Blockchain, DLT and the Capital Markets Journey: Navigating the Legal and Regulatory Landscape

Hogan Lovells, Innovate Finance and EY have collaborated on a new report providing an overview of how blockchain and other distributed ledger technologies (DLT) fit into the current regulatory and legal regimes governing capital markets.

It also sets out policy and industry recommendations to ensure interoperability and increased regulatory certainty as technology and use cases develop.

According to the report, regulation needs to keep pace with evolving technologies, or risk hindering innovation. It recommends principles based guidance, rather than set requirements to enable much needed flexibility.  

Rachael Kent, Global Head of Hogan Lovells' Financial Institutions Sector, said: "We are at a point of convergence where the technological innovation and legal regulatory worlds need to evolve to operate as one if the full potential of DLT is to be realised. Understanding the wider legal context is crucial to mitigate early adopter risk whilst the law races to catch-up, knowing not only how regulation will categorise technology, but how and when dialogue with regulators should form part of the process. Industry collaboration will be key to integrating DLT into the capital markets."

Securities are one such example – the technology required to use DLT to transfer securities is available but it is impossible to implement without a change in legislation, which requires the involvement of Central Security Depositories (CSDs) and being able to satisfy regulators that it manages the risks that intermediaries such as Central Clearing Parties (CCPs) or CSDs currently mitigate. A DLT solution would need to offer similar benefits to CCPs and CSDs.

Smart contracts are another key issue according the report. The technology is being designed to encode financial contract obligations on to a DLT, but the legal status of such smart contracts is still vague.

Regulators are urged to foster a supportive environment by consulting on key issues such as authorisations, transitions and security of DLT and to promote a culture of collaboration with the industry.

Imran Gulamhuseinwala, EY Global FinTech Leader, said: "High quality thinking on the regulatory and legal aspects of blockchain, for the most part, has been deferred whilst IT and business leaders have tried to come to grips with the technology and where it might best be applied. We believe that now is the right time to bring the regulators and law makers more actively into the debate to help mitigate some of the inherent blockers in the current frameworks and, more importantly, to shape the future architecture of blockchain."

The report further outlines that Brexit creates an opportunity - as a result of the need to address EU law currently embedded in the UK's regulatory framework - to implement legislation more accommodating of DLT that allows the UK to be more flexible than under EU law, favouring equivalence rather than current approach to specific requirements.

Rachel Kent, Global Head of Hogan Lovells' Financial Institutions Sector, added: "Brexit would mean that the UK's regulatory framework would need to be re-cast, as the EU law currently embedded in it falls away. By grasping the nettle and designing regulatory structures which enable the emergence of transformative technologies, whilst managing risk, the UK could show its commitment to staying at the heart of progressing better financial regulation internationally".

The report can be downloaded here.

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