Today HM Treasury published a consultation document for its Digital Securities Sandbox (DSS). The aim is to relax legislation for digital securities, whether they are native or tokenized representations of existing securities. The government recognizes that digital assets could be “genuinely transformative for financial markets,” both in terms of efficiencies and also more radical market changes. The Sandbox will run for an initial period of five years.
Limits and post Sandbox experience
The UK has learned from some of the issues experienced in the EU’s DLT Pilot Regime, which has similar objectives. For example, some larger banks found the EU volume limits too restrictive. In the UK, the limits will be more flexible and are yet to be announced. One of the limits will be on the volume of digital securities for an entire asset class. And the second limit will apply to the organization, but is flexible based on its size, activities and sandbox performance.
The asset classes exclude cryptocurrency but include debt, equity and money market instruments.
In the EU, there were also concerns about what happens at the end of the Pilot Regime. For the UK’s Sandbox, HM Treasury now has the power to adapt the laws using a statutory instrument – in other words it is secondary legislation not requiring the conventional process. It intends to implement new legislation before the end of the Sandbox, and might make multiple changes. It can also extend the Sandbox period.
Who can participate
The Sandbox will be open to regulated entities as well as new entrants, although they must be UK based. However, the government does not envisage significant regulatory changes for exchanges or so-called multilateral trading facilities (MTFs). So they need to have conventional licenses. In contrast, the roles of the central securities depository (CSD) is where legal flexibility is needed and these activities will be open to new entrants.
Legal relaxations for digital securities
With existing laws, exchanges and CSDs would usually be operated by separate entities, but the same organization can do both in the Sandbox. Many current CSD regulations don’t accommodate a DLT-based system, so these will be relaxed. The Sandbox will also allow settlement with tokenized commercial bank money, as well as linking to payment systems and other formats. For example it envisions linkages with central bank omnibus accounts, as used by DLT-based settlement firm, Fnality.
There are areas where the Sandbox is more restrictive than the EU’s DLT Pilot Regime. For example, the consultation expressed doubts that a public permissionless blockchain can be sufficiently compliant, but is open to arguments to the contrary. It also doesn’t envisage changes to access for retail investors, whereas the EU relaxes retail access.
The timing of the consultation followed the royal assent earlier this month of the Financial Services and Markets Act 2023. This gave HM Treasury the power to set up Financial Market Infrastructure (FMI) sandboxes via statutory instrument (SI), with the Digital Securities Sandbox as the first. The DSS consultation runs to August 21.
Meanwhile, last week UK Finance published a report on tokenization. In addition to asking for the launch of the Sandbox it also requested the government to explore a potential shared infrastructure where deposit tokens, CBDC and digital assets could be exchanged and settled.