UK advancing ‘digital securities sandbox’ keying in on crypto tech

The United Kingdom is set to implement a “digital securities sandbox” in an effort to uncover potentially needed legislative tweaks to accommodate the rise of crypto technology. 

Uncertainty around the makeup of future financial markets, as well as associated key risks, have made it difficult to put in place a proper framework ahead of time, the UK’s HM Treasury said in a report on Tuesday.

“It is important that this does not lead to inertia in the legislative and regulatory space, but to acknowledge instead that the job of re-working financial services legislation and regulation will be an ongoing process that may take many years,” the report states. 

The UK has acknowledged digital assets and distributed ledger technology (DLT) could be used by what it calls financial market infrastructures (FMIs) — networks that allow financial transactions to take place — to boost efficiency and cost effectiveness.

The country’s HM Treasury conducted a “Call for Evidence” in 2021 to examine the application of DLT and FMIs and published a response in April 2022. Findings highlighted that the UK’s legislative framework was not built to support the use of DLT, adding that testing would be needed. 

Respondents said sandboxes — “a safe space in which to experiment, learn, and in some circumstances test new technology” — could be key to achieving that goal, per HM Treasury.

How it would work

The Financial Services and Markets Act 2023, put into law this month, gives HM Treasury “sufficiently flexible” power to allow sandboxes to test different technologies and practices.

Statutory instruments — legislation that allow provisions to act without passing a new one  — put before Parliament “would provide the legal basis for each sandbox and for temporarily disapplying or modifying relevant legislation for participants,” the report says. 

Firms would be able to set up and operate FMIs using digital asset technology to perform the activities of a central securities depository and operate a trading venue.

The UK government intends to include “digital representations” — either tokenized or digitally native — of financial instruments, such as debt, equity and money market instruments in the sandbox. 

But “unbacked crypto assets” and derivatives were not initially included. 

The intent is for the digital securities issued, traded, settled and maintained within the sandbox to interact with wider financial functions, such as collateral or repurchase agreements.

HM Treasury expects to put a statutory instrument before Parliament later this year to set up the sandbox’s legal framework. 

The UK’s latest plans come a few months after the European Union passed its Markets in Crypto Assets (MiCA) regulation.

Similar sandboxes have been among the ideas floated in the US, too.

In an April white paper, Chris Perkins, a member of the CFTC Global Markets Advisory Committee, called on lawmakers to prioritize sandboxes and safe harbor programs, echoing a similar proposal from SEC Commissioner Hester Peirce.

First floated in 2021, Peirce’s “token safe harbor proposal” included a three-year grace period for developers to work on a decentralized network, exempt from registration provisions of federal securities law.

“Entrepreneurs should be encouraged to innovate thoughtfully without fear of regulatory reprisal,” Perkins told Blockworks in April. “Sandboxes allow this to happen.”

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