His Majesty’s Treasury (HMT) published the responses to the Digital Securities Sandbox consultation it launched in July. So far 19 organizations have expressed interest and the Government is still open to other potential applicants. The five-year Sandbox will support the relaxation of certain regulations to trial the tokenization of securities and DLT market infrastructures. The Bank of England and Financial Conduct Authority (FCA) will supervise the Sandbox.
Assets in scope of Digital Securities Sandbox
The initial consultation said the assets in scope would include debt, equity and money market instruments but not cryptocurrencies. Consultation responses asked for clarification and suggested equity-like instruments such as depository receipts, UCITS and other funds, gilts and Treasury bills, mortgage backed securities and tokenized commodities.
In response, the government said all assets “currently in scope of the regulatory perimeter, aside from derivatives” can potentially be included. That includes collective investments excludes cryptocurrency. The reason for excluding derivatives is that there are no plans to alter derivatives legislation within the Sandbox. However, derivatives that refer to sandbox securities are allowed, but the derivatives themselves have to comply with unamended regulations.
Sovereign debt might be included later, but initially the focus is on private sector debt instruments. Each applicant will be informed which specific asset classes are in scope for them.
When we previously compared the Sandbox to the EU DLT Pilot Regime we noted that the EU’s low volume limits had dissuaded some banks from participating. In contrast, individual limits in the UK Sandbox will be based on the size of the organization. However, the government has still not clarified how the limits will work.
Activities included in the Digital Securities Sandbox
The four activities in scope of the Sandbox are notary, settlement, maintenance (CSD), and operating a trading venue. While the institution performing these roles in the UK Sandbox must be based in the UK, users of the digital assets need not be. A key aim is to treat digital assets in the same way as conventional assets. Hence, the digital securities can be used outside of the Sandbox. For example, as collateral.
Most of the legislative relaxations will be related to some requirements in the UK Central Securities Depositories Regulation (CSDR). Regarding Settlement Finality Regulations (SFRs), the Bank of England will be given the power to choose to allow entities an exemption from getting an SFR designation for the Sandbox. This designation applies to payment and settlement systems.
The Bank will also have the power to decide which digital cash solutions can be used. Initially, the cash leg will have to use GBP, but the Sandbox legislation will allow for non-GBP payments later on.
Two areas that appeared to differ between the Sandbox and EU Pilot Regime were permissionless blockchains and retail access. The government said it isn’t ruling out either. However, it will be tricky for permissionless systems to comply with current legislation.
Regarding retail access, the government will retain the current requirements on intermediation between retail and wholesale. But it doesn’t consider retail participation to be ruled out. Presumably, that means provided an end user goes via an intermediary. More ‘novel’ retail targeted solutions could be explored in future sandboxes.
Update: added clarification that derivatives referring to sandbox financial instruments are allowed.
