The Digital Securities Sandbox (DSS) is now open for applications. Digital securities, or tokenized assets, are widely believed to be the future of the securities sector. While anticipation of the migration to digital from more analog issuance and trading of securities has been predicted for years, global adoption has moved slowly. Part of the challenge is policymaker/regulator buy-in, and the UK is taking a significant step forward in its pursuit of Fintech innovation with the Bank of England and the Financial Conduct Authority (FCA) DSS. The two agencies have established an MoU for the Sandbox. The goal is to ensure regulation does not inhibit innovation while protecting financial stability.
The two government entities are encouraging Fintechs to apply to the regulated Sandbox. As outlined in a joint statement today:
“The DSS gives firms the opportunity to explore new technologies in traditional financial markets, for example, distributed ledger technology (DLT), a system for storing and managing information distributed across participants in a network. This technology has the potential to improve efficiency and reduce costs in wholesale markets, benefitting industry and investors.
We believe the DSS could also lead to a quicker, more effective and collaborative way of delivering regulatory change.
The DSS supports innovation, helps protect financial stability and strengthens the UK’s leading position as a global and vibrant financial centre, built on globally respected high standards.”
The DSS follows a consultation on digital securities published earlier this year. Responses closed on May 29, 2024 and the launch of the DSS is being accompanied by responses to the consultation. Several respondents allowed their names to be affiliated with their comments.
The DSS is accepting applicants interested in the following financial instruments: equities, bonds, money markets, fund units, and emission allowances. Derivative contracts may be written on these securities. but derivatives are not in the scope of the Sandbox. As well, “unbacked crypto” like Bitcoin and Ethereum are not part of the project.
The DSS is expected to enable regulators to determine how the existing regime for the issuance, trading and settlement of securities would need to be adjusted to support the use of digital securities.
While not assuming that blockchain or distributed ledger technology will be the tech of choice, there is an expectation that technology can improve the efficiency of treading and settlement leading to savings across the financial sector. Retail participation in the digital security platforms is not ruled out.
Guidance for aspiring participants is available here.
Digital securities are expected to improve capital markets, enabling more investor participation while reducing the cost of issuing securities.
Gilbert Verdian, Quant’s CEO, shared his opinion on the DSS. Verdian previously worked at HSBC, Mastercard, and HM Treasury before founding Quant. He also partnered with the Bank of England’s exploration of CBDCs. Quant assists firms and public entities in taking advantage of blockchain technology. Verdian believes the DSS is very important for the UK’s global competitiveness.
“It has been well documented that London’s status as a global financial hub is under threat, but tokenised securities can put our capital markets at the forefront of technological innovation for the next 30 years. These instruments offer greater liquidity for issuers and, in the case of investors, a democratisation of asset classes and financial products that were previously unavailable to them, in addition to new operational efficiencies and cost reduction. By working collaboratively in a pilot sandbox environment with participants and counterparties, you can better achieve timely and effective project implementation. With emerging technology, start small, test and iterate and then go bigger. This is the approach of many successful central bank digital currency pilots, which run on a variety of DLTs,” explained Verdian.
He added that the DSS lays the foundation for market participants to benefit from the technological advancements all in a safe and regulated environment.
Verdian also said the DSS “puts the UK in a strong leadership position when it comes to tokenisation. With the EU having already launched its DLT pilot regime, it is vital that the UK does not fall behind in this new era of digital finance.”
The EU has approved MiCA or Markets in Crypto Assets regulation in place. The European Securities and Markets Authority (ESMA) is consulting on digital securities. A DLT pilot regime is ongoing
The UK has long been a top global finance hub and it is vital it embraces innovation like digital securities to remain relevant and if successful may be made permanent by amending financial services legislation to establish a single framework.
Then there is the leading financial hub in the world, the US, will has struggled to acknowledge digital securities and the nuances associated with tokenizsed assets. Congress has failed to pass legislation to mandate officials embrace innovation.
Meanwhile, at the US Securities and Exchange Commission (SEC), under the leadership of Chairman Gary Gensler, the focus has been on prosecuting digital asset issuers – frequently without any evidence of fraud. Ignoring the immense opportunity of digital securities during Gensler’s tenure will inevitably be recognized as an enormous missed opportunity for the Chairman. Gensler will be remembered as the SEC Chairman who failed to empower digital securities and fell short on the job while pursuing political ambitions and specious policies like climate disclosure.
