On April 3, 2024, the Bank of England and the UK Financial Conduct Authority published a joint consultation paper on proposed rules for the inbound digital securities sandbox. The Financial Services and Markets Act 2023 (discussed in our client note “A Boost for UK Financial Services”) authorized the UK Treasury to establish sandboxes to facilitate the use of digital assets in financial markets. The UK Treasury confirmed its approach to the DSS, the first sandbox of its kind, in December 2023. The DSS provides eligible entities with a modified set of rules and regulations for a period of five years, allowing them to provide services using technologies such as distributed ledgers -Improve technology and give regulators time to refine a regulatory system. It is hoped that digital securities could bring benefits such as streamlining processes and reducing settlement risk and times.
The Financial Services and Markets Act 2023 (Digital Securities Sandbox) Regulations 2023 were published in January 2024 and provide that recognized investment exchanges, recognized central securities depositories and securities firms licensed to operate multilateral securities trading are eligible to participate in the sandbox in the United Kingdom are trading establishments or organized trading establishments and any other entities identified by the FCA or PRA. Securities that can be traded within the sandbox include shares, corporate and government bonds, money market instruments, shares in collective investment schemes and emission allowances. Derivative contracts and uncollateralized cryptocurrencies such as Bitcoin are not in scope.
Responses to the regulators' consultation on their proposed rules for the DSS can be submitted by May 29, 2024. Final guidelines and rules for the DSS will be published upon feedback and the DSS will open for applications in summer 2024. Key aspects of the proposed BoE/FCA rules include:
Eligibility
Under the proposed rules, companies must demonstrate clear regulatory barriers that would otherwise prevent their activities outside of the DSS. There are three possible business models for participation: (i) carrying out the activities of a central depository for digital securities (so-called digital securities depository); (ii) operating a trading venue; and (iii) combining both activities in a financial market infrastructure.
stages
The DSS will have five stages and companies will have to pass through a series of four gates consisting of compliance with increased regulatory standards before moving on to the next stage.
DSS rules
Regulators have the authority to establish rules that apply to both sandbox participants and other persons who conduct DSS activities but are not themselves sandbox participants. The BoE published proposed rules for digital securities depositories as part of the consultation paper, as it was found that these entities face the greatest legal and regulatory barriers to the use of evolving technologies. The FCA has not published any proposed rules for a new regime as there do not appear to be any particular legal or regulatory challenges for trading venues when operating with digital assets. Therefore, the FCA considers it unlikely that firms that only want to operate a trading venue will be included in the DSS as they do not face regulatory barriers but decisions are made on a case-by-case basis.
Management of financial stability and market integrity risks
The BoE will limit digital securities custody activities in the DSS to manage financial stability risks. The FCA will require trading venues within the DSS to meet the same standards as those outside the DSS.
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