The FCA and Bank of England (BoE) issued a consultation on how to implement and operate the digital securities sandbox (DSS) on 3 April 2024. This builds on the DSS Regulations that set the legal framework for DSS.
The DSS is the first financial market infrastructure sandbox in the UK, allowing participating firms to use distributed ledger technology (DLT) when undertaking activities traditionally performed by a central securities depository (CSD), and when operating trading venues under temporarily modified legislation. Wider financial market participants will be able to interact with the DSS firms as normal.
The DSS will operate for five years. Authorities will determine how the existing laws and regulations would need to be permanently amended to support the use of new technologies.
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What does this mean?
The purpose of the DSS programme is to assess how new technologies could improve the efficiency of ‘post-trade’ processes, and potentially lead to material savings across financial market participants, such as pension funds, investment firms and banks.
The DSS will be open to existing financial institutions and new entrants provided they are 1) UK established entities, 2) intend to carry on traditional CSD activities (notary, settlement and maintenance of securities), 3) propose to issue, trade, settle or maintain in-scope assets, and 4) identify clear regulatory barriers or obstacles preventing the activity being carried on outside the DSS.
Example financial instruments which could be issued and traded in the DSS include: equities, corporate and government bonds, money market instruments such as commercial paper and certificates of deposits, units in collective investment undertakings (fund units), as well as emissions allowances. DSS will not facilitate the trading and settlement of derivative contracts and of ‘unbacked cryptocurrencies’ (e.g. Bitcoin).
The DSS Regulations allow for three possible business models: undertaking the activities of a CSD by being a digital securities depository (DSD), operating a trading venue, or combining both into one financial market infrastructure (FMI) to create a hybrid entity. Firms undertaking CSD activities, must apply to be a DSD. Firms aiming to operate a trading venue in the DSS will need to have the necessary authorisations or exemptions to do so.
The authorities propose overall capacity limits for established key sterling asset classes. Trading and settlement for other asset classes will also be possible in the DSS, but limits on those activities would be confirmed separately based on further discussions with the industry. The DSS will also include a series of gates to move through for sandbox entrants to progress from one stage to the next. Each stage increases the amount of permitted activity. Eventually, firms may graduate through this glidepath to a possible new settlement regime, assuming they meet the relevant standards.
The FCA and BoE will tailor their supervisory approach to the risks posed by firms in the DSS. Operators of trading venues will need to meet the same standards as currently in place outside of the DSS. DSDs will not have to meet the same standards as are currently in place for CSDs. Instead, the BoE will implement proportionate standards for DSDs, which will change to reflect their progress in the DSS, and therefore their risks.
The authorities stress that the DSS is not a permanent regime and the rules can be amended during the sandbox lifetime, as firms and regulators learn about the application of new technology in practice.
The consultation also sets out the proposed fees for the DSS participants, to allow the BoE to operate the programme.
What do firms need to do?
All eligible firms should consider applying to support the implementation of new technologies within financial services.
Firms intending to participate should carefully consider the eligibility criteria and attached regulatory requirements.
All market participants should look into ways to play a part in the wider sandbox programme, to enhance the outcomes.
Next steps
The consultation closes on 29 May 2024. The FCA and BoE will issue a response and the DSS will open for applications over the summer of 2024.
The first cohort of DSS applicants will become sandbox entrants in autumn 2024.
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