Yesterday, the government announced three sets of blockchain-related legislative plans. After several consultations, it outlined plans for a financial market infrastructure regulatory sandbox (FMI sandbox) using DLT, which is discussed in more detail below. In addition, it shared its regulation plans for the stablecoin sector (separate article follows). There will be further consultations on cryptocurrency legislation later this year. The Ministry of Finance has also asked the Legal Commission to review the legal status of Decentralized Autonomous Organizations (DAOs).
In a speech yesterday, John Glen, business secretary at the Treasury, said: “Above all, we want to position the UK as an innovation-friendly jurisdiction, attractive to investment from abroad and to companies that don’t already have a solid base.”
A year ago, the Treasury Department mentioned plans for a new FMI DLT sandbox without many details. This will likely primarily cover FMIs looking to issue security tokens and others focused on using blockchain for post-trade clearing and settlement. Yesterday’s newspaper said the scope of the sandbox is not limited to blockchain or distributed ledger technology in order to maintain technology neutrality. The sandbox is planned to be operational by 2023. This is around the same time that the EU’s sandbox for the DLT pilot regime is expected to launch.
FMI sandbox goals and playbook
There is a recognition that regulatory changes may be required to support DLT infrastructures. At the moment, however, it’s unclear exactly what these changes might be. Therefore, a key objective of the FMI sandbox is to clarify the required regulatory changes.
In the existing FCA sandbox framework, companies must work within the applicable regulations. In contrast, the FMI sandbox allows for the modification or repeal of certain relevant laws. However, the Treasury wanted to emphasize that there is still a high compliance bar for participants.
For FMIs, the requirement for exchanges to have a third-party central securities depository (CSD) is one of the biggest obstacles to reaping the benefits of blockchain. Historically, CSDs hold securities and provide the single source of truth about who owns which security. But that’s one of the points of using blockchain.
Therefore, the Ministry of Finance plans to allow exchanges – multilateral trading facilities (MTFs) – to test the provision of CSD functionality using blockchain. However, the FMI still has to comply with the CSD regulations, although they are being adapted for DLT settlement.
Although there was no mention of the EU’s DLT sandbox, it is worth noting that the EU plans to allow quite a significant trading volume with a total limit of €6 billion for each individual FMI. The UK Treasury said it would not allow any scale that could pose risks to financial stability. It also wants to see business plans to either complete the trials without disruption or to scale beyond the sandbox.
Recognizing benefits and risks
As part of its consultation on wholesale markets, it summarized the benefits of DLT in offering greater market efficiencies and reducing risk. Blockchain also enables improved transparency and traceability of transactions, as well as greater infrastructure resilience.
But in order to achieve these benefits, there will be a fundamental reorganization of the financial markets. This includes new types of intermediaries and different relationships between market participants.
There is therefore a risk that existing market infrastructures will be disrupted. In each new market there is a multitude of services. This in turn will likely lead to new liquidity pools, but if there is insufficient interoperability between liquidity pools, the blockchain could lead to market fragmentation. Add to this the potential cost to existing organizations of integrating blockchain and challenges of integrating with legacy systems.
An example (not mentioned in the report) is the opposition to the ASX’s DLT CHESS implementation due to the impact of DLT on the established roles and the cost of adaptation.
A Wholesale CBDC?
The Treasury also mentioned that its consultation received multiple responses on the need for a wholesale central bank (CBDC) digital currency. The Treasury did not comment on the details, apart from a reference to the CBDC task force set up with the Bank of England.
However, it did mention the central bank’s new omnibus bank account, which will allow the private sector to provide synthetic CBDC. And a deputy governor of the Bank of England has previously pointed out why CBDC is a higher priority for retail customers.
Finally, it was mentioned that the BIS Innovation Hub set up in London is planning to explore how an RTGS payment infrastructure could be synchronized with digital asset ledgers.
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