RegTech Intelligence 
The UK’s Digital Securities Sandbox (DSS), which will test a new approach to rulemaking for digital securities trading and settlement infrastructure, should launch at the end of the first quarter 2024.
“This is not our traditional Innovate sandbox. It is being specifically set up to allow infrastructure to test a new rule set that would allow it to do new things with digital securities. It is going to be set up and hopefully opening at the end of Q1 next year,” Helen Boyd, head of capital markets at the Financial Conduct Authority (FCA), told CCData’s Digital Asset Summit last month.
The DSS is designed to allow firms to try innovative approaches for trading and settling digital assets. It will be a place where firms can test ideas safely and with “regulatory clarity around it,” Boyd said.
It will also permit a nimbler approach to transitioning from the sandbox to live, customer-facing activity. HM Treasury anticipates being able to make permanent amendments to legislation “reasonably quickly.” Regulators, however, will need to determine what that transition will require and whether sandbox firms need any additional authorisations.
“It is a completely new way of us making regulation,” Boyd said.
“In the past, we have tended to wait for new activity to come along and regulate it. Sort of, ‘it’s here now here are the rules.’ This is a much more iterative process. We expect it to be a learning curve. It’s an interesting way of making regulations, so as a nerdy regulator, that in itself is exciting.”
Consultation response, statutory instrument
The Financial Services and Markets Act 2023 (FSMA 2023) empowered HM Treasury to create financial infrastructure sandboxes. HM Treasury published its consultation response this week, setting out next steps to get DSS started.
Those steps include consultations from the FCA and the Bank of England to clarify the application process, as well as rulemaking in the DSS. The FCA will regulate trading venues inside the sandbox, and the BoE will regulate notaries, settlement, and maintenance services providers.
The government also must propose a statutory instrument before parliament to provide a temporarily modified legal framework to implement DSS. Modifications in this statutory instrument could be made permanent with possible further modifications to facilitate firms’ transition from the sandbox.
“The DSS is taking shape in the context of the restructuring of UK law following Brexit. The government is transferring powers to the regulators, including the Bank of England, the PRA, and the FCA, to define how the sandbox will work in practice. That will include disapplying certain legislation and allowing it to be amended as regulatory rules. The inter-institutional cooperation required to make this work is significant. It is remarkable that the system is yielding results both in relation to the DSS and the work on stablecoin regulation. There is still work to be done, but the UK is demonstrating that it has the interest and intention to renovate its laws to support the digital economy,” said Etay Katz, head of digital assets at Ashurst in London.
The statutory instrument will likely include modifications to the UK Central Securities Depositories Regulation (CSDR), the Companies Act, Settlement Finality Regulations (SFR), Uncertificated Securities Regulation (USR), Financial Collateral Regulations (FCAR), and potentially others. It is expected to be laid before parliament this year, and the government could use more of them to create additional financial market infrastructure (FMI) sandboxes.
“That statutory instrument will create the legislative framework that will then allow regulators to flesh out all of the detailed rules about how the sandbox will work, including when and how applications can be made and exactly what legislative modifications participants will have access to,” said Sophia Le Vesconte, counsel and fintech specialist at Linklaters.
Contrast with European approach
The European Securities and Markets Authority (ESMA) started work on its distributed ledger technology (DLT) pilot in 2022, and it began taking applications to participate in March. The purpose of the ESMA DLT pilot and the UK’s DSS are largely the same, to facilitate development of digital market infrastructure in relation to regulated securities.
These programmes were needed, because some of the use-cases for novel technologies aimed at streamlining market infrastructure are incompatible with the existing regulatory framework, Le Vesconte said.
“That’s not to say that it’s impossible to use novel technologies under the existing regulatory framework,” Le Vesconte said. “It’s just that there are certain structural limitations to what can be achieved in the existing regulatory framework.”
There are some differences in the approach, for example, on limiting the volume of securities that can be traded on the sandbox infrastructure. The EU approach limits that volume, whereas the UK has left that decision to regulators. The UK government can make the modifications set out in the SI permanent, which could streamline the process out of the sandbox, whereas the EU will need to make changes through another legislative process, Le Vesconte said.
“The EU approach has been to hardwire into legislation the types of permissions that can be sought,” Le Vesconte said.
“That’s probably the only way they could have done it, because they’re dealing with a single market across multiple jurisdictions, and they’re trying to establish a common framework. But the UK approach has been to give the regulators a lot of flexibility, which is why we still don’t know a lot of the detail. That could be quite helpful in terms of allowing regulators to tailor modifications and limits to particular types of applicants and adjust them over time.”
The DSS is scheduled to run for five years, while the ESMA DLT pilot will run for six years. The UK DSS will be open to authorised central securities depositories and trading venues, such as multilateral trading facilities, organised trading facilities, and UK firms seeking authorisation.
This article was produced by Thomson Reuters Accelus Regulatory Intelligence on 27-Nov-2023