The UK government has set out the next steps towards the launch of a financial market infrastructure sandbox – named the ‘Digital Securities Sandbox’ (DSS) – in its response to a consultation.
The sandbox is being set up to help UK financial markets to adopt digital asset technology – a field seeing surging levels of interest and investment in financial services centres across the globe. It will allow financial market infrastructure providers and relevant parties to test and adopt new technologies and practices by temporarily disapplying or modifying certain regulation.
HM Treasury (HMT) kicked off a six-week consultation on the DSS, which will be run by the Bank of England (BoE) and Financial Conduct Authority (FCA), in July. It described the use of digital assets as having the ‘potential to be genuinely transformative for financial markets’ as the government sought feedback on the sandbox’s proposed main features, policy and legal issues in the same ballpark, as well as inviting respondents to formally express their interest in actually using it.
‘The fundamental design of the DSS was well received,’ the executive summary of HMT’s ‘Digital Securities Sandbox: Response to consultation’ notes, going on to state that ‘feedback stressed the need for further clarity in various areas, including the application process, […], the interaction of activities in the DSS with activities outside the DSS, and the process for exiting the DSS.’ It states that ‘in most cases these details will be provided by the regulators in due course’.
Nineteen expressions of interest from companies ‘considering participating’ in the DSS – a mix of incumbent financial market infrastructures (FMIs), existing regulated financial services firms and ‘new entrants’ – were received, the document reveals. It adds that ‘informal engagement with industry suggests that more will be sent’ and that HMT ‘continue[s] to welcome expressions of interest from potential applicants’.
‘Near universal’ agreement on five-year plan
The government proposed in its consultation that the DSS will run for up to five years, with the possibility of extension.
‘There was near universal agreement in responses that five years would be an acceptable duration for the DSS, on the understanding that permanent amendments to legislation can be made before the end, and that the DSS is capable of being extended,’ the 32-page consultation response reports. It adds that ‘throughout the DSS, the government, working with the regulators, will communicate the process for making any permanent amendments or extending the DSS in a timely fashion’.
The sandbox will be set up under powers granted to the government in the Financial Services and Markets Act (FSMA) 2023. This legislation received Royal Assent on 29 June, giving HMT the power to set up FMI sandboxes via statutory instrument (a type of secondary legislation). ‘Under the powers in FSMA 2023, the government can also set up further FMI sandboxes, if this is desirable,’ the consultation response notes. ‘Responses [to the consultation] emphasised that while the starting point is existing legislation, the flexibility to change requirements in response to novel use cases through the DSS was also important.’
The DSS’s creation gained a mention in the ‘Autumn Statement’ presented by the Chancellor of the Exchequer on 22 November, as did a separate initiative to launch a pilot Artificial Intelligence (AI) Regulatory Sandbox in spring 2024.
In respect of next steps for the DSS, the government will ‘shortly’ lay the required statutory instrument before Parliament to launch it. The BoE and FCA will need to set out the application process, as well guidance and rules.
The government also intends to set up a ‘body to facilitate dialogue on digital assets issues’. This will be ‘put in place once live activity in the DSS starts’. It states that it will ‘work with industry to consider how such a body should be structured, its composition, what subjects it will consider and how it will share information with the rest of industry.’
RELATED ARTICLE Treasury consultation prepares ground for UK ‘digital securities sandbox’ – our news story (12 July 2023) on the launch of the consultation
Laying the sandbox’s foundations
The DSS sandbox has been in gestation for almost three years.
HMT ran a call for evidence during the first quarter of 2021 on the ‘UK regulatory approach to cryptoassets and stablecoins’ that included a section on the application of distributed-ledger technology (DLT) to FMIs. 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 BoE and 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 DSS consultation noted that one obstacle identified in responses to the 2021 call for evidence was that the UK legislative framework had not been built to support the use of DLT in FMIs. The FSMA 2023 has resolved that hurdle.
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. HMT’s consultation highlighted 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. The Monetary Authority of Singapore (MAS) issued an update on its major asset tokenisation initiative, known as ‘Project Guardian’, earlier this month.
RELATED READING Sandboxes could ‘amplify problems’: IMF analysis questions many test-spaces’ impact – a news story (11 September 2023) based on an IMF paper titled ‘Institutional Arrangements for Fintech Regulation: Supervisory Monitoring’
International considerations and complications
The DSS consultation response devotes a section to international considerations.
‘Responses highlighted the need for international co-ordination on various issues relating to the adoption of digital asset technology, in order to avoid frictions cross-border,’ it states. ‘These include the need to build cross-border interoperability of systems, harmonisation of regulation, taxation and compatibility of legal frameworks.’
Initiatives by supranational organisations – ‘in particular’ from the Financial Stability Board (FSB), Bank for International Settlements (BIS) and International Organisation of Securities Commissions (IOSCO) – are described as ‘helpful’ but ‘will need to be built on further.’
‘Feedback [from the consultation] noted that some digital FMIs may be multi-jurisdictional (or even non-jurisdictional when public blockchains are used), making the determination of any governing law very difficult,’ it adds. ‘Digital securities may not be fully recognised under the laws of some jurisdictions.’
‘The government recognises that global co-ordination is essential for facilitating the successful adoption of digital securities worldwide. It recognises that a mixture of regulator and industry-led initiatives is desirable, as now,’ it states.
Among examples of UK authorities’ contributions internationally, it mentions that the FCA is part of a ‘Project Guardian policymaker group’ recently announced by MAS.
*** The UK government-commissioned ‘Future of Payments Review’ report has also just been published. Focused on retail payments, it follows a ‘call for input’ launched in July. The 108-page assessment is authored by Joe Garner, who ran British mutual financial institution Nationwide Building Society until last year.