During a speech today, Sir Jon Cunliffe, Deputy Governor of the Bank of England, said that the UK’s FMI Sandbox would initially focus on DLT-based securities settlement systems. In April, the regulatory sandbox was announced as a joint initiative between HM Treasury, the Bank of England and the Financial Conduct Authority to be launched in 2023.
Cunliffe outlined the potential pros and cons of using blockchain for securities trading and settlement. These include:
- collapsing or eliminating the number of intermediaries, radically reducing costs
- a simpler process could mean fewer potential points of failure, reducing the risk
- instant or atomic settlement removes the need for netting and holding margin
- fractionalization could improve liquidity
- smart contracts enable automation and potential new business models.
He also mentioned the potential risks:
- atomic settlement requires cash and securities to be in the same place at the time of the trade
- if each securities ledger has its own token, it could increase aggregate liquidity requirements and systemic risk
- instant settlement leaves no time to identify or correct errors
- multiple ledgers could lead to fragmentation
- decentralization creates oversight challenges if there’s no accountable legal entity
- the period of transition to new technologies carries risk.
A key demand for securities settlement is to have cash on ledger. However, IOSCO’s principles of financial market infrastructures (PFMI) recommend that securities transactions be settled in central bank money where possible.
Cunliffe mentioned systemic stablecoins. “But there is, in my view, a case for public infrastructure in this area. Central bank reserves, as a settlement asset play a key role in the resilience of conventional post trade functions,” said Cunliffe.
One possibility is to offer a tokenized central bank digital currency (wholesale CBDC) as well as the rail on which it is transacted. Last year Cunliffe stated he did not see the need for a wholesale CBDC for domestic use.
An alternative is to make the existing real time gross settlement (RTGS) systems compatible with DLT systems. The Bank is currently working on its RTGS renewal and is considering “a generic interface into RTGS which would allow a range of ledgers to connect to the system, as well as building a system with no technical barriers to 24/7 operation,” said Cunliffe.
Plus, the central bank can allow those with access to central bank accounts to tokenize money. On the latter point, the Bank of England created a new omnibus type of bank account which Fnality – backed by 17 institutions – is using to tokenize British Pounds.
Cunliffe concluded, “The emerging evidence is clear that the technological innovation we have seen in crypto markets offers at least the possibility of a major transformation in financial market infrastructure – and one that could yield significant benefit.”
Meanwhile, the EU’s DLT Pilot regime comes into force in March 2023 and yesterday ESMA released a report on a recent consultation.