Introduction

Long time the European Union has taken a positive, but wait-and-see attitude towards blockchain and distributed ledger technology. Both related to use cases and regulatory intervention. But that is changing rapidly. Last week the European Commission announced the launch of its #Blockchain4EU Project enlarging their scope to more than FinTech applications. This proves that the EU is taking steps (may be) to become one of the leading economic blocks in the blockchain race. It may therefore be interesting to take a closer look at what the plans/initiatives are from the various EU institutions such as European Commission, European Parliament, ECB, ESMA and others related to blockchain.

European Commission

#Blockchain4EU Project
Last week the European Commission’s Joint Research Center (JRC), together with The Directorate-General for Internal Market, Industry, Entrepreneurship, and SMEs, have announced the launching of the #Blockchain4EU Blockchain for Industrial Transformations initiative to develop industrial use cases for blockchain and DLT.  

The project, which will run until February 2018, will take a look at how blockchain technology and other distributed ledger technologies (DLTs) can be applied to nonfinancial sectors.

“Blockchain and other Distributed Ledger Technologies are developing very fast. They have the potential to reshape many business models and we notice a growing interest by companies in the technologies. Many applications are at an early stage, however, and we need already to identify areas where the impact may be most significant and discuss potential challenges with stakeholders. Therefore, we are launching this project together with the JRC’s EU Policy Lab to be better prepared to unlock the new opportunities provided by these technologies for industrial transformations and mitigate potential risks.” Slawomir Tokarski, DG GROW’s Director of Innovation and Advanced Manufacturing

The project’s objective is to identify, discuss and communicate possible uses and impacts of blockchain and other DLT objects, networks and services within EU industrial or business contexts. The project will thereby initially focus exclusively on logistical and validation use cases, such as supply chains, assets monitoring, intellectual property rights, and certification authentication. Outputs from the project will contribute to the risks and opportunities assessment that will ultimately outline the approach that Small to Medium Enterprises (SMEs) will take with blockchain and DLT applications in the future.

Virtual currency legislation
Last year July the European Commission adopted a proposal for legislation to amend the 4th Anti-Money Laundering Directive (4AMLD) that will bring virtual currency exchanges and wallet providers into the EU’s anti-money laundering framework.  In this proposal only those engaged in exchanging between virtual and fiat currencies are included.

Virtual currency to virtual currency exchanges are not covered (for example, Bitcoin-to-Ether exchanges will not be regulated). And only those wallet providers offering custodial services “of credentials necessary to access virtual currencies” are to be included in the legislation.

The proposal is now under the European Council and the EP. Member states will have to transpose the Directive into national law and that is expected by half 2018.

EC February Statement on blockchain
In February this year the European Commission Vice President Andres Ansip published an official statement in reaction to EP questions, saying that “the Commission is planning to grow its support for blockchain projects”, and that ”the Commission is actively monitoring Blockchain and DLT developments”. This statement went into detail about the efforts the Commission is undertaking, both within and beyond the scope of the task force (see below),  highlighting potential technology pilots focused on ‘decentralised innovation ecosystems”.

“The Commission is already supporting [distributed ledger tech]-enabled projects (DECODE, D-Cent, MyHealth MyData). Support activities are going to increase in the coming months (e.g. Decentralised Data Management). A study will be launched to investigate how DLT can help in reshaping public services and preparing for EU specific DLT actions to address relevant EU challenges.” Andres Ansip

The Commission has set up an internal FinTech Task Force, following a report on virtual currencies from European Parliament Member Jakob von Weizsäcker, published in May 2016. This Task Force involves all relevant services working on financial regulation, technology, data and competition to ensure “that our assessment reflects the multi-disciplinary approach that FinTech developments ask for”.

Blockchain Observatory
The European Commission (EC) established/set up  a European Union (EU) Blockchain Observatory in April this year in response to a European Parliament mandate to strengthen technical expertise and regulatory capacity. The EU blockchain observatory is being developed under the framework of the European Commission’s Task Force on FinTech. It is expected to deliver its final recommendations in the course of this year.

The observatory task is to create a platform for the European blockchain community and provide up-to-date information on relevant initiatives around the world as well as development of the technology and related opportunities and challenges

 “The observatory will include a platform for the blockchain community to interact and share up-to-date information on relevant initiatives around the world. The European Commission hopes to create an “expertise hub” on blockchain technology and its potential applications. It will aim at fostering expertise on infrastructure, smart contracts, governance and validation mechanisms. Regulatory and legal challenges, as well as interoperability issues, will also fall within its scope. The purpose of the observatory will also be to assess the added value of potential applications of innovations that it will identify. In addition, it will provide the European Commission with advice on the role to be played by European public authorities.” European Com mission

Aim is to assist the EC in determining what role – if any – public authorities can play to encourage the creation of such technologies and to develop policy recommendations.

"The purpose will be to inform and assist the European Commission in understanding what role, if any, European public authorities should play to encourage the development and uptake of these technologies and to formulate related policy recommendations," European Commission

It will also develop expertise on topics such as infrastructure, governance and validation mechanisms, contracts, regulatory and legal challenges, interoperability and standards, and will explore possible use cases within the EU.

