HM Treasury (HMT) has launched a six-week consultation on the introduction of a UK financial market infrastructure sandbox – to be referred to as the ‘Digital Securities Sandbox’ (DSS).
The sandbox is to be launched to allow financial market infrastructure providers and other relevant parties to test and adopt new technologies and practices, such as distributed ledger technology (DLT), by temporarily disapplying or modifying certain regulation.
HMT describes the use of digital assets as having the ‘potential to be genuinely transformative for financial markets’ in the document, which is seeking feedback from the private sector on plans for the sandbox, as well as input on further policy and legal questions. It also invites respondents to formally express their interest in using the sandbox.
It is envisaged that the DSS will run for up to five years, with the possibility of extension by HMT, the 51-page ‘Consultation on Digital Securities Sandbox’ document states.
The aim is for different FMI sandboxes to be established in order for different technologies and practices to be tested by different entities.
SANDBOXES: EXPLAINED Sandboxes are (virtual) spaces for projects to test and experiment with new technology, overseen by regulators. One well-known example is the regulatory sandbox launched by the UK’s Financial Conduct Authority (FCA) in 2016. Sandboxes are becoming increasingly common worldwide.
Path to the sandbox
HMT ran a call for evidence during the first three months of 2021 on the ‘UK regulatory approach to cryptoassets and stablecoins’ that included a section on the application of DLT to financial market infrastructures. The document stated that testing ‘could entail making use of existing schemes, such as the FCA sandbox, or developing new propositions, such as an initiative for testing the operation of a DLT FMI [financial market infrastructure] in the market’.
The government then announced in April 2021 that HMT, in conjunction with the Bank of England (BoE) and the FCA, would proceed with the launch of a dedicated FMI sandbox. In the government’s consultation response, published in April 2022, it stated that the sandbox would be ‘up and running’ during 2023.
The newly issued consultation notes that one obstacle identified in responses to the 2021 call for evidence was that the UK legislative framework has not been built to support the use of DLT in financial market infrastructures, and that changes would be needed to enable the use of DLT and realise its potential benefits.
The Financial Services and Markets Act 2023, which received Royal Assent a couple of weeks ago (29 June), gives HMT the power to set up FMI sandboxes via statutory instrument (SI) – a type of secondary legislation. Each SI laid before Parliament would provide the legal basis for each sandbox and for temporarily disapplying or modifying relevant legislation for participants.
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Quantitative limits to reflect risks
The consultation, which closes on 22 August, concerns the first FMI sandbox.
The DSS will enable firms to set up and operate FMIs using innovative digital asset technology, performing the activities of a central securities depository (specifically notary, settlement and maintenance) and operating a trading venue (under a legislative and regulatory framework that has been temporarily modified).
These activities will be performed in relation to existing security classes, which could either be ‘digitally native’ issuances or digital representations of existing securities. Limits will be put in place for participating entities, which can be increased as progress is made, the consultation states. But HMT does not ‘currently’ intend to set quantitative limits in legislation. Instead, limits will ‘reflect the ability of a participating entity to meet requirements and manage risks’.
‘These will be real-world market activities and assets,’ the document notes. ‘The intention is that any digital securities issued, traded, settled and maintained via entities in the DSS will be able to interact with wider financial market activities (for example, for collateral posting or repos – repurchase agreements), where this can be done in compliance with existing legislative and regulatory frameworks.’
The document also mentions that the BoE is setting up a DLT experimentation function with the aim of ensuring that DLT is ‘appropriately considered’ in the design of a potential digital pound (UK central bank digital currency) and with the aim of ‘incubating UK private sector digital currency technology, while also deepening DLT expertise within the Bank of England in support of its broader mission’.
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EU’s DLT pilot regime in force
Other jurisdictions and nations have been making progress in the same space.
In the European Union (EU) – which the UK left in January 2020 – a regulation on a pilot regime for market infrastructures based on DLT began applying on 23 March 2023. In a separate development, in April European parliamentarians have also voted overwhelmingly to approve the high-profile Markets in Crypto Assets (MiCA) regulation, making the 27-member bloc the world’s first major jurisdiction to establish a comprehensive regulatory framework for crypto-assets.
HMT’s consultation highlights that Switzerland – which is also a non-EU member – created a framework for digital assets and for DLT FMIs a couple of years ago; and that Singapore has put in place a DLT framework and completed a number of practical experiments, for example through the Monetary Authority of Singapore’s ‘Project Guardian’ (announced just over one year ago).
The Financial Services and Markets Act was trumpeted by the government as ‘seizing the opportunities of Brexit [Britain’s exit from the European Union] by tailoring financial services regulation to fit UK markets’.
*** The ‘European Blockchain Sandbox’, which launched earlier this year and is being funded through the EU’s Digital Europe Programme, last week announced some details of its first annual cohort of 20 use cases (after receiving ‘almost 90’ applications).