During a speech today, Sir Jon Cunliffe, Deputy Governor of the Bank of England, said that the UK’s IMF 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 due to launch 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 failure points, reducing risk
• instantaneous or atomic settlement eliminates the need for netting and retaining margin
• fractionation 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 transaction
• 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 is no responsible legal entity
• The transition period to new technologies carries risks.

A key demand for securities settlement is to have cash on the ledger. However, the IOSCO 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 opinion, 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,” Cunliffe said.

One possibility is to offer a tokenized central bank digital currency (wholesale CBDC), as well as the rail on which it trades. Last year, Cunliffe stated that he saw no need for a wholesale CBDC for home use.

An alternative is to make existing real-time gross settlement (RTGS) systems compatible with DLT systems. The Bank is currently working on the renovation of its RTGS and is considering “a generic interface in RTGS that would allow a variety of ledgers to connect to the system, as well as the construction of a system without technical barriers for 24/7 operation” Cunliffe said. .

Additionally, the central bank can allow those with access to central bank accounts to tokenize money. On this last point, the Bank of England created a new type of omnibus bank account that 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 potential for a major transformation in financial market infrastructure, and that it could deliver significant profit.”

Meanwhile, the EU pilot DLT regime comes into force in March 2023 and yesterday ESMA published a report on a recent consultation.