At the end of September last year, the Bank of England and Financial Conduct Authority opened applications for its Digital Securities Sandbox (DSS), a program that’s designed to relax some regulations to support the trading and settlement of tokenized securities on distributed ledgers.
There are strong parallels with the EU’s DLT Pilot Regime, but when the UK’s concept was first announced in 2023 there were three important differences. While the EU regime supports permissionless blockchains, retail access and stablecoins, the British one did not. However, a recently published Q&A reinforces some movement on the first two of those points.
Stepping back, current regulations in both the EU and UK require the use of a central securities depository (CSD) for the settlement of secondary market securities trades and force the separation of trading and settlement venues. Both the regimes relax some of these laws.
Hence, they each support three types of market infrastructures: trading venues, settlement venues and infrastructures that combine both. The UK settlement venues, Digital Securities Depositories (DSDs), are not the same as a central securities depository (CSD).
Retail focus and permissionless ledgers
The Digital Securities Sandbox allows retail-focused venues to apply, but their applications will receive “additional scrutiny” in order to address the perceived risks.
Regarding permissionless blockchains, “regulators are taking a permissive approach”. However, applicants would need to show regulators how their approach meets the required regulatory standards. When the first DSS consultation was published in mid 2023 it expressed doubts that a permissionless blockchain could meet the regulatory hurdles.
Currently the Basel Rules for banks that deal with crypto-assets, classifies digital securities on permissionless blockchains as having the same risks as cryptocurrencies. That said, the Basel Committee subsequently published a document exploring how the additional risks might be addressed.
One thing that hasn’t changed, is the UK’s DSS does not support the use of stablecoins from any jurisdiction. Settlement can use conventional payments, tokenized deposits or a central bank omnibus bank account, which is the route that Fnality takes for its tokenized settlement network.
So far only three participants have been approved at the ‘Gate 1’ DSS assessment: ClearToken CSD, Archax’s Montis Digital and BPX Markets which is building an exchange for tokenized real estate securities. Gate 1 is a preliminary step that does not allow live transactions. Notably, all three are startups.