Blockchain proof-of-concept on blockchain
According to a Communication of February this year addressed to EU institutions including the European Parliament and the European Central Bank,  the European Commission wants to create a Blockchain proof-of-concept focused on regulation.

A pilot project is aimed at reinforcing the capacity and technical expertise of national regulators with regard to distributed ledger technology. The pilot would center on improving knowledge and awareness of the technology among the EU’s regulatory community. For that purpose the Commission launched a public consultation effort on financial technology more broadly, one that is seeking input on how it can improve market efficiency and accessibility. This consultation focused on three areas: increasing consumer trust and empowerment reduce legal and regulatory obstacles; and, support developments of ‘and innovative digital world’.

As for next steps, the Blockchain Observatory will continue to engage industry representatives to get a feel for where to focus their regulatory efforts.

European Parliament

EP votes for smart regulation of blockchain technology
Last year June the European Parliament voted for ‘smart regulation’ of blockchain technology, taking a hands-off approach. The MEPs voted in  a proposal set out in a resolution drafted by Jakob von Weizsäcker, suggesting that a new task force established at the EU level which would be overseen by the European Commission, should build expertise in the underlying technology. It would also be tasked with recommending any necessary legislation, but the text warns against taking a ”heavy-handed approach” to this new technology.

The proposal clearly stated that distributed ledger technology should not be stifled by regulation at this early stage.

“To avoid stifling innovation, we favour precautionary monitoring rather than pre-emptive regulation. But IT innovations can spread very rapidly and become systemic. That’s why we call on the Commission to establish a task force to actively monitor how the technology evolves and to make timely proposals for specific regulation if, and when, the need arises” Jacob von Weizsäcker

EPRS blockchain report

In February the European Parliamentary Research Service (EPRS) published a new report “How blockchain technology could change our lives”, providing an introduction for those “curious about blockchain technology” and aimed at stimulating reflection  and discussion.

“Spotlight on Blockchain” workshop
In collaboration with the European Commission, the European Parliament has organised various blockchain events including a kick-off conference on “Demystifying Blockchain” and a series of workshops to look at blockchain developments and use case applications.

A session of discussion early May held at the European Parliament (EP) centred on the future of blockchain regulation in the 28-nation economic bloc. The "Spotlight on Blockchain" workshop, was hosted jointly by the European Parliament and the European Commission.

Part of the program initiated by the Blockchain Observatory was to cautiously approach the who, what and why of blockchain legislation.

"It's probably too early to intervene at this stage, because we as legislators don't yet see sufficiently clearly to know what the main issues are going to be – so in order to not to stifle innovation, we don't want it to be now." Jakob von Weizsäcker, MEP 

The opinion was ventured that it's not so much about creating new regulation as about adapting existing regulation to new terminology.

European Central Bank

Report: Distributed Ledger Technology (DLT) – challenges and opportunities for financial market infrastructures
The European central bank (ECB) has led a study to analyse the benefits and risks of blockchain technology and consider its possible integration in its market infrastructure. The final report named Distributed Ledger Technology (DLT) – challenges and opportunities for financial market infrastructures was published in March this year.

In the report the ECB acknowledges the various benefits of DLT, such as the ability to lower back office costs and improve reconciliations by enabling automatic updates of records as well as shortening  settlement cycles and therefore reducing collateral requirements.

The ECB however concluded that the distributed ledger technology does not (yet) meet the Bank’s requirements in terms of safety and efficiency. The bank is not firmly opposed to blockchain, but it considers that the technology is not mature enough to be integrated into its infrastructure as it is constantly evolving, citing deficiencies in safety and security. The report's tone is in keeping with the ECB's cautious approach to DLT and mirrors previous statements made by bank executives.

The European Central Bank, has ruled out using distributed ledger technology within the so-called Eurosystem’s market infrastructure for the foreseeable future, until the software meets high safety and reliability standards.

 “Yet the technology does not yet meet the ECB's standards for safety and efficiency, says the report” "The ECB is open to considering new ways to enhance its market infrastructure. However, any technology-based innovation would have to meet high requirements in terms of safety and efficiency … At this stage of its development, [distributed ledger technology (DLT)] is not mature enough and therefore cannot be used in the Eurosystem's market infrastructure. As DLT-based solutions are constantly evolving, the ECB will continue to monitor developments in this field and explore practical uses for DLT." Report

DLT Project Team
Nonetheless, the ECB is keeping its options open, recognising the benefits that the technology could bring to securities settlement. To this end, the ECB has created a DLT Task Force to "bring together market experts on financial innovation and cyber security. Its objective is to avoid any negative consequences of technological innovation regarding the harmonisation and integration of post-trade markets in Europe and to explore the potential of DLT to help remove some of the remaining barriers to a fully integrated post-trade market in Europe".

For that they hired a senior technology executive, Dirk Bullman, with practical experience in distributed ledger applications and front and back office project management expertise to bring DLT expertise into the ECB. Dirk Bullmann, is fintech coordinator and adviser to the director general of the ECB. Not only is Bullmann's mandate to explore distributed ledgers, but he's leading a team actively seeking to identify ways to use the tech to enhance the ECB's services.

