On 3 April 2024, the Bank of England (BoE) and the Financial Conduct Authority (FCA) published a joint consultation on their proposed approach to implementing and operating the Digital Securities Sandbox (DSS), an initiative run by the regulators that is intended to help facilitate the adoption of innovative technology in digital assets in the UK.

Background

The Financial Services and Markets Act 2023 gave HM Treasury (HMT) the power to legislate to create financial market infrastructure (FMI) sandboxes to be operated by regulators. Following a July 2023 consultation on the DSS and the publication of its response in November 2023, HMT laid the relevant statutory instrument creating the DSS (the DSS Regulations) in December 2023.

The proposals

The DSS will allow for the use of developing technology, such as distributed ledger technology (DLT), in the undertaking of FMI activities, in particular those traditionally performed by a central securities depository (CSD) – i.e. notary, settlement and maintenance of securities – and the operation of a trading venue. As the current framework for the operation of a CSD was not designed with the use of developing technology in mind, a new category of firm – the Digital Securities Depository (DSD) – has been created for the purpose of the DSS. A firm wishing to perform one, or a combination, of the activities of a CSD in the DSS, will apply to be a DSD, and HMT has provided for this through the DSS Regulations by creating a temporarily modified legislative and regulatory framework.

As the BoE supervises CSDs and the FCA supervises the operation of trading venues, the DSS and sandbox entrants will be jointly overseen by both regulators.

Firms will not be obliged to participate in the DSS, and any firm wishing to undertake the activities of a CSD outside the DSS would need to comply with existing requirements. However, if firms wish to operate an FMI under the modified framework, they will first need to apply to the regulators to become a sandbox entrant. The BoE and FCA note that firms that do not require the modified framework to operate their business models should do so outside the DSS.

The consultation

The consultation paper sets out the BoE and FCA’s joint proposed approach to:

  • Implementing and operating the DSS.
  • The application process to enter the DSS.
  • The use of rule-making powers.
  • Managing financial stability and market integrity risks in the DSS.
  • Supervision and enforcement.

It also includes the BoE’s proposed approach to fees and to managing the limits on DSD activity within the DSS.

The consultation is relevant to firms intending to apply to enter the DSS and be approved as a sandbox entrant, as well as firms wishing to engage with a sandbox entrant but not become one themselves (e.g. firms seeking to offer custody services for the digital securities that are recorded, traded or settled on those FMIs).

There is also a draft guidance document, included as Appendix A to the consultation paper, which sets out how the DSS will operate and what firms looking to apply to the DSS can expect. The draft guidance should be read alongside the consultation and the BoE and FCA are inviting feedback on its contents (as well as the proposals in the main body of the consultation paper), including on areas where additional guidance is required.

Next steps

The consultation closes on 29 May 2024. Subject to feedback, the BoE and FCA propose to publish final guidance and rules for firms and to open the DSS for applications during Summer 2024.

Under the proposals, the DSS will last for 5 years and may lead to a new permanent regulatory regime for securities settlement under which firms could operate in the future. The BoE and FCA note that the Government has the tools to put in place permanent changes reasonably quickly.