The DSS is now opened after consultation with industry, which closed in May 2024. In the Digital Securities Sandbox (DSS) policy statement (PS) the Bank and the FCA have set out their approach to safely adopt new technologies in the operation of financial market infrastructures. The PS is published alongside other documents, including the DSS Guidance and the relevant application form.
1.1 This joint Bank of England (the Bank) and Financial Conduct Authority (FCA) policy statement (PS) provides feedback to responses which the Bank and FCA (together ‘the regulators’) received to the Digital Securities Sandbox (DSS) joint Bank of England and FCA consultation paper (CP).footnote [1]
1.2 The DSS is the first Financial Market Infrastructure (FMI) sandbox created under the FMI sandbox powers conferred on HM Treasury (HMT) by the Financial Services and Markets Act (FSMA) 2023. FMI sandboxes allow firms to experiment with new or different practices and developing technology in the key functions of FMI.
1.3 The DSS will facilitate the use of developing technology, such as distributed ledger technology (DLT), in the issuance, trading and settlement of securities by allowing firms to operate under a temporarily modified legal and regulatory framework (‘modified framework’). As the first FMI sandbox, the DSS is also a test-case for this new form of policymaking, where regulators can observe activity and consider whether changes to rules or legislation are required to enable it.
1.4 The DSS will allow sandbox entrants to undertake the notary, maintenance and settlement activities traditionally associated with central securities depositories (CSDs) and combine these activities with the operation of a trading venue. The DSS will allow firms to trial new business models. It is important to note that DSS activity will be ‘live’ and the regulators’ intention is that the wider financial ecosystem should be able to interact with a sandbox entrant in broadly the same way they would with a traditional FMI. To protect financial stability however, limits will be placed on the value of securities issued into the DSS.
1.5 Nevertheless, persons engaging with Digital Securities Depositories (DSDs) should note that DSDs are not required to meet the same standards or requirements as a CSD. The level of service or protections offered by a DSD could therefore differ from those that a user would expect of a CSD. This is explained further in Section 7 on the Bank’s approach to supervision. Before choosing to engage with a DSD, users should take into account this difference in risk relative to equivalent services outside the DSS. Also, users of DSDs and wider market participants should expect a higher risk of failure and operational disruption relative to activity outside of the DSS. However, any broader, systemic disruption from DSS activity will be contained as long as DSDs stay within their limits and are able to appropriately manage risks created through linking into the financial system (for example through cyber contagion or knock-on impacts of asset losses). The Bank will supervise DSDs to achieve this.
1.6 Although the DSS is by its nature a temporary regime, it is the shared intention of the regulators and HMT that it should not be a bridge to nowhere. The powers in FSMA 2023 allow the government to legislate using secondary legislation to put in place a permanent regime, after reporting to Parliament. A smooth transition should be available for successful sandbox entrants into any new permanent regime introduced when the DSS closes.
1.7 The DSS is now open to applications.
1.8 This PS is being published alongside:
1.9 Links to all relevant documents are available on the DSS landing page and the DSS dashboard webpage. Also published with this PS are:
1.10 The DSS Guidance (Appendix 2) and the Bank DSS Rules instrument (Appendix 3) have been updated since the drafts were published as part of the CP to reflect the changes to policy summarised in this document.
1.11 This PS is relevant to existing Financial Market Infrastructures and prospective providers of financial market infrastructure which are interested in applying to the DSS to operate a trading venue and/or carry out other FMI activitiesfootnote [2] using developing technology such as DLT. It may also be of interest to firms which wish to engage with a sandbox entrant, such as prospective members, issuers, dealers, investors or firms seeking to offer custody services for the digital securities that are recorded, traded or settled in the DSS. Law firms and industry bodies acting on behalf of potential DSS applicants will likely also find the publication of interest. Prospective applicants to the DSS should also read the DSS Guidance and rules alongside this PS.
1.12 This PS may also be of interest to firms that provide platforms on which digital assets are being issued, and to issuers of those digital securities and digital assets. The regulators would encourage those firms to familiarise themselves with the legal requirements under UK Central Securities Depositories Regulation (CSDR) Article 3(2). Article 3(2) would apply when a transaction in transferable securities takes place on a UK trading venue or when transferable securities that are admitted for trading or traded on a UK trading venue are transferred following a financial collateral arrangement. In those cases, the requirements under UK CSDR Article 3(2) would be triggered, and those securities would need to be recorded on a CSD or on a DSD in the DSS.
1.13 The application of developing technology such as DLT could materially improve the efficiency of ‘post-trade’ processes, which remain encumbered by sequential, often manual processes that are time-consuming, costly and operationally risky. By making these processes faster and cheaper, the adoption of these technologies could, if successfully implemented, lead to material savings for financial market participants, such as pension funds, investment firms and banks. This can help to create a more efficient, competitive, and robust financial system that helps facilitate economic growth. The Bank and FCA are launching the DSS with the aim of realising that potential.
1.14 The regulators consider that these technologies could introduce novel risks. Therefore, they need to be introduced in a way that ensures that markets continue to function well, including by protecting consumers from bad conduct, protecting the integrity of the UK financial system and promoting effective competition, while also maintaining financial stability. This is consistent with the regulators’ objectives.
1.15 Recognising this, the Government and regulators have decided to explore the use of these developing technologies in the DSS first. In the CP, the regulators set out their proposals to implement and operate the DSS.
1.16 The consultation period closed on 29 May 2024 and in determining their policy, the regulators considered representations received in response to the CP. This PS sets out a summary of the proposed approach in the CP, the consultation responses, and the regulators’ joint response (‘feedback’) to responses and the changes made as a result.
1.17 The regulators received 33 responses to the CP. The names of respondents to the CP who consented to their names being published are set out at Appendix 1. We received 26 responses from respondents who did not consent to us publishing their names. The regulators also held three industry roundtable events on the DSS in April 2024.
1.18 The regulators thank respondents to the CP for the high quality of responses received and the suggested changes to our policy. The regulators consider that the level and quality of engagement from respondents has led to improvements in our approach to the DSS that will further assist the safe adoption of developing technologies in the operation of FMIs. Continued constructive engagement from a wide range of interested parties, including sandbox entrants and their clients, during the lifetime of the DSS will be critical to regulators developing a regulatory regime that is practical and effective in delivering financial stability and market integrity objectives.
1.19 Respondents generally welcomed the regulators’ proposals. Many of the respondents welcomed the collaborative approach taken by the regulators in designing the DSS, and the regulators’ commitment to innovation while protecting financial stability, market integrity and cleanliness. In particular, 20 respondents were either broadly or highly supportive of the creation of the DSS and welcomed the overall approach proposed by the regulators. No respondents explicitly disagreed with the creation of the DSS.
1.20 A number of respondents made several observations and requests for changes and for clarification in relation to the Bank DSS Rules Instrument and the DSS Guidance. Respondents also made suggestions for how the approach of the regulators with respect to the DSS could be adapted to attract more investment and to support ongoing innovation in UK financial markets. The regulators' feedback to these observations, requests and suggestions is set out in Sections 2–8 of this PS.
1.21 Respondents did not raise any Equality Act 2010 considerations.
1.22 The regulators have carefully considered the responses to the CP and made changes to the proposed policy, including to the Bank DSS Rules, in response. The PS sections below have been structured broadly in the same way as the chapters in the CP, with some areas rearranged to better respond to related issues. In carrying out their policymaking functions, the regulators have continued to pursue three overarching aims in line with their statutory objectives:
1.23 Overall, we have largely maintained the approach and guidance as consulted on in the CP. However, after consideration of the comments, suggestions and observations made by the CP respondents, the regulators made some changes to the DSS approach. These are summarised in Table A.
Scope |
|
Flexibility |
|
Proportionality |
|
Addressing other issues in rules |
|
1.24 Participants encouraged the regulators to maximise the flexibility afforded to them under the DSS framework as well as to be as transparent as possible about developments in the DSS. A high degree of transparency and clarity is critical to forming business plans and unlocking investment from private sector firms. The ability to make changes to rules to reflect the experiences of participants in the DSS and their feedback is also essential to effective regulations in the long run.
1.25 When reflecting on the suggested changes to the draft Gate 4 (end-state) rules, the Bank found that meeting the participants need for transparency and clarity can be contrary to maintaining a flexible approach to writing rules. Given that one of the main aims of the DSS is to test how existing legislation may need to change to accommodate digital asset technology and new practices associated with it, and noting feedback received in the CP responses, the Bank has decided to defer the publication of the draft Gate 4 (end-state) rules. This will allow the Bank to better understand how DSDs are operating within the DSS before considering suggested changes to the draft Gate 4 (end-state) rules. Section 2 of the PS on ‘Glidepath approach to regulating DSS entrants’ provides more information for participants on this issue.
1.26 Respondents requested access to a communications channel with the regulators to provide feedback about the DSS. The regulators will arrange roundtables to discuss significant legal and policy issues within the DSS. See ‘Transparency and communication’ in Section 7 of the PS for more information.
1.27 In the CP, the regulators said that they were working with HMT to determine whether and how the application of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) to DSS activity should be addressed. In order to facilitate activity in the DSS, HMT have decided that they intend to bring the MLRs into scope of the FMI sandbox powers in FSMA 2023 and provide a temporary exemption so that engaging in DSS activity does not in itself make a firm a cryptoasset exchange provider or a custodian wallet provider under those Regulations.
1.28 The Bank has also made amendments to the draft rules attached to the CP on the Bank’s own initiative following its review of the rules. These changes are covered in more detail in Section 6 and summarised in Table C.
1.29 The regulators have updated the DSS Guidance in line with this PS and made some clarifications, including further guidance on how the DSS will affect firms which do not enter the DSS but engage with sandbox entrants and corrected typographical errors.
