UK plans DLT sandbox for financial market infrastructure by 2023 – Ledger Insights
Yesterday, the government announced three sets of blockchain-related legislative plans. Following multiple consultations, he presented plans for a financial market infrastructure regulatory sandbox (IMF sandbox) using DLT, explored below. Additionally, he shared his regulatory plans for the stablecoin industry (separate article to follow). Later this year, there will be further consultations regarding cryptocurrency legislation. The Treasury has also asked the Law Commission to review the legal status of Decentralized Autonomous Organizations (DAOs).
In a speech yesterday, John Glen, Economic Secretary to the Treasury, said: ‘Above all, we want to position the UK as an innovation-friendly jurisdiction… which attracts foreign investment and companies which have not base yet established.
A year ago, Treasury mentioned plans for a new IMF DLT sandbox without much detail. This will likely primarily cover MFIs looking to issue security tokens and others focusing on using blockchain for post-trade clearing and settlement. Yesterday’s article said that the scope of the sandbox would not be limited to blockchain or distributed ledger technology to maintain technology neutrality. He expects the sandbox to be operational by 2023. This is around the same time that the EU sandbox for the DLT pilot scheme is expected to launch.
IMF Sandbox Goals and Playbook
It is recognized that regulatory changes may be required to support DLT infrastructures. However, for the moment, we do not know exactly what these amendments could be. Therefore, one of the main objectives of the IMF sandbox is to clarify the necessary regulatory changes.
Within the existing FCA sandbox framework, companies must comply with applicable regulations. On the other hand, the IMF sandbox will make it possible to modify or waive certain relevant legislation. However, the Treasury was keen to point out that there is still a high compliance bar for participants.
For MFIs, the requirement for exchanges to have a third-party central security depository (CSD) is one of the biggest barriers to reaping the benefits of blockchain. Historically, CSDs hold securities and provide the single source of truth about who holds what security. But this is one of the points of using blockchain.
Therefore, the Treasury is considering allowing exchanges – Multilateral Trading Facilities (MTFs) – to test CSD functionality using blockchain. However, the MFI will still have to comply with the CSD regulation, although it is suitable for the DLT regulation.
Although he didn’t mention the EU’s DLT sandbox, it’s worth noting that the EU plans to allow quite substantial levels of trading with an overall limit of €6 billion for a IMF alone. The UK Treasury has said it will not allow any ladder that could pose risks to financial stability. He also wants to see business plans to either complete trials without interruption or scale beyond the sandbox.
Recognition of benefits and risks
As part of its wholesale market consultation, the benefits of DLT were summarized as providing greater market efficiency and reduced risk. Blockchain also enables improved transaction transparency and traceability, as well as greater infrastructure resilience.
Hence the risk of disrupting existing market infrastructures. In any new market there is a proliferation of services. In turn, this will likely lead to new liquidity pools, but if interoperability between liquidity pools is insufficient, blockchain could lead to market fragmentation. On top of that, there are the potential costs for existing organizations to integrate blockchain and the challenges of integrating with legacy systems.
One example (not mentioned in the report) is ASX’s rejection of the CHESS DLT implementation due to the impact of the DLT on incumbent roles and adaptation costs.
A wholesale CBDC?
The Treasury also mentioned that its consultation received several responses on the need for a wholesale central bank digital currency (CBDC). The Treasury did not comment in detail other than referring to the CBDC task force set up with the Bank of England.
However, he mentioned the new central bank omnibus bank account, allowing the private sector to provide synthetic CBDC. And a Deputy Governor of the Bank of England has already highlighted this as a reason why retail CBDC is considered a higher priority.
Finally, it was mentioned that the BIS Innovation Hub set up in London plans to explore how an RTGS payment infrastructure could be synchronized with digital asset registers.