While everyone understands that securities will inevitably become digital, policymakers have been slow to provide an ecosystem to support the nuances intrinsic to the transition from analog. Eventually, digital securities will become the dominant sector of digital assets, and clear-cut rules are needed.

Today, the Bank of England and the Financial Conduct Authority (FCA) announced a joint consultation and draft guidance that will take a significant step toward a digital securities ecosystem.

The consultation follows Parliament’s adoption of the Financial Services and Markets Act 2023, which gave HM Treasury the power to legislate to create Financial Market Infrastructure (FMI) Sandboxes to be operated by regulators. HM Treasury consulted on the DSS in July 2023.

The consultation is to generate feedback on the proposed approach to operating the Digital Securities Sandbox (DSS). The DSS is an initiative that will be run by regulators to help facilitate the adoption of digital asset innovation in the UK. The DSS is expected to last up to five years.

The goal is to “modify” regulations in the UK to enable the trading and settlement of digital securities leveraging technology. This may include blockchain or distributed ledger technology (DLT) but may incorporate other technology.

The DSS will be open to both establishment firms and new participants in the digital asset sector.

Described as a “major step in exploring innovation in digital assets in the UK,” the expectation is that digital securities will foster an ecosystem for cheaper and faster trading, leading to a “transformation” that will also boost resilience in the financial services system.

The following sectors have been highlighted as potential assets to be traded in the DSS:

  • Equities
  • Bonds, both corporate and government-issued
  • Money Market securities, including commercial paper and certificates of deposits
  • Fund Units or units in collective  investment undertakings
  • Emissions allowance

The program does not include “Unbacked” digital assets or crypto assets, such as Bitcoin or Ether.

The three goals of the consultation include:

  • Testing how existing UK legislation needs to change to accommodate digital asset technology and the new practices associated with it.
  • Enabling the financial sector to test and adopt digital asset technology in FMIs.
  • Testing the use of FMI sandboxes as a policymaking concept.

The DSS aims to accomplish the following objectives:

  • Facilitating innovation to promote a safe, sustainable and efficient financial system
  • Protecting financial stability
  • Protecting market integrity and cleanliness

Sasha Mills, the Executive Director for Financial Market Infrastructure at the Bank of England, said the DSS will be an important tool for learning how to benefit from new technology.

“This consultation is an innovative approach for regulators and an exciting milestone in supporting innovation in the financial industry. We welcome views from potential participants and look forward to working with the FCA, government and industry over the lifespan of the DSS.”

Sheldon Mills, Executive Director of Consumers and Competition at the FCA, said the DSS would allow policymakers to test digital securities before permanent changes.

“The new sandbox also helps strengthen the UK’s leading position as a global and vibrant financial centre, by driving adoption of new technologies for trading and settling traditional assets, like bonds and equities,” said Mills.

The UK’s leadership position in Fintech is a key mission for the UK government and is supported by a wide group of Fintech proponents. The UK has long been a global financial services hub, and there is recognition that innovation must be embraced to maintain relevance in the world of finance.

While multiple private firms around the world are enabling digital securities, the UK’s establishment of rules that will encompass public securities should boost digital securities adoption. Global equity markets globally alone are around $110 trillion, and the transition to digital securities will be substantial.

The US, which is home to the largest financial services sector in the world, has been slow to create an environment that encourages digital securities adoption. The US Securities and Exchange Commission has sought to regulate digital assets mostly through enforcement actions. Some observers believe this has been a missed opportunity for the agency, which has become highly political, focusing resources on issues and rules that do not align with the Commission’s mission.

The first cohort firms accepted into the DSS will be announced this fall (2024).

The closing date for responses to the consultation paper is May 29, 2024

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Thomas Carter

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