2.1 The DSS responds to a desire by industry to experiment with the use of developing technology such as DLT in wholesale markets and the view expressed in response to HMT's call for evidence that the current FMI regulatory framework was not designed with the use of such technologies in mind.footnote [3] In the CP, the regulators made clear the DSS should be proportionate and flexible to accommodate a variety of business models and provide a glidepath for successful sandbox entrants to transition smoothly into operation without limits under a new permanent regime.
2.2 The regulators also set out how firms could apply to the DSS, and the different stages that successful entrants would move through, summarised in Table B. As they move through a series of gates, we expect sandbox entrants will have limits raised and be subjected to progressively higher standards applied by the Bank with respect to their DSD activities. As the DSS progresses, the regulators will work with HMT to consider what form the future regime that sandbox entrants can transition into should take. In the CP, we also stated that we would consider whether the introduction of a separate regime for non-systemic DSDs could be warranted.
2.3 The DSS Regulations have given the regulators the power to make rules applying to sandbox entrants and other persons engaging in DSS activity, but which are not themselves a sandbox entrant (see Regulation 3(4) of the DSS Regulations) as appears necessary or expedient to implement and operate the DSS.
2.4 The FCA set out in the CP that the framework governing the operation of a trading venue had not been modified for the purposes of the DSS. This was because, as HMT noted in its consultation response, feedback from industry largely did not suggest that particular changes were needed to facilitate the use of developing technology, such as DLT, by the operator of a trading venue. By maintaining the existing framework, the FCA also aims to facilitate the ability for activity in the DSS to interact as smoothly as possible with the wider financial system.
2.5 The Bank set out the proposed Gate 4 (end-state) rules to give advance notice to entities wishing to apply to the DSS and other interested market participants, of the future regulatory and supervisory standards that may be expected of DSDs who reach a systemic level of activity within the DSS. Thus, Gate 4 (end-state) rules would be applied to DSDs wishing to carry on FMI activities once they had exited the DSS. The Bank’s view was that providing advance notice of the standards that might be applied to DSDs once they exited the DSS might allow prospective DSS applicants and sandbox entrants to make the necessary adjustments to the design and build of their systems and controls to prepare for this eventuality.
Stage | Purpose | Legal designation | Criteria/applicable rules |
|---|---|---|---|
Initial application | Identify firms eligible to join the sandbox. | None | Eligibility criteria for Gate 1 (assessed via application form):
|
Gate 1: | |||
Testing stage | Testing stage and seek authorisation to operate a trading venue or to be a DSD. No live business. | Sandbox entrant. Sandbox Approval Notice (SAN) issued confirming status. | Continue to meet eligibility criteria. |
Gate 2: | |||
Go-live stage | Ability to carry out live business under initial limits. | DSD/operator of trading venue. SAN updated covering permissions and any conditions. | Gate 2 Bank rules for DSDs (assessed via Gate 2 application form). FCA requirements for operators of trading venues. |
Gate 3: | |||
Scaling stage | Scaling the business, with a glidepath to authorisation for DSDs. | DSD/operator of trading venue. SAN updated for any changes in permissions and/or conditions. | Gate 3 Bank rules for DSDs. FCA requirements for operators of trading venues apply. |
Gate 4: | |||
Operating outside DSS under new regime | Authorisation to operate outside the DSS for DSDs. | CSD/new category of FMI. | Revised CSD regime reflecting sandbox learnings or alternative regime. Bank end-state rules to provide the ‘default’ of what the revised regime could look like to provide a glidepath. |
2.6 A significant portion of the CP responses addressed the Bank’s approach to flexible rule-making in the DSS, as well as comments on the content of the draft Bank DSS rules instrument. While some respondents welcomed the consultation, they considered the current proposals did not encourage the participation of small innovative entrants.
2.7 Respondents broadly agreed with the Bank’s approach to creating Gate 2 rules, commending the balance achieved between establishing a standard of good governance, while allowing for innovation. One respondent noted that although the rules provide additional flexibility in some areas, such as allowing a single entity to operate a combined trading and settlement system within the DSS, its likeness to the existing regime means many of the existing obstacles to innovation remain. They also requested the Bank’s approach to rule-making be reactive to learnings from the sandbox.
2.8 A few respondents had concerns around the development and approach of the DSS. A couple of respondents said that the DSS is too focussed on traditional FMI structures, while some respondents said that the DSS might not offer substantially more flexibility than the existing legal framework. One respondent stated that they had concerns that a regulatory sandbox premised on existing principles of regulation can only produce change of an incremental nature, rather than transformational change.
2.9 A number of respondents discussed the so-called ‘cliff-edge risks’, arguing that while the regulators’ staged approach to the DSS (including a Scaling stage) will enable firms to develop towards operating outside the DSS under controlled circumstances, the draft end-state rules still heavily resembled the existing frameworks for established FMIs. They suggested more could be done to avoid the situation where firms utilising DLT might have to revert to a set of requirements at the end of their term in the DSS which resembles the current regulatory status quo.
2.10 The regulators also received several comments stating that the DSS proposals did not go far enough to facilitate Decentralised Finance (DeFi).
2.11 Five respondents requested clarity on the possible creation of a new permanent regime for non-systemic DSDs, while four respondents raised questions around the transition of non-systemic DSDs into systemic DSDs. There was concern that uncertainty about the form a potential permanent regime may take, specifically whether hybrid entities will still be permitted, could deter participation in those entities. One respondent also called on the government to legislate for the areas of statutory reform recommended by the Law Commission for digital assets.
2.12 Three respondents raised the application of the MLRs to DSS activity. One respondent stated that the registration requirement for cryptoasset businesses is a considerable material barrier for some innovative business models.
2.13 The regulators consider that their approach to implementing and operating the DSS will facilitate a variety of business models and encourage new entrants into the market, in line with the objectives of the DSS. Furthermore, the regulators note that a regulatory sandbox premised on existing principles of regulation can still facilitate transformational change even if the process of evolving that regulation is incremental.
2.14 The Bank acknowledges comments that the Bank DSS Rules are based on the existing regulatory framework for CSDs. Following the consultation period, the Bank has sought to make additional targeted modifications to its applicable regulatory requirements at Gate 2 where appropriate, with the objective of making these proportionate in the early stages of the DSS (Appendix 3 sets out the published Bank DSS Rules Instrument) to ensure sandbox entrants can scale their business and increase compliance incrementally to mitigate financial stability risk.
2.15 Acknowledging calls for the Bank’s approach to rule-making to be more reactive to learnings within the sandbox, the regulators recognise the importance of communication and feedback in the DSS. The regulators will, while maintaining ongoing supervisory engagement and dialogue with DSS firms as they progress through the DSS, communicate and support entrants’ efforts to move towards later stages (see Section 7 for more information on how the regulators plan to communicate with sandbox entrants).
2.16 The regulators will be receptive to issues raised by firms, and requests made to regulators to address these issues. The regulators will consider such requests on a case-by-case basis. However, there is no guarantee that the regulators will be able to remove the impediment faced by the firm. The regulators consider that it is only likely to be appropriate to use the DSS rule-making powers (such as waiving or modifying a rule) where there is a material obstacle to a firm’s business model, rather than where a firm is subject to similar requirements by different regulators, some of which are higher than others. In that case, the firm would need to satisfy the highest requirement. In this vein, one respondent suggested referring to the Bank’s Gate 2 rules as ‘minimum standards’, which we believe is an accurate representation.
2.17 As stated in the CP, the Bank’s rules at Gate 2 (applied at the Go-live stage) and Gate 3 (applied at the Scaling stage) are designed to be proportionate for DSDs and to increase towards the regulatory standards applicable to CSDs operating outside of the DSS, as activities scale up. This flexibility in approach is because DSDs will be subject to overall capacity limits for live activity, while operating within the DSS. The Bank also published draft end-state rules in Appendix B of the CP. It was proposed that the end-state rules would then apply to a DSD that has met the requirements of Gate 4 – the final gate within the DSS.
2.18 However, given that one of the main aims of the DSS is to test how existing legislation may need to change to accommodate digital asset technology and new practices associated with it and noting feedback received in the CP responses, the Bank has now decided not to publish the draft end-state rules at this juncture. The Bank is mindful that the end-state rules themselves will be modified as the DSS regime evolves, and the regulators learn about novel business models and the risks created or accentuated by them. The opportunity to observe activity will also give the Bank the chance to consider whether more material changes to the end-state regulation are necessary as compared to CSD regulations, as suggested by several respondents.
2.19 The Bank anticipates that it will publish draft Gate 3 rules, and a revised draft version of the Gate 4 (end-state) rules once the DSS has been up and running for at least 15 months). This will give the Bank and the FCA sufficient time to observe entities within the DSS, during the ‘Go-live’ stage and for the Bank to make suitable, corresponding changes to the rules. Furthermore, the Bank confirms there will be opportunities for industry engagement on DSS rules as set out at paragraph 7.50.
2.20 Notwithstanding the above, the Bank confirms that it considered consultation responses received on the Gate 4 (end-state) rules and provided its feedback (see Section 6). The Bank confirms that it will keep Gate 4 (end-state) rules under review during the lifetime of the DSS.
2.21 With regards to DeFi the regulators are sympathetic to these views and look forward to discussing proposals with a DeFi element with firms in more detail. The regulators remain open to making changes in our approach to facilitate new technologies and approaches. However, we note that certain aspects of DeFi – most notably the decentralisation of governance – pose challenges to regulatory oversight and enforceability. This is because the pseudonymous and borderless nature of DeFi makes it challenging for regulators to identify the applicable legal jurisdiction and the entities or individuals accountable for meeting regulatory obligations.
