Yesterday the government announced three sets of blockchain-related legislative plans. Following multiple consultations, it outlined plans for a regulatory sandbox for financial market infrastructures (FMI sandbox) using DLT, explored below. Additionally, it shared its regulatory plans for the stablecoin sector (separate article to follow). Later this year, there will be further consultation regarding legislating for cryptocurrencies. The Treasury has also asked the Law Commission to consider the legal status of Decentralised Autonomous Organisations (DAOs).
In a speech yesterday, John Glen, Economic Secretary to the Treasury, said, “Above all, we want to position the UK as a pro-innovation jurisdiction… which is attractive to inward investment, and to firms who don’t yet have a settled base.”
A year ago, the Treasury mentioned plans for a new FMI DLT sandbox without many details. This will likely primarily cover FMIs looking to issue security tokens and others focused on using blockchain for post-trade clearing and settlement. Yesterday’s paper said the sandbox’s scope would not be limited to blockchain or distributed ledger technology to maintain technology neutrality. It plans for the sandbox to be operational by 2023. That’s around the same time the EU’s sandbox for the DLT pilot regime is expected to launch.
FMI sandbox goals and playbook
There’s a recognition that regulatory changes may be needed to support DLT infrastructures. However, at the moment, it’s unclear exactly what those amendments might be. Hence a key goal of the FMI sandbox is to clarify the needed regulatory changes.
In the existing FCA sandbox framework, companies have to work within current regulations. In contrast, the FMI sandbox will allow certain relevant legislation to be modified or waived. However, the Treasury was keen to emphasize that there’s still a high compliance bar for participants.
For FMIs, the requirement for exchanges to have a third party central security depository (CSD) is one of the biggest obstacles to reaping the benefits of blockchain. Historically, CSDs hold securities and provide the single source of truth about who owns which security. But that’s one of the points of using blockchain.
Hence the Treasury envisages allowing exchanges – multilateral trading facilities (MTFs) – to trial providing CSD functionality using blockchain. However, the FMI will still need to comply with CSD Regulations, although they will be adapted for DLT settlement.
While it didn’t mention the EU’s DLT sandbox, it’s notable that the EU plans to allow fairly substantial trading levels with an overall limit of €6 billion for any single FMI. The UK’s Treasury stated it would not allow any scale that might pose risks to financial stability. It also wants to see business plans to either wind down the trials without disruption, or scale up beyond the sandbox.
Recognition of benefits and risks
As part of its consultation on wholesale markets, the DLT benefits were summarized as providing greater market efficiencies and reducing risks. Blockchain also enables improved transparency and transaction traceability, and greater infrastructure resilience.
But to achieve these benefits, there will be a fundamental reorganization of financial markets. This will include new types of intermediaries and different relationships between market participants.
Hence there’s a risk of disrupting existing market infrastructures. In any new marketplace, there’s a proliferation of services. In turn, this will likely result in new liquidity pools, but if there’s insufficient interoperability between liquidity pools, blockchain could result in market fragmentation. On top of this are the potential costs for existing organizations to incorporate blockchain and challenges in integrating with legacy systems.
An example (not mentioned in the report) is pushback against the ASX’s DLT CHESS implementation because of the impact of DLT on incumbent roles and the costs of adapting.
A wholesale CBDC?
The Treasury also mentioned that its consultation received several responses about the need for a wholesale central bank digital currency (CBDC). The Treasury did not comment in detail apart from referring to the CBDC Taskforce set up with the Bank of England.
However, it mentioned the new central bank omnibus bank account, enabling the private sector to provide a synthetic CBDC. And a Bank of England deputy governor has previously pointed out this as a reason why retail CBDC is seen as a higher priority.
Finally, it was mentioned that the BIS Innovation Hub set up in London plans to explore how an RTGS payments infrastructure could be synchronized with digital asset ledgers.
