
