T2S
The ECB will continue to monitor DLT’s developments and could use the technology in the administration of Target2Secrities. The report states that DLT could play an important role in the administration of Target2Secrities, as well as helping to achieve its overall aim of "deeper integration of financial markets".

Bullmann's group is now exploring how DLT could be used in its new securities clearance platform T2S. Central securities depositories (CSDs) that participate in T2S today can effectively pool their securities so they can be bought and sold by investors across Europe. Since some technology would need to be selected in standardizing the issuance, Bullmann said DLT was a natural candidate for testing.

"We are currently exploring the idea to offer an issuance service for certain supranational debt securities in the European Union, and we are testing if DLT could potentially be used to offer specific aspects of such a service," "It allows us to further explore the potential benefits of this technology, and at the same time, see whether it could be used efficiently and safely. It's more of a proof of concept," Dirk Bullman

Other use cases
Bullmann reported having conversations with various market participants who were moving to implement specific DLT use cases, and given those conversations, he suggested the ECB is currently moving in line with the market by analysing specific, new use cases. Yet, like other enterprises, the ECB is also looking for faster ways to test how blockchain could be applied to newer markets, ones that don't disrupt or interfere with established practices and working processes.

Bullmann pointed out that much of the work is focused on modelling payment exchanges between member institutions via smart contracts, or self-executing blockchain-based code. "If the market moves to DLT relatively quickly, we have to make sure that the DLT world could smoothly interact with our world." Bullman

ECB – Bank of Japan joint initiative
The ECB has also launched a joint research project with the Bank of Japan in December last year to study the impact of new innovations of the global financial market and explore possible use of blockchain technology for market infrastructure services.

"This international collaboration aims to bring greater clarity regarding the impact of new technologies on the global financial ecosystem, as well as to ensure that central banks are adequately prepared" it states.

Bullmann's task now is to coordinate with the Bank of Japan (BOJ) to explore topics such as how financial market participants could send payments using the technology, prioritizing how a certain payment might be cleared, for instance.

European Supervisory Authorities

The joint committee of the European Supervisory Authorities has released a report in April on Risks and Vulnerabilities in the EU Financial System, in which cybersecurity, including the rising use of blockchain technology, is marked as a major concern for the financial sector.

While further study is required before the EU submits new regulation regarding the financial sector and FinTech adoption, also the European Securities and Markets Authority (ESMA) has undertaken a study of cyber risk and controls of financial institutions throughout the EU. These results will be analyzed in light of existing regulations and used in making future recommendations. In June the ESMA publicized its response to the commission’s proposal on FinTech regulation following a public consultation.

ESMA and regulation
The ESMA, has stated in a new report that the current regulatory framework in effect does not pose a hurdle for the adoption and development of blockchain or distributed ledger technology in the short term. The report acknowledges the benefits of adopting blockchain before notably adding that blockchain applications are still at a nascent stage and, as such, do not require regulation. Regulatory action for blockchain technology at this ‘early stage’ is ‘premature’, said the European Securities and Markets Authority (ESMA) in its report.

“At this stage, ESMA believes that it is premature to fully appreciate the changes that the technology could bring and the regulatory response that may be needed, given that the technology is still evolving and practical applications are limited both in number and scope” ESMA report.

The ESMA also states that it does not see blockchain technology, through its fundamental core concept of decentralization, post a threat to central financial market infrastructures. The ESMA deems it “unlikely” that blockchain technology would eliminate financial market infrastructures such as Central Securities Depositories (CSDs) and Central Counterparties (CCPs). Still, the watchdog says it “realizes” that blockchain technology may render some traditional processes redundant, or affect and “change the role of some intermediaries through time”

ESMA adds that the presence of blockchain technology “does not liberate users from complying with the existing regulatory framework, which provides important safeguards for the well-functioning of financial markets.” The ESMA will continue to monitor developments in the Fintech space, to assess if blockchain technology requires a regulatory response.

European Union Agency for Network and Information Security (ENISA)

The European Union Agency for Network and Information Security (ENISA) also entered into the blockchain debate with a report launched in December 2016 aimed to provide financial professionals in both business and technology roles with an assessment of the various benefits and challenges that their institutions may encounter when implementing a distributed ledger.

ENISA analysed the technology and identified security benefits, challenges and good practices. There are however new challenges that the technology brings, like consensus hijacking and smart contract management. Additionally, it highlights that public and private ledger implementations will face different sets of challenges.

“Cyber security should be considered as a key element in the Blockchain implementation by financial institutions.” Udo Helmbrecht, Executive Director of ENISA

ENISA has identified good practices to overcome the issues identified as well as introduce the key concepts that decision-makers should be aware of when approaching this technology. Some good practices are: using recovery keys; using multiple signatures for authorizing and processing transactions; and, using library of standardized smart contracts.

In this paper, they also identified that there are challenges that may require further development, such as: anti-money and anti-fraud tools; interoperability of blockchain protocols; and, legal provisions and tools for implementing privacy and the right to be forgotten.