2.22 The regulators will keep under review as a key priority the question of whether a new permanent regime for non-systemic settlement activity is appropriate. DSDs may serve markets that are not systemic to the overall functioning of the financial system. The regulators will provide further communications with sufficient advance notice on what the route to exit the DSS might be like for firms deemed to be non-systemic, should the regulators decide that a non-systemic regime is justified.
2.23 The regulators acknowledge the importance of providing clarity to sandbox entrants on this question of whether or not to create a non-systemic regime as early as practicable to ensure any capital investment by firms is geared towards meeting rules and standards that will apply to them.
2.24 Please see paragraph 1.27 of Section 1 of this PS.
3.1 To determine whether an applicant is eligible to enter the DSS, the regulators set out in the CP that they will assess at Gate 1 whether the applicant meets the eligibility criteria for entry into the DSS (Gate 1 eligibility criteria) and at subsequent gates for progression into each DSS stage thereafter. The Gate 1 assessment will be carried out against the information provided in the Gate 1 DSS application form. The Gate 1 eligibility criteria, which reflect and build on the minimum requirements under the DSS Regulations, are as follows:
3.2 Six respondents queried whether only those explicitly listed in Regulation 3(2) of the DSS Regulations are eligible to apply to become a sandbox entrant. Some respondents sought clarity on the eligibility of technology providers or vendors. A number of respondents commented that requiring firms to be captured by the existing regulatory regime (or apply for the necessary permissions when entering the DSS) was prohibitive to new entrants, or non-traditional applicants (such as research institutions). One respondent stated that there is a view that the DSS is not taking advantage of the international interest in such a sandbox.
3.3 Four respondents made requests for clarity on the application of the eligibility criteria at Gate 1. One respondent suggested that instead of assessing eligibility at Gate 1, the regulators should allow entities to enter the sandbox and then apply controls, to mitigate the market dominance of incumbent firms.
3.4 Regarding the scope of assets permitted within the DSS, one respondent queried whether warrants would be permitted, while another requested that the scope of emission allowances be extended to include other types of energy certificate.
3.5 One respondent asked whether a sandbox entrant with a direct link to one or more CSDs could represent securities and cash from those linked CSDs in a DSD for the purpose of trading and settling securities, and securities financing transactions.
3.6 Two respondents queried whether the exclusion of cryptoassets from the scope of the DSS extended to their use to pay ‘gas fees’. Gas fees are the costs to conclude a transaction on some distributed ledgers and are often paid using cryptoassets.
3.7 Two other respondents also asked that the exclusion of cryptoassets be kept under review as and when they are brought within the regulatory perimeter.
3.8 One respondent enquired what the Bank’s view is on how the DSS could accommodate a digital gilt including any views on the prospect of modifications to the Government Stock Regulations. The respondent also requested that HMT (via the Debt Management Office) support the DSS by issuing a digital gilt.
3.9 One respondent made the suggestion that the role of central counterparties (CCPs) be considered in the DSS or in an alternative sandbox.
3.10 Three respondents stated that activity carried out within the DSS should not be seen as restricting the extent to which the same activity could occur outside of the DSS if the firm's business model were structured differently. Furthermore, one of these respondents asked the regulators to clarify that the operation of the DSS would not limit the scope of permissible innovation – including utilising DLT – taking place outside of the DSS. One respondent queried how to interpret the first paragraph of Article 3 in the EU CSDR – specifically the reference to ‘dematerialised form’.
3.11 While the regulators will be retaining their proposed approach to eligibility and Gate 1, we have provided clarification on the points raised by respondents.
3.12 The parameters of which firms can participate in the DSS are set out in the DSS Regulations. The regulators confirm that an entity does not need to be a firm which is already regulated, nor does it need to hold the necessary permissions for the activity it wishes to undertake in the DSS prior to application, to meet the Gate 1 requirements. Under Regulation 3(3) of the DSS Regulations the regulators have the power to allow any other person who is established in the UK to apply to become a sandbox entrant at Gate 1. The regulators have exercised this power and the DSS is open to any person where they are established in the UK as a legal entity.
3.13 Although the DSS Regulations specify that sandbox entrants must be established in the UK, the DSS Regulations do not restrict the way in which overseas firms that are clients, customers or service providers of a sandbox entrant can interact with that sandbox entrant.footnote [6]
3.14 The regulators welcome applications from a wide range of applicants. There is nothing precluding technology providers or other unregulated firms from becoming sandbox entrants, provided they meet the eligibility criteria, apply for the necessary permissions, and are willing and able to meet the relevant requirements. Firms that apply for entry to the DSS should note that they are applying to conduct regulated activities and would exit the DSS as regulated financial market infrastructure providers under a new set of permanent regulations that will be developed by the regulators.
3.15 Technology providers may also offer their services and products to sandbox entrants to help them deliver their services in the DSS. Where this is the case, technology providers would not necessarily be expected to apply for entrance to the DSS themselves. Rather, they may supply such services and products as ‘third party suppliers’. In this instance, such technology providers will not be directly supervised by the regulators. However, the required resilience and recovery standards, as set out in the DSS rules and in CSDR (where such rules are not varied in the DSS), will apply. The Bank will have a proportionate approach to regulatory assurance levels sought. The FCA’s rules on outsourcing remain unchanged for the DSS.
3.16 In the CP and the draft DSS Guidance, the regulators stated that they proposed to consider the supervisory record of applicants and any past enforcement action taken against them. This was not intended to be limited to authorised applicants and will apply to all applicants. The regulators said that, if they become aware of any adverse information, this will be taken into account and can result in the rejection of the application. Given that respondents asked for greater clarity on Gate 1 criteria, the regulators wish to clarify that they are referring to a range of potential causes of concern, such as criminal or financial sanctions, severe regulatory misconduct or other relevant adverse information which may be discovered.
3.17 The regulators may reject an application at Gate 1 on the basis of such findings if they are considered to be sufficiently material such that approving the person as a sandbox entrant would be inconsistent with the policy intent underlying the DSS. This policy intent includes protecting market integrity and financial stability, as well as facilitating innovation to promote a safe, sustainable and efficient financial system. The decision on whether to grant or reject an application at Gate 1 will ultimately turn on the specific facts and concerns identified. The regulators will take relevant information discovered through Gate 1 checks into account in determining whether the applicant is suitable to be approved as a sandbox entrant, and to what extent, to attach any scope alterations, conditions, limitations, approvals or restrictions to an applicant’s SAN. However, this is without prejudice to the regulators’ ability to consider further and, if appropriate, to modify or cancel the SAN at Gate 2 or any subsequent point in time.
3.18 While modifications to legislation are made for participating entities, the firms still need to adhere to the same regulatory requirements (except where disapplied or modified) and regulatory principles as comparable firms outside the DSS. Participating firms will be supervised by the regulators according to their respective objectives.
3.19 It is important to note that the assessments at Gate 1 and Gate 2 have different purposes and so will be different in scope, and it is envisaged that the assessment at Gate 2 will consider a broader range of information. As set out in the CP, the DSS is divided into a series of gates for sandbox entrants to move through to progress from one stage to the next, with the amount of permitted activity increasing with each stage. Success at Gate 1 does not prejudge success at Gate 2, nor should it be interpreted as the regulators’ view on the likelihood of the applicant subsequently passing Gate 2.
3.20 At Gate 2, unauthorised persons which require Part 4A permissions in order to operate their proposed DSS business model will be assessed by the FCA against the Threshold Conditions, which will include a determination of whether the applicant is a fit and proper person. For firms seeking to operate a standalone DSD, the Bank will assess applicants in line with the requirements set out in the DSS Gate 2 rules and guidance and evaluate whether they may proceed into Gate 2 based on firms’ ability to demonstrate that they are able to meet the level of assurances required at this Gate.footnote [7]
3.21 The types of instruments that may be used in connection with FMI activities in the DSS (FMI sandbox instruments) are those listed in Part 1 of Schedule 2 to the Financial Services and Markets Act 2000 (Regulated Activities Order) 2001footnote [8] (RAO) except for instruments set out in paragraphs 4–10. As such, derivatives are therefore not eligible to be considered as an FMI sandbox instrument under the DSS Regulations unless they also fall under paragraph 1 of Part I of Schedule 2 to the RAO. However, given that the categories of financial instrument are not mutually exclusive, it is the regulators’ position that tradeable instruments such as exchange tradeable derivatives, could be both a derivative and a transferable security. Instruments such as warrants may also be transferable securities.
3.22 With regard to emission allowances, the regulators’ note that they have no discretion to expand the instruments in scope of the DSS, as these are specified by the DSS Regulations, and therefore, to be eligible, instruments need to satisfy the existing definition.footnote [9]
3.23 As set out in HMT’s consultation, both digitally native and tokenised securities are in scope of the DSS. footnote [10] Tokenised securities are a digital representation of the beneficial ownership of the securities or rights to securities, where the ownership of such securities, or rights, is recorded off-ledger, whether in electronic or physical form. The regulators will discuss the detail of tokenisation proposals with each individual applicant, but do not rule out the possibility of using CSD links to deliver these services.
3.24 HMT’s consultation made clear that cryptoassets which do not qualify as financial instruments under the RAO are out of the scope of the DSS and on this basis they do not qualify as FMI sandbox instruments. The Bank’s position, set out below, is that such cryptoassets would also not be appropriate as a settlement asset on financial stability grounds. However, the regulators’ understanding is that cryptoassets used to pay gas fees would be neither an FMI sandbox instrument nor a form of settlement asset accepted as money, but rather a separate service payment (fee) which would pass between participants in the system, and that these fees are most commonly associated with permissionless ledgers.
3.25 Provided that a firm’s choice of technology satisfied the regulators’ expectations for operational and technological resilience, a firm which envisaged a tangential role for cryptoassets which do not qualify as financial instruments under the RAO would need to consider how that affects its ability to benefit from the exemption to the cryptoassets framework in the MLRs.
