Today HM Treasury published a consultation paper for its Digital Securities Sandbox (DSS). The goal is to relax the legislation for digital securities, whether they are native or tokenized representations of existing securities. The government acknowledges that digital assets could be “genuinely transformative for financial markets”, both in terms of efficiency and more radical changes in the market. Sandbox will run for an initial period of five years.

Limits and Post Sandbox Experience

The UK has learned from some of the problems experienced in the EU DLT Pilot Scheme, which has similar objectives. For example, some larger banks found the EU limits too restrictive. In the UK the limits will be more flexible and have 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 it is flexible based on its size and activities.

Asset classes exclude cryptocurrencies, but include debt, equity, and money market instruments.

In the EU, there were also concerns about what will happen at the end of the Pilot Regime. For the UK Sandbox, HM Treasury now has the power to adapt laws using a statutory instrument; in other words, it is secondary legislation that does not require the conventional process. He intends to implement new legislation before the end of the Sandbox and could make multiple changes. You can also extend the sandbox period.

Who can participate

Sandbox will be open to regulated entities as well as new entrants, although they must be based in the UK. However, the government does not foresee significant regulatory changes for exchanges or so-called multilateral trading facilities (MTFs). So they need to have conventional licences. By contrast, the central securities depository (CSD) functions is where legal flexibility is needed and these activities will be open to new entrants.

Legal relaxations for digital securities

Under existing laws, exchanges and CSDs would generally be operated by separate entities, but the same organization can do both in the Sandbox. Many current CSD regulations do not accommodate a DLT-based system, so they will be relaxed. Sandbox will also allow settlement with money from tokenized commercial banks, as well as linking to payment systems and other formats. For example, it envisions links to central bank omnibus accounts, such as those used by DLT-based settlement firm Fnality.

There are areas where Sandbox is more restrictive than the EU DLT Pilot Regime. For example, the query expressed doubt that a permissionless public blockchain could be sufficiently compliant, but is open to arguments to the contrary. It also does not foresee changes in the access of retail investors, while the EU relaxes retail access.

The timing of the consultation followed the royal approval 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 through an instrument legal (YES), with Digital Securities Sandbox a first. The DSS inquiry runs through August 21.

Meanwhile, last week, UK Finance released a report on tokenization. In addition to calling for the launch of the Sandbox, he also asked the government to explore a potential shared infrastructure where deposit tokens, CBDCs, and digital assets can be exchanged and settled.