Digital securities are broadly acknowledged as the future of all securities. Yet, progress has been slow for regulators around the world to craft the needed rules to enable digital to replace existing analog securities. The advent of distributed ledger technology (DLT), or blockchains, is expected to be the technology to enable digital securities while empowering a new era of alternative assets as intrinsic friction is removed.
Last month it was reported that 19 firms had applied to be part of the UK’s Digital Securities Sandbox (DSS), a safe place for innovators to work with regulators to advance the digital securities future. In mid 2023, HM Treasury launched a consultation on digital securities. The consultation closed in August 2023.
The Financial Services and Markets Act 2023 (Digital Securities Sandbox) Regulations 2023 will come into force on January 8, 2023. The DSS will be managed by the FCA and the Bank of England.
As explained in a government memorandum:
“These regulations create the first Financial Market Infrastructure (FMI) sandbox, the ‘Digital Securities Sandbox (DSS)’. The DSS will allow firms and the regulators to test the use of new technology across our financial markets. In particular, this will involve trialing the use of developing technology (such as distributed ledger technology, or in general, technology that facilitates what are commonly referred to as ‘digital assets’) to perform the activities of a central securities depository (specifically notary, settlement and maintenance), and operating a trading venue. It will enable participating entities to be subject to modified legislative requirements, where the existing requirements act as a barrier or an obstacle to using new technology. In some cases, legislative requirements will be disapplied within the DSS, with the regulators able to make rules instead. The DSS will enable the Government and regulators to test and then make changes on a permanent basis to accommodate new and developing technologies.”
The DSS is expected to last up to five years with the option of being extended. Participating entities will either fail (wind down) or continue to operate under an updated framework.
CI received some commentary from enterprise (permissioned) blockchain firm R3. Chief Economist Dr. Alisa DiCaprio described the advent of the DSS and the pursuit of digital securities as a “significant milestone in the adoption.” DiCaprio said:
“By allowing firms to experiment with DLT within a regulated framework, the FMI sandbox will serve as a stepping stone to a more collaborative, open, and trusted digital economy. Over the next five years, DLT is predicted to help tokenize an estimated $5 trillion in assets. The government must continue to recognize the role that this technology will play in maintaining the competitiveness of the City. The introduction of smart regulation and standards will be key in creating the right environment for financial services to innovate with technology. As we move ahead, we look forward to seeing how the Digital Securities Sandbox will foster a dynamic and secure financial environment, paving the way for continued growth and innovation.”
R3 would like to play a role in the future of digital securities.
The UK has long been a top global financial center, which has morphed into a leading global Fintech hub. An entrepreneurial population combined with global financial services firms interested in advancing their abilities has helped to maintain London as a vital financial center. This industry is also crucial for the UK economy, more so following Brexit. At the same time, the only way the UK can maintain its status in financial services is with the support and participation of policymakers. The DSS is a prime example of key government support of innovation that can lead to London becoming the leading location for digital securities innovation.
It is interesting to note that the US, home to the top financial markets, has been slow to advance digital securities. While many private sector firms are working towards the digital securities future, legislators and regulators have been unable to create an environment similar to what the UK is doing now. Perhaps, most glaringly, is the Securities and Exchange Commission, which has focused on controversial and divisive social issues to the detriment of innovation in digital assets, missing an opportunity for real change in financial markets that will be beneficial to all. Maybe a change in leadership at the Commission will address this misallocation of resources and empower the creativity of financial innovators in the US.