3.26 Should such cryptoassets be brought within the regulatory perimeter, then any consideration regarding bringing them into the scope of the DSS would ultimately reside with HMT. However, the Government’s proposal is that such cryptoassets would not be treated as financial instruments, where they would not otherwise qualify as such under the existing RAO categories.footnote [11]
3.27 The regulators note that the issuance of digital UK sovereign bonds are matters for HM Government to consider and as such the regulators can confirm that where permitted by the respondent, we have passed comments on this topic to HMT.
3.28 As stated in the CP, the focus of the DSS is on trading and settlement of securities, rather than clearing activities. Clearing activities will continue to be undertaken by CCPs outside of the DSS, and firms that wish to undertake these activities need to apply for the relevant permissions.
3.29 The regulators stated in the CP that they would require applicants to identify the regulatory or legal barriers and/or obstacles to using developing technology such as DLT which in the view of the applicant prevent them from operating their optimal business model outside of the DSS, and which would be removed or mitigated by the modified framework of the DSS. This will help focus the resources of the DSS on those business models which do need modifications and allow HMT and the regulators to better assess whether and what permanent legislative and regulatory changes are needed to allow for a more widespread safe adoption of these new practices or developing technologies. The regulators have become aware of certain use cases which it may be possible to implement in compliance with existing laws and regulations but which it may be advantageous to test within the DSS in order to observe the risks and benefits from these use cases and to consider the future regulatory and legal regime applicable to them, including where the regulatory perimeter should be set in the future. In such cases the regulators will consider applications even where the relevant activity could lawfully be carried on outside the DSS, given the existing regulatory perimeter.
3.30 As such, the regulators would like to clarify that applicants will not be required to demonstrate that their business model is not possible in any form without the modified framework of the DSS. Applicants may point to areas of legal uncertainty in the existing framework where it is difficult to ascertain whether their business model is compliant. If a firm is accepted into the DSS, it should not be interpreted as a view from the regulators that the business model is not possible to be pursued in any form under the existing framework outside the DSS.
3.31 The question of how the relevant legislation is interpreted is ultimately one for the courts to consider. However, the regulators’ view is that the legislative changes that have been made as part of the DSS do not necessarily imply that uses of DLT that were capable of being delivered prior to the DSS are affected by its implementation. Firms can continue to innovate outside the DSS, provided this can be accommodated within the existing legislative and regulatory requirements. The advantage of the DSS is that it makes it clear that firms can use developing technology inside the DSS, regardless of whether the specific way in which the technology is being applied is allowed outside the DSS. This allows for a wide range of firms and broad variety of business models to carry out the relevant activities as DSDs.
3.32 Regulators would like to clarify that Article 3(2) in the UK CSDR has been modified by the DSS regulations to include ‘recording of transferable securities using developing technologies’. Regulators would also like to clarify that, as Article 3(1) in the EU CSDR has not been onshored it is out of scope of this PS.
3.33 In the CP, the regulators acknowledged industry’s interest in fund tokenisation, which could facilitate the effectiveness of financial markets and facilitate new opportunities such as the use of certain fund units as collateral. The Bank said that they would carry out further work to assess whether and what limits are appropriate on fund tokenisation activity and how they could be applied after consulting firms on their plans. The regulators also said that they would welcome views from firms who may wish to carry out fund tokenisation within the DSS including on the potential financial stability implications of this activity.
3.34 Four respondents expressed the general view that tokenising units in money market funds (MMFs) could enable efficiencies in the financial system through their use in the global transfer of ‘value’, collateral management, transaction settlement and reducing counterparty exposure. In particular, one respondent stated that the tokenisation of qualifying MMF units could promote liquidity, reduce financial stability risk, and allow holders to significantly benefit from this increased utility. Furthermore, another respondent stated that using tokenised MMFs as collateral does not increase the risk to financial stability. The respondent was of the view that in the UK, tokenisation in this context is seen as next-generation record keeping rather than the creation of a new asset type or class.
3.35 The DSS was set up to allow for modifications to be made to the regulatory framework so that developing technologies may be tested. The regulators had previously stated that prospective participants should pay attention to UK CSDR Article 3(2), which sets out the requirement for certain transactions or transfers of transferable securities that are admitted to trading or traded on a UK trading venue to be recorded in book-entry form in a CSD. Some respondents asked for further clarity in this area.
3.36 The Bank and FCA consider that some units in collective investment undertakings (CIUs) are capable of amounting to transferable securities. As noted in paragraph 1.12, in certain cases, transferable securities would need to be recorded on a regulated CSD – or on a DSD in the DSS – to satisfy the requirements under UK CSDR Article 3(2). The Bank encourages firms engaging in fund tokenisation to familiarise themselves with these requirements and further notes that this requirement could be expanded in future to adequately capture risks to financial stability as activity evolves. As fund tokenisation starts to grow, the Bank considers that novel use cases for fund units, including their use as collateral, could greatly increase the importance of their settlement in the financial system.
3.37 The Bank and the FCA welcome fund tokenisation activity taking place in the DSS such that the risks and benefits can be observed in practice.
3.38 In the CP, the Bank stated that further work will be done to assess whether limits are appropriate on fund tokenisation activity, and if limits are appropriate, what limits should be applied and how they would be applied.
3.39 The Bank has decided that where fund tokenisation activity is taking place in the DSS, individual sandbox entrants will be subject to limits, in line with the approach to other asset classes in scope of the DSS, where firms will be allocated higher limits as they go through stages of the DSS. These will ensure that these firms can scale in a way that is consistent with safe and well-functioning markets.
3.40 However, while firm-level limits will be in place, in contrast to other asset classes, the regulators will not impose an aggregate limit on fund tokenisation activity in the DSS. The Bank does not consider that an aggregate limit will be effective at controlling aggregate risks to UK financial stability in the case of fund tokenisation given that such activity could take place outside the DSS – without any such limits applying – depending on the precise nature of the activities that firms choose to undertake.
3.41 The Bank proposes to set these firm-specific limits such that DSDs can only record the units of a fund up to a certain size, i.e. as a cap on the total Assets Under Management (AUM). That restriction will apply from Gate 2 and the AUM cap will increase as firms move through the stages of the DSS. As stated above, as fund tokenisation starts to grow, the Bank considers that novel use cases of fund units, including their use as collateral, could greatly increase the importance of their settlement in the financial system. The approach of having guardrails around firms that are facilitating that settlement activity using new technology (in a market that has the potential to rapidly become systemically important) is consistent with the way that the Bank is facilitating the use of new technology in systemically important markets such as corporate bonds.
3.42 The Bank considers that such a limit will be effective at controlling financial stability risks from any activities that firms may wish to undertake with tokenised fund units, including using them as collateral, to the extent that tokenisation is undertaken in the DSS. However, the Bank acknowledges that fund tokenisation activity could take place outside of the DSS, depending on the nature of that activity. Any activity outside of the DSS will not be subject to limits and will carry its own risks, including risks for the broader system if it scales rapidly.
3.43 In line with other assets in scope of the DSS, tokenised fund units can be used as collateral where they are compliant with the relevant agreements and regulations on collateral eligibility. The Bank considers that using tokenised fund units as collateral has the potential to bring benefits to UK financial stability by reducing some liquidity mismatch risks in stress as holders in MMFs will no longer need to redeem their MMF units for cash to post collateral. But the Bank is also mindful that risks could increase in a severe stress scenario where a MMF needs to suspend redemptions, meaning that collateral posted is not available. The Bank also encourages participants to carefully consider the risks associated with using fund units as collateral, and in particular scenarios where the fund units could rapidly become illiquid. The Bank therefore welcomes fund tokenisation activity taking place in the DSS in order to consider the risks and benefits from all potential use cases in the safe controlled environment of the DSS, including using tokenised fund units as collateral.
3.44 The Bank will informally consult the fund management industry in the coming months before calibrating and publishing these limits as soon as practicable thereafter.
3.45 In the CP, the Bank stated that it intended to limit the scope of assets in the DSS to GBP-denominated assets and for settlement to take place in GBP (pound sterling) with the intention to review this position as we learned more about the use cases applicants proposed to bring into the DSS.
3.46 Nine respondents called for the Bank to consider changing our proposal to limit the scope of assets to GBP-denominated assets and for settlement to take place in GBP. Respondents reported that widening the scope to other currencies would facilitate serving an international client base that borrows (or issues) in multiple currencies. Three respondents noted that not allowing multi-currency settlement could be a deterrent for perspective issuers interested in accessing DSS infrastructures and raising capital in other currencies on UK markets. Another respondent said that enabling non-GBP issuance within the DSS would be welcomed by most UK incorporated entities considering issuing securities via the DSS and stated that this would prove crucial to ensuring the DSS is attractive to market participants. Two respondents stated that it is currently very common for UK-based companies to raise capital in UK capital markets in currencies other than GBP.
3.47 At least three respondents noted that restricting the scope of activities in the DSS to GBP would be at odds with the current regulatory and supervisory frameworks for traditional CSDs and international CSDs (ICSDs), which permit the recording and settlement of assets dominated in multiple currencies. Another highlighted that multi-currency settlement would likely be a ‘desirable feature’ of any new emerging infrastructure model.
3.48 A respondent reported on the impact technologies such as DLT are having on existing FMIs worldwide. The respondent noted that the global cryptoasset market was ‘multi-currency by design’. Another respondent stated that exchange venues which use DLT in theory could facilitate the trading of any asset, and that for the DSS to require all trades to settle in a single currency could negatively impact best execution prices and degrade the user experience.
