The Bank of England and FCA’s joint consultation on the UK’s Digital Securities Sandbox closed last week. We reviewed four sets of feedback representing a wide range of opinions. Two aspects mentioned the most were the volume limits and the lack of discussion of digital currencies.
The five-year Digital Securities Sandbox which came into force in January, temporarily relaxes some of the legal requirements relating to central securities depositories (CSDs). This supports experimentation with distributed ledger technology (DLT) and tokenization, including the ability to operate both a trading and settlement market infrastructure.
Digital currency for settlement
Given that the core function of CSDs is settlement and that a key benefit of blockchain is instant settlement, there was surprisingly little coverage of the topic in the Bank of England and FCA consultation paper. The document mentioned that the Bank of England was considering synchronized settlement using its real time gross settlement (RTGS) system but it didn’t clarify if or when that might be available.
Plus it mentioned the central bank omnibus account facility. It didn’t explicitly mention Fnality, the company that uses the omnibus central bank account for its tokenized settlement infrastructure. Finality has launched in the UK but in a controlled manner subject to Bank of England limits.
In its response, UK Finance suggested it would be a missed opportunity not to use on-chain digital money. Given that Fnality is only accessible to banks, it puts non banks in the Sandbox at a competitive disadvantage. We didn’t see a mention of stablecoins in the paper, but UK Finance said its use was restricted.
The Global Blockchain Business Council and International Regulatory Strategy Group (IRSG) also called for the use of systemic stablecoins as part of the Sandbox, with the IRSG additionally suggesting the use of electronic money issued by commercial banks.
Monetary limits too restrictive
Regarding monetary limits, there’s a proposal to split the monetary limits for each asset class equally amongst participants, presumably out of a sense of fairness.
UK Finance noted a single large issuance could use up the limit for a firm. It suggested applying limits on a firm-by-firm basis rather than globally. Similarly, IRSG warned that the UK should learn from the EU’s DLT Pilot Regime, which has failed to attract significant incumbents because of the low limits. As an aside, the Deutsche Börse gave a vivid analogy to explain the challenge of small limits in the DLT Pilot Regime. Jens Hachmeister said it was like asking an aircraft carrier to be adapted to support Cessna aircraft and only for a couple of landings.
The IRSG also noted that if there’s a desire to test a digital gilt (UK Treasury bond), the limits are not viable. They are also impractical for a CSD serving a large part of the market.
Other digital securities topics
The consultation feedback raised a wide range of issues. We previously reported that SEC Commissioner Hester Peirce suggested expanding the Sandbox to include the United States. UK Finance also proposed taking a more international approach.
The IRSG made an interesting point that quite a few of the legal adjustments simply clarify that the laws also apply to digital securities. It suggested that potentially these legal clarifications, which are not true legal waivers, could be applied outside of the Sandbox.
Batting for startups, the GBBC highlighted that the Sandbox’s design caters to incumbents. If startups engage, they have to pay licensing costs to get regulated, which is a significant expense, as well as Sandbox fees. Additionally, they have to perform two sets of compliance with the FCA and central banks. The GBBC argued for more flexible capital requirements, particularly as startups should have a smaller scale.
ICMA emphasized the need for greater flexibility in many aspects, particularly relating to Sandbox activity scaling continually rather than on a fixed timeline. The other three consultation responses also mentioned greater flexibility. The level of flexibility requested would make the Sandbox far more usable. However, it would impose considerable workloads on the regulators.