3.49 Finally, a respondent noted that allowing settlement in currencies such as the USD and EUR would be particularly relevant for financial instruments playing a meaningful role in today’s financial ecosystem.
3.50 We have noted industry’s feedback on currency of denomination for digital securities. The Bank will enable DSDs to settle securities denominated both in GBP and non-GBP currencies within the DSS, and for the money settlement of these securities to take place in these currencies where available. Having carefully considered the feedback, the Bank agrees with respondents that restricting activity in the DSS to GBP-denominated assets and for settlement of these assets to take place in GBP would be at odds with the current regulatory and supervisory framework for traditional CSDs (including ICSDs), both in the UK and other jurisdictions like the EU, where such FMIs are permitted to settle the cash leg of their securities transactions in multiple currencies. We note that in the UK, the only authorised domestic CSD carries out settlement of securities in multiple currencies. With an eye to overseas frameworks, we also acknowledge that two major ICSDs, authorised under the EU CSDR framework, currently support multi-currency settlement activity across a number of types of internationally traded financial instruments.
3.51 The Bank also welcomes feedback from CP respondents who noted that restricting activity to GBP-only may be misaligned with the interest of their clients, given London’s role as a leading global financial centre. We also acknowledge that UK companies are reliant on non-GBP-denominated bond markets for funding – while some of UK companies’ issuance in bond markets takes place in GBP, there is also a material level of borrowing occurring in euros (EUR) and US dollars (USD).
3.52 The Bank also understands from respondents, as well as from our own engagement with overseas authorities, that other jurisdictions that already have regimes for the trading and settlement of tokenised securities and digital bonds do not appear to have any type of currency restrictions.
3.53 Having considered responses from firms, the regulators consider that imposing currency restrictions in the DSS would place DSDs at a disadvantage relative to existing CSDs and ICSDs, essentially protecting established firms from competition, and potentially stifling innovation, which would go against one of the DSS objectives, to support innovation.
3.54 In response, the Bank intends to calculate and set limits for activity in non-sterling assets that hold an important position regarding the functioning and financial stability of the financial system. These limits will be in addition to limits published in the CP for selected sterling asset classes. We expect limits to be required for asset classes including (but not limited to) corporate bonds in EUR and USD, which as noted earlier serve as an important form of funding for some UK firms. When setting firm-specific limits for non-sterling assets, the Bank may take into account a firm’s overall limits across currencies and asset classes. These limits will be published as soon as practicable.
3.55 The regulators encourage prospective DSS participants to consider engaging with overseas regulators to ascertain that planned DSS activities that serve markets outside of the UK are compliant with regulations in those jurisdictions. The regulators may in parallel engage strategically with overseas regulators and authorities to ensure that they have no concerns around this activity.
3.56 Specifically for non-UK government bonds, the regulators will confirm that the relevant home regulator has given their consent for the proposed activity to take place before the regulators permit it in the DSS.
4.1 In the guidance document, the regulators drew attention to Article 40 of UK CSDR which sets the current requirements for payment assets in CSDs. In the interest of clarity and recognising the fact that forms of wholesale central bank money that can interact fully with DLT are not currently available, the Bank made it clear that it will allow for the use of commercial bank money with little or no credit or liquidity risk, or equivalent private forms of money, to be used as a payment asset within the DSS. While the Bank would assess this on a case-by-case basis, it also stated that it was unlikely that e-money or stablecoins not regulated by the Bank would meet the required standard. The Bank also stated that, looking ahead, it may require DSDs to provide settlement of the payment leg in central bank money.
4.2 A couple of respondents called for the Bank and FCA to consider further how to incorporate solutions for central bank money such as Real-Time Gross Settlement (RTGS), options into the DSS. Six respondents also raised the possibility of wholesale Central Bank Digital Currencies (CBDC) being used as a settlement asset, as developments take place in the UK and in other jurisdictions. Some respondents asked for more clarity on the timelines for moving to settlement in central bank money, given the Bank had communicated a preference for settlement to take place in central bank money where practicable.
4.3 At least three respondents called for the Bank to consider accepting stablecoins as a settlement asset, with one noting that restrictions around stablecoins should be considered as out-of-step with the objectives of the DSS. The same respondent stated that stablecoins are already the dominant settlement asset globally and should the DSS prevent their use, it could render the sandbox less attractive.
4.4 Another respondent stated that it was unclear as to why e-money that is permitted to be issued by credit institutions under the Electronic Money Regulations 2011footnote [12] could not be used as a settlement asset.
4.5 Respondents also provided comments in relation to the rules governing cash leg options. One respondent called for a more flexible approach to the cash leg of settlement (under article 40 and 54 of Chapter 2 of the rules (both at Gate 2 and end-state)), to allow for alternative routes to delivery versus payment (DvP) settlement that can be achieved using innovative technology and open banking services. While acknowledging the rationale underpinning existing requirements to be a type (a) or type (b) banking services provider connected to traditional financial structures, the respondent proposed that when smart contracts, standard settlement instructions (SSIs) and open banking services are combined, DvP can be similarly achieved without compromising risks or compliance considerations.
4.6 The same respondent also provided detailed comments in relation to the cash leg as currently envisaged under the Bank DSS Rules Instrument. In particular, they noted how the current provisions under Article 40.2 of Chapter 2 of the rules envisage that where (settlement via) central bank money is not practical or available, DSDs must settle the cash leg of their securities transactions via accounts opened with a credit institution with permission to accept deposits (or through its own accounts) in accordance with the provisions of Articles 54 to 60 of Chapter 2 of the rules. The respondent stated that where firms choose to utilise open banking technology, the Article 40.2 requirement to (settle via) accounts at credit institutions (or via own accounts) and related compliance with Articles 54 to Article 60 is made irrelevant.
4.7 Another respondent stated that settlement of the payment leg in their platform is automatic, with execution of transactions in digital securities such that there will be no need for cash or tokenised deposits held on general deposit with a credit institution for purposes of settlement in their platform. The same respondent stated that non-systemic DSDs may find it challenging to identify a credit institution to provide accounts for cash leg settlement given the prudential requirements imposed, and that we should seek to enable other forms of fiat cash services such as open banking in the drafting and implementation of the Gate 2 rules.
4.8 While it is appreciated that banking services used for settlement must be undertaken by firms with appropriate risk management controls, the respondent stated that the regulator’s own acknowledgment that DSDs may not become systemic during the DSS may make access to services for non-bank providers excessively costly. That is because credit institutions would be required to ringfence activities related to DSDs in a separate entity, and thus may end up charging extremely high fees or that they could decide not to provide their services to non-systemic DSDs.
4.9 Another respondent called for the Bank to clarify whether a business model whereby the DSD holds a single omnibus cash account with a credit institution and offers settlement finality, including payment of the cash leg on their DLT systems, would require the DSD to be classified as a banking services provider (BSP). It was stated that this would create concerns for prospective applicants, given the additional regulatory burden and capital requirements associated with being a BSP and the operational necessity that atomic settlement requires cash to be represented on the DLT systems.
4.10 A couple of respondents called for clarifications as to whether the Bank is proposing to relax the CSDR prohibition on comingling banking and other CSD activities only at Gate 2, where activity is subject to strict limits, or if such relaxation would also apply at Gate 3 (Scaling), arguing this had not been explicitly stated. One of the two respondents highlighted how the commingling of commercial bank activities may bring benefit if it did not also trigger the capital requirements linked to performing banking services as a commercial bank.
4.11 One respondent was concerned that firms without a permission to accept deposits could be placed at a disadvantage by the exclusion of on-chain settlement mechanism. One respondent called on the Bank to ensure DSDs can represent fiat currency held in traditional commercial or central bank accounts on the same DLT as other in-scope securities, arguing this would enable real-time atomic settlement and maintain the credit and liquidity risk mitigation benefits inherent to DLT systems.
4.12 The regulator understands that the industry would welcome more certainty around what the Bank's expectations are regarding settlement solutions for the payments leg as applicants progress through stages and they would like detail around how it will assess specific risks in relation to the use of both commercial bank money and central bank money.
4.13 We welcome feedback on incorporating solutions for central bank money settlement. The Bank has recently published a detailed Discussion Paper setting out our payments’ strategy called The Bank of England’s approach to innovation in money and payments. As noted in the Discussion Paper (DP), the settlement of wholesale transactions is important to the Bank’s financial and monetary stability objectives, and the Bank has indicated publicly that we have a low appetite for a shift away from current levels of settlement in central bank money to private forms of money.
4.14 Accordingly, the Bank is working to offer a more accessible, functional and resilient platform for the settlement in central bank money through ongoing work to renew our RTGS system. We have already introduced omnibus accounts to facilitate innovative settlement backed in central bank money. As part of the future roadmap for RTGS, we are now also working with the industry to design a synchronisation functionality, which would allow RTGS to support safe settlement of transactions involving digital assets.
4.15 The Bank’s approach to innovation in money and payments DP has also proposed a programme of experiments with so-called ‘wholesale central bank digital currency’ (wholesale CBDC) technologies. If the Bank were to launch any such pilots, we intend for firms participating in the DSS to be able to participate where practical. We are also supportive of firms participating in experiments in digital central bank money in other jurisdictions, for example some of the cross-border Bank for International Settlements projects.
4.16 Nonetheless, we recognise that the Bank has not yet finalised our future vision for the provision of central bank money settlement in GBP. The Bank is not ruling out transitioning to mandated use of central bank money to settle certain transactions at some point, as stated in the guidance document. However, frameworks underpinning the domestic and international regulation of forms of money are still developing to embrace digitisation and given that operational lead times for transitioning to a new settlement asset can be long, we do not believe it is appropriate at this time to set any firm timeline for mandating a requirement for the use of central bank money for activity in the DSS. Additionally, the Bank would like to reassure prospective participants in the DSS that it would engage extensively with the industry before any decision to mandate a move to central bank money. Any such transition will be proportionate, well signposted with sufficient time for adoption, and in-line with the wider payments’ strategy of the Bank (taking into consideration the wider UK Government’s National Payments Vision).
4.17 While the Bank acknowledges the feedback on the use of stablecoins and e-money as settlement assets in the DSS, it currently believes there are significant financial stability risks around wholesale use of new private forms of money alongside some of the identified benefits, as has been discussed in more detail in the Bank’s DP on its approach to innovation in money and payments. Settlement assets are assets used to complete transactions, and confidence in them is crucial for any transactions to take place. As such, settlement assets should have minimal credit and liquidity risks, and should adhere to the principle of ‘singleness of money’ whereby all different forms of money must be exchangeable with each other at par value at all times.
4.18 With regards to stablecoins, the Bank considers that there are significant financial stability risks from the use of stablecoins for wholesale transactions. Even if stablecoins are backed with central bank deposits, there are risks associated with a stablecoin having an unstable value – which contravenes the principle of singleness of money and creates credit and liquidity risk for the stablecoin. For example, these could arise from operational risks or an imbalance between the supply and the demand for stablecoins, including if financial market participants run to this new low-risk asset at times of stress. If the value of stablecoins were to deviate from par, this would compromise their acceptance as a settlement asset and could have broader consequences for trust in money. These risks are particularly acute in wholesale markets given their systemic nature and could have financial stability implications. The Bank will monitor developments in the use of stablecoins, including the extent to which the risks outlined above might be mitigated.
4.19 The Bank continues to consider that e-money and other money-like assets that are used for payments do not meet the standards required (specifically in relation to credit and liquidity risk) to be used as a settlement asset. While some of these are regulated to support a stable value, issuers are subject to different regulatory standards from commercial banks. This increases the risk of e-money having unstable value, or for confidence in e-money to fall.
4.20 Given these risks, at present the Bank will not allow stablecoins or e-money to be used for money settlement in the DSS for any currency.
4.21 The Bank acknowledges the need for DSDs to access commercial bank money solutions as a settlement asset, including in relation to our decision to extend the DSS to incorporate non-GBP denominated securities. In the Gate 2 rules for the DSS, we removed some restrictions on the provision of banking services that DSDs can use. Existing credit institutions with the relevant Part 4A permissions under the Financial Services and Markets Act 2000 (FSMA) can enter the DSS to carry out ancillary banking activity without having to separate their DSD activity from their existing operations. To ensure a level playing field for all DSD operators, the Gate 2 rules also allow for a bank with the relevant Part 4A permissions to provide ancillary banking services to a third-party DSD operator in the Sandbox, without having to separate these activities from their existing operations. In both cases, this is subject to the bank meeting the prudential and capital requirements within the DSS rules and will be subject to a supervisory decision that will be noted in the SAN of the DSD operator.
4.22 We welcome calls from respondents relating to clarifying whether the Bank is only relaxing the CSDR prohibition on comingling banking and other CSD activities requirements at Gate 2, where activity is subject to strict limits, or if such relaxation would also apply at later stages of the DSS (eg, Gate 3). The Bank anticipates that we would allow this comingling throughout the DSS, including at Gate 2 and Gate 3, but firms should prepare themselves to operate under a future permanent settlement regime where this relaxation will not be permitted. The regulators will host regular roundtables with sandbox entrants to ensure industry can discuss and are sighted on key positions on the end-state regimes given that they could impact on firms’ business models.
4.23 In response to feedback asking for further clarity on how a DSD would interact with a credit institution in order to provide settlement solutions for the payments leg to its clients, the regulators note that specific permissions under part 4A of FSMA are required to take deposits or undertake payments. Without such permissions in place, we would expect a DSD to partner with or use the services of a commercial bank with those appropriate permissions to hold its members’ cash balances and effect payments. The regulators recognise that this may make it difficult for DSDs to offer the settlement of cash and assets on a single ledger but consider that activities such as deposit-taking and payments should continue to be provided only by banks that are required to meet high prudential standards appropriate for those activities. Any third-party provider of banking services would need to liaise with the PRA to ensure these standards were being met though the provision of the additional activity.
4.24 To clarify this further, the Bank has of its own initiative made targeted changes to DSS Rules based on Article 54 of UK CSDR so that it requires the DSD to be a credit institution with permission to accept deposits under Part 4A of FSMA and have the relevant permissions to carry on any other regulated activity for both the core settlement service in relation to the payments leg and also to provide the other ancillary banking services. We have also removed the threshold condition at Article 54.5, so that the requirements of Article 54.4 apply in relation to the use of a credit institution by a DSD to settle the payments leg or otherwise provide banking-type ancillary services regardless of the total value of settlement that takes place through accounts with other credit institutions.
4.25 However, the Bank is committed to ensuring that DSS entrants experiment with innovative solutions to the cash leg provided it meets the singleness of money principle. The Bank notes it has powers to waive the rules and grant exemptions to entrants where appropriate.
4.26 The Bank has amended article 40 to make it easier to understand but does not deem it necessary to make further changes to Article 40 at this stage.
5.1 The Bank proposed overall DSS-wide capacity limits for the settlement of selected sterling asset classes in the DSS, and proposals for how this capacity would be allocated to firms. The Bank stated that trading and settlement for other asset classes will also be possible in the DSS, but any limits on either the overall capacity of settlement, or at an individual firm level for such assets, would require further discussion with applicant firms on the detail of their proposals and potential impact to financial stability.
5.2 The majority of respondents supported having aggregate capacity limits for the DSS as a whole. However, one respondent raised the concern that the DSS seemed to be designed to guide participants to commit to one key asset class upon entry into the sandbox and for its entire duration. Eight respondents stated that the proposed Go-live limits lacked flexibility or were too low. These respondents expressed concern that they might reach their limit with a single, possibly even first, issuance, and that there was a lack of flexibility in the limits, particularly with regard to the long wait for the Gate 3 review point for an uplift in limits. Respondents thought this concern was particularly pronounced for the limits relating to gilts. One respondent also requested clarification as to whether the limits for corporate bonds included bonds issued by financial institutions. Another respondent also encouraged greater clarity on the extent to which limits would apply to other securities activities and to third parties of DSDs.
5.3 The Bank will maintain the aggregate limits (capacity) in key sterling asset classes published in the CP and will retain the commitment to review these limits over the term of the DSS. The Bank will also continue to apportion capacity between firms in the DSS.
5.4 Consistent with the feedback received, the Bank recognises that a rigid ‘Go-live’ limit at Gate 2 may significantly constrain firms’ ability to grow their business gradually and could therefore make planning and investment difficult for potential entrants. Consequently, the Bank is introducing flexibility for firms to be granted some uplift to limits within the Go-live stage of the DSS should they reach their initial Gate 2 limit before application windows for Gate 3 have opened. The lower bound of these ranges will be the previously communicated Gate 2 limit, but firms may be able to have limits higher than this before a Gate 3 assessment. For gilts and Sterling corporate bonds, these ranges will be as follows:
5.5 Uplifts to limits will also be possible for other asset classes such as commercial paper and certificates of deposit, but the Bank is not setting out a range for those as multiple median-sized issuances are already possible within the initial limit.
5.6 After passing Gate 2, uplifts to limits within the Go-live stage will be granted provided that:
5.7 Uplifts to limits will be an operational decision made by the Bank based on current and projected capacity utilisation within a given asset class. One consequence of granting uplifts to certain sandbox entrants means that firms within the Go-live stage may face different firm-specific limits at any given time in practice, despite meeting the same set of requirements. These limits will be set out in their SANs. The Bank recognises that this is a departure from the approach set out in the CP, but judges that this change is justified to respond to the feedback from the industry. The Bank also considered the alternative of granting any uplift in limits to all firms at the Go-live stage but concluded that this approach could end up allocating extra capacity to firms who do not need it, and consequently unduly constrain the ability of some firms to grow their business meaningfully at later stages of the DSS.
5.8 Firms can still expect a limit increase at Gate 3, when they can demonstrate that they meet higher regulatory requirements (known as the ‘Gate 3 requirements’).
5.9 The Bank confirms that DSDs can provide services in relation to multiple asset classes. After their initial approval as a DSD, a firm would be able to operate in additional asset classes by seeking a change to their SAN. In general, the limits that apply to their activity will be in accordance with the stage of the DSS at which they are operating within. For example, if a firm has passed Gate 3 and expands to support a new asset class, the limits applied would correspond to those limits for a firm in the Scaling stage. However, where a firm launches a new business line that does not meet the required regulatory standard in comparison to its peers in the same stage it is unlikely (eg due to less developed systems and controls) the Bank will increase its limits. We also confirm that limits for a given asset class apply to all issuances or assets, including those issued by financial institutions, unless a subset is specifically indicated (for example, the equities limit only applies to FTSE350 shares).
5.10 We are not setting limits on specific trade lifecycle activities. This will enable the pool of assets to be utilised in a similar way to non-DSS assets, for example allowing DSS assets to be utilised as collateral.
5.11 In the CP and draft DSS Guidance, the Bank stated that it would hold two review points in the DSS for DSDs to demonstrate they meet Gate 3 requirements. These review points would be when firms would be able to progress from the Go-live stage of the DSS to the Scaling stage, at which point they would be allocated an uplift in limits. The review points were set to ensure that the overall limits in the DSS (in the asset classes for which they have been set) were allocated to firms in a fair and prudent way.
5.12 Six respondents commented on the fixed review points as part of the approach for capacity management, specifically how the proposal would slow the progress of a sandbox entrant through the DSS. Of those, all called for as much flexibility as possible for when a sandbox entrant might be able to apply to move through Gate 3 and access increased limits to facilitate efficient scaling. One respondent referred to the ‘lengthy period’ that a successful early participant would face for an opportunity to scale given that the first available Gate 3 review window would be 12–15 months after the first Gate 2 assessments (approximately 15–18 months after the DSS launch). Another respondent added that the small Go-live limits paired with the wait between Gate 2 and 3 would be particularly damaging to start-up companies who need to ‘strike while the iron is hot’ to make the most of potential market participants’ excitement at the early success of a business model’s returns.
5.13 The Bank understands respondents’ concerns about how the proposed approach to fixed review points for Gate 3 assessments might contribute to slowing the progress of sandbox entrants through the DSS. As set out in in both the CP and the draft DSS Guidance, the fixed review points are the best way for the Bank to allocate the overall capacity of the DSS fairly among sandbox entrants. As such, there is no plan to alter this approach to assessment. However, the Bank retains flexibility over the timing of the review points such that the timing of these is guided in part by firm readiness and the speed at which firms scale in the DSS. The timings for the Gate 3 windows should therefore only be seen as indicative.
5.14 In addition, the Bank recognises that holding two review points in the DSS for DSDs to demonstrate they meet Gate 3 requirements may not be sufficient and may unduly hold some firms back. Consequently, the Bank has decided to add another optional review point – depending on whether it is necessary – to prevent firms that miss the first Gate 3 assessments having a long wait to progress. This will also ensure that the overall limits in the DSS (in the asset classes for which they have been set) are allocated to firms in a fair and prudent way. This assessment will take place approximately midway between the two previously proposed dates, contingent on both sufficient demand and capacity to assess the firms.
6.1 This section summarises responses received on the draft DSS Rules, and the regulators’ feedback to them, except for responses to rules that were already considered in previous sections (eg Section 4 on cash settlement).
6.2 The CP proposed that a sandbox entrant is approved by the Bank as a DSD after passing Gate 2. The Bank explained that at this point a DSD will not be subject to the full set of requirements in unmodified CSDR nor the full end-state Bank rules but to the Gate 2 requirements, reflecting the risks posed by firms during this stage and the limits they are operating under.
6.3 The FCA proposed in the CP to maintain the existing framework which governs the operation of a trading venue. Consequently, the FCA did not propose to make or modify any rules for the DSS.
6.4 The Bank has used its flexible rulemaking powers to create the draft Bank’s DSS Rules Instrument which we consulted on alongside other elements of the DSS in the CP. We set out below the summary of feedback and our response. Please refer to Appendix 3 for the published Bank DSS Rules Instrument.
6.5 Respondents provided comments on the content of the Gate 2 rules further to those set out in the ‘Flexibility of rule-making’ section in Section 2 at paragraphs 2.6.
6.6 One respondent queried whether the regulators intended to monitor and provide sufficient visibility to other market participants of any issues reported by a DSD or exchange, and whether downstream participants would receive reassurances on whether a particular platform may have encountered issues prior to engagement.
6.7 Two respondents called for clarity on the interaction between the Uncertificated Securities Regulations 2001.footnote [13] (USRs) and the DSS frameworks, questioning whether the provisions incorporated from UK CSDR, in particular Articles 34 and 49, are intended to supersede those incorporated from the USRs in the case of a conflict. They suggest that if the UK CSDR provisions are to supersede the USRs, then this would be at odds with the stated objective to achieve the same regulatory outcome in the Sandbox.
6.8 Two respondents queried whether the DSS rules relating to the USRs would support the use of DLT and suggested amendments to ensure this. They recommended removing the reference to computers to ensure technology neutrality, clarifying that a ledger could satisfy register requirements, and accommodating corrections to the register through rectification in a ledger.
6.9 A respondent asked whether there is a regulatory and supervisory vacuum by disapplying and not replicating articles 62, 64-66 of the UK CSDR relating to enforcement actions and whistleblowing provisions in the Gate 2 and the end-state rules.
6.10 Another respondent stated that the requirement to operate a DSD Link under Bank DSS Rules Article 48.6 on a DvP basis may be incompatible with their business model. They noted how securities which are represented in other CSDs and which are linked to a DSD may not necessarily require a DvP transaction to be immobilised in those CSDs so that they may be admitted for book entry in a DSD. They noted also that this process could be considered a free of payment (FOP) book entry in the linked CSD, leading to the creation of an entry in the DSD without a corresponding or required cash leg.
6.11 A respondent said that while the CP did define DSD links and provide extensive details on the operational and risk management aspects of DSD links, it was unclear whether a hybrid entity with a direct link to one or more other CSDs could represent securities and cash from those linked CSDs on the same DSD exchange venue ledger for the purpose of trading and securities financing transactions (SFT).
6.12 While respondents to the CP did not in general disagree with the decision to maintain the existing trading venue framework (to note, timelines for authorisation are considered separately in Section 7), some respondents requested clarification of how it would apply to the DSS in certain areas, while others made suggestions on how the FCA could better accommodate the issuance and trading of digital securities.
6.13 Three respondents asked for clarity around custody arrangements for digital securities and private key management, with one respondent stating that a proportionate technology-neutral principles-based approach would be welcomed by industry. Another respondent called for clear guidance on the acceptability of private key management practices, including self-custody, unhosted wallet software, smart contract wallets, and multi-signature wallets.
6.14 One respondent said that the DSS should explore alternatives to traditional bid/ask frameworks, such as automated market makers (AMMs) and liquidity pools, arguing that they can enhance liquidity and market efficiency. While the respondent’s view was that the current framework does not explicitly prevent such models, they stated there is a lack of guidance or encouragement for exploring these.
6.15 Two firms asked for confirmation from the regulators that the use of smart contracts is permitted in the DSS, while one respondent asked for the regulators to clarify that proxy appointment through tokenised shareholder voting, referred to as tokenised proxy voting, is acceptable.
6.16 If a particular platform is encountering issues prior to engagement, depending on the nature and severity of these issues it would be for the platform to decide how and when to communicate the issues to their downstream participants and the wider market. It is not the Bank’s role to provide market-wide communications in the event of a firm incident in the DSS. The primary responsibility of timely and transparent communications would rest with the firm experiencing the issue. The Bank expects participants to carry out their own due diligence before engaging with a DSD. However, as part of its supervisory oversight of firms in the DSS, the Bank expects DSDs to provide notice to the Bank of any significant operational incidents that occur in the DSS.
6.17 The Bank confirms that the DSS provisions related to the USRs in the DSS Regulations and Bank DSS Rules Instrument interact with the rules on the subject matter of the CSDR in the same way as the USRs interact with the UK CSDR outside of the DSS. To extent that this causes a conflict, the Bank will consider using its powers under the DSS Regulations and/or propose amendments to the DSS Regulations to HMT to act to resolve the conflict for the purposes of the DSS. On removing the reference to computers to ensure technology neutrality, clarifying that a ledger could satisfy register requirements, and accommodating corrections to the register through rectification in a ledger. The Bank is committed to supporting the use of developing technologies in the DSS and has amended the rules to address these issues. The FCA has clarified in the published DSS Guidance that the DSS Regulations modified the USRs so that a DSD could be also a relevant system under those Regulations and, consequently, persons seeking to engage with a DSD should note that the scope of the regulated activities relating to sending dematerialised instructions is wider in the context of the DSS.
6.18 Where an issue arises with the compatibility of a DSS rule and technology, the appropriate regulator may modify or waive the DSS rule (Regulation 7(5) of the DSS Regulations). The regulators encourage sandbox entrants to promptly raise their requests for such a modification or waiver.
6.19 The Bank welcomes requests for clarity by respondents as to whether there may be a regulatory and supervisory vacuum via disapplying and not replacing several provisions of the UK CSDR relating to enforcement actions and whistleblowing in the Gate 2 and end-state rules. The Bank confirms that in relation to articles 62, 64 and 66 of UK CSDR no regulatory vacuum has been created by the DSS Regulations disapplying these provisions. This is because the DSS Regulations also modify and apply provisions within FSMA 2000 (DSS FSMA) that give the Bank (and the FCA) appropriate oversight and enforcement powers over DSDs and members of the DSD management body.
6.20 The Bank agrees that the article 65 of the UK CSDR setting out whistleblowing provisions (such as establishing effective mechanisms to encourage reporting of potential or actual infringements), should be reapplied. Where permitted by the respondent, we have passed comments on this topic to HMT.
6.21 The Bank acknowledge concerns around whether operating a DSD Link on DvP basis may be incompatible with some business models, on the basis that securities represented in CSDs linked to a DSD may not necessarily require a DvP transaction to be immobilised in another DSD or CSD, so that they may be admitted for book entry in a DSD. The Bank can confirm that that Article 48(7) of Chapter 2 of the rules does not prohibit Free of Payment (FOP) transfers – it does not require DvP settlement of intermediate transactions which facilitate transactions between participants, rather it stipulates that DvP settlement of transactions between participants must be possible.
6.22 On grounds of proportionality, the Bank has decided to remove detailed provisions relating to the use of bank guarantees and letters of credit used to secure DSD links that were based on provisions in Commission Delegated Regulation (EU) 2017/390. Instead, the Bank is relying on the high-level provisions in Article 48 of Chapter 2 of the Gate 2 rules. The Bank believes this will make it easier for the industry to understand and use the Bank DSS Rules Instrument. The Bank will maintain the optionality of utilising the SAN on a bespoke basis to address issues.
6.23 We welcome feedback from respondents seeking clarity as to whether a hybrid entity with a direct link to one or more other CSDs could represent securities and cash from those linked CSDs on the same DSD exchange venue ledger for the purpose of trading and securities financing transactions (SFT). The Bank can confirm that Article 48 Chapter 2 of the Bank DSS Rules Instrument on DSD links relate to the linking of securities settlement systems rather than trading systems. Nevertheless, assuming that the security is immobilised in the original CSD, there would seem to be nothing that would prevent a hybrid DSD entity with a direct link to one or more CSDs from offering trading in securities settled on those CSDs (and settling resulting transactions via the link), or from settling via the link SFTs where the underlying securities are settled on the linked CSDs.
6.24 The Bank has made some own-initiative changes to the rules. These include a change to the provisions in Chapter 3 replicating technical standards, which were proposed to be made using the technical standards power in Regulation 8 of the DSS Regulations. The provisions in Chapter 3 will be made as rules using the power in Regulation 7 of the DSS Regulations, so that the provisions can be waived or modified using the power in that regulation (as there is no equivalent power in relation to the technical standards).
6.25 Also, the Bank has amended Article 19.1 of Chapter 2 so that, if a firm wants to provide an ancillary service to core services other than those permitted under Section B (Non-banking type ancillary services that do not entail credit or liquidity risks) of Chapter 4, it must request a variation of its SAN, as this was not required by the previous drafting.
6.26 Further own-initiative changes to the rules related to Articles 40 and 54 of the DSS Rules are covered in Section 4.
6.27 In addition, the Bank has made some minor changes to make the rules easier to understand and to align more closely with the scope of the rule-making power. The Bank does not think these changes are significantly different to the CP version of the rules.
Changes made to the DSS Bank Rules Instrument
Article | Changes to the DSS Bank Rules Instrument post consultation and rationale | Own initiative changes or response to feedback | Paragraph of policy statement |
|---|---|---|---|
Article 19 (Extension and outsourcing of activities and services) of Chapter 2 | We have amended Article 19.1 so that, if a firm wants to provide any ancillary FMI activity (as defined in the DSS Regulations), it must request a variation of its SAN, as this was not required by the previous drafting.
| Own initiative. | 6.27 |
Article 39 (Settlement finality) of Chapter 2 | We have amended this article to clarify that ‘adequate protection’ to participants in any securities settlement system that a DSD operates can include protection by contractual arrangements. This is so that it is clear that, for the purposes of the DSS Bank rules, adequate protection can be provided by contractual means in the absence of Settlement Finality Regulations designation by DSDs. | Response to feedback. | 8.10 |
Article 40 (Cash settlement) of Chapter 2 | We have amended the provision to make it easier to understand. The revised provision makes it clear that for transactions denominated in pounds sterling, a DSD must settle the cash payments of any securities settlement system it operates through accounts opened with the Bank of England, where practical and available.
Where it is not practical and available to settle in pounds sterling with the Bank of England or for transactions denominated in any currency other than sterling, a DSD may offer to settle the cash payments for any securities settlement system it operates through accounts opened with a credit institution with permission to accept deposits under Part 4A of FSMA 2000, or through its own accounts if the DSD complies with articles 54 to 60 of Chapter 2. | Own initiative. | 4.23 |
Article 47 (Capital Requirements) of Chapter 2 | We have reduced a DSD’s minimum capital requirement to 6 months of operating expenses from the original proposal of 9 months of operating expenses. | Response to feedback. | 7.8 |
Article 54 (Conditions for providing banking-type ancillary services) of Chapter 2 | We have amended article 54.3(a) so that it requires the DSD to be a credit institution with permission to accept deposits under Part 4A of FSMA and have other relevant permissions to carry on any other regulated activity for both the core cash settlement service and also to provide the other ancillary banking services. This is to clarify that the provision of cash settlement services, which involves taking deposits, can only be performed by a bank and not by a firm that has other permissions under Part 4A of FSMA. The regulators consider that activities such as deposit-taking and payments should continue to be provided only by banks that are required to meet high prudential standards appropriate for those activities. We have also removed the exemption at Article 54.5, so that the requirements of Article 54.4 in relation to the use of a credit institution by a DSD to settle the cash leg or otherwise provide banking-type ancillary services apply regardless of the total value of cash settlement that takes place through accounts with other credit institutions. While this minimum threshold may be sensible for established FMIs, it may introduce a loophole that allows DSDs to bypass the requirements that must be met for a credit institution to be used for cash settlement. | Own initiative. | 4.21 |
DSD links (provisions based on technical standards) in Chapter 3 | We have removed detailed provisions relating to the use of bank guarantees and letters of credit used to secure DSD links that were based on provisions in Commission Delegated Regulation (EU) 2017/390 and instead we are relying on the high-level provisions in article 48 of Chapter 2. This is designed to make the provisions relating to DSD links in the Bank DSS Rules Instrument easier to understand and navigate. | Own initiative. | 6.23–6.25 |
Chapter 3 Technical Standards | We have amended the provisions in Chapter 3 that are based on provisions in Commission Delegated Regulation (EU) No 2017/390 on DSD so that these are now made as rules using the power in regulation 7 of the DSS Regulations (as opposed to technical standards under the power in regulation 8). This is so that the provisions can be waived or modified using the power in regulation 7, as the Sandbox develops. | Own initiative. | 6.26 |
6.28 With regards to custody, the FCA intends to consult separately on the application of the custody framework to cryptoassets, which could include some digital securities. In the meantime, firms which safeguard and administer digital securities in scope of the DSS will need to comply with the current regulatory framework in CASS.
6.29 With regards to alternatives to traditional bid/ask frameworks, given that the trading venue framework remains unchanged for the DSS, the FCA does not consider the permissibility of such a system to be a question specific to the DSS. As such, firms are advised to seek their own legal advice on how their proposed business model would fit into the existing framework.
6.30 With regards to the use of smart contracts, these could be used in a broad set of circumstances and a firm would need to consider how its proposed use case fits into the current framework, seeking its own legal advice where appropriate. However, if a firm considers that there are any specific FCA requirements that would be an obstacle to the use of smart contracts in the DSS, then it invites them to raise this during the application process.
6.31 With regards to tokenised proxy voting, the FCA does not consider this question to be specific to the DSS, noting that the DSS Regulations did not modify any requirements in the Companies Act 2006 relating to shareholder voting. However, firms wishing to use this function in the DSS may need to seek advice on how their proposed model fits into the existing framework.
6.32 The regulators and HMT, having learned from the activity in the DSS, intend to create a new permanent regime for settlement if this is considered appropriate.footnote [14] The CP included the draft Bank’s DSS rules instrument which set out the anticipated end-state rules (in Annex B) of such a possible new permanent regime to help firms to understand what requirements that is likely to entail.
6.33 Respondents also provided comments on the end-state rules.
6.34 One respondent queried whether the Bank should remove all references to SAN in the end-state rules on the basis that the SAN – will act as a ‘visa’ for firms participating in the DSS by specifying which set of rules apply to DSDs at a given point in time alongside any waivers granted by the Bank – should cease to play a role at the point of firms transitioning to the end-state regime.
6.35 The respondent also queried why, given the DSS allows firms to consolidate trade and post-trading functions within the same entity, Article 34 of Chapter 2 (Transparency) of Annex B (end-state rules) still assumes that each aspect of CSD activity in the traditional sense ought to be disaggregated and priced separately. The same respondent called for flexibility to be introduced here so that where services cannot be so disaggregated, the firm is permitted to publicly disclose the prices and fees associated with each of its services that is offered as a stand-alone service to one or more platform users.
6.36 The same respondent stated that in the context of platforms that seek to take advantage of the many benefits that (modified) decentralisation can offer, requirements for a more traditional approach to user committees could disenfranchise platform participants and inhibit UK financial services from the benefits offered by this aspect of DLT innovation. Similarly, they also stated that as models for decentralisation become prevalent, it may become possible for non-executive members of the management body of the DSD to be drawn from the platform participant community, provided that such members meet the suitability requirement.
6.37 Another respondent queried whether a DSD might be treated as a critical third party (CTP) under the proposed new regime for CTPs.
6.38 One respondent called for changes to end-state rules relating to Article 35, on the basis that the DSS Regulations include a modification to the CSDR definition of international open communication procedures and standards, and that – should this not be made permanent – by HMT then the Bank rules should be adapted to include this modification for end-state DSDs. Another respondent stated that the regulators should propose a standard for 24/7 DSD exchange venues, such as defining ‘close’ as 11:59:59pm and ‘open’ as 12:00:00am. The same respondent was of the view that standardisation will ensure consistency in reconciliation procedures and better align regulatory requirements with the operational realities of DLT business day definitions.
6.39 The same respondent also stated that Article 37.1 (Integrity of the issue) at both Gate 2 and end-state still assume a reconciliation process which, in the case of DLT-native assets, is an oxymoron because the ledger is the record of accounts and so there is no other record against which to reconcile.
6.40 A respondent stated that Article 38 of Chapter 2 (Protection of securities of participants and those of their clients) both at Gate 2 and end-state, appears to contemplate traditional off-chain securities accounts that enable omnibus client segregation. This is typically effected by appropriate naming of the securities account as well as the account-holder maintaining a separate record of the entitlements of the underlying clients to the securities recorded against that account. The account-holder has a reconciliation obligation against the securities account on the one hand and their own underlying records on the other hand. The respondent stated the article should be drafted and interpreted in a way that acknowledges that where digital assets are registered to a single participant wallet, if that participant holds those digital assets on an omnibus basis for multiple of its underlying clients, it is the obligation of the participant to hold its own records as to the entitlements of the underlying clients.
6.41 The Bank affirms the end-state rules will need to be periodically updated as the DSS progresses and matures, and as lessons are learned about risks that arise from developing technologies for in scope DSS activities and services. The Bank commits to reviewing the end-state rules over the term of the DSS. As explained in Sections 1 and 2, we have decided not to publish the revised version of the draft end-state rules alongside the PS. Instead, the Bank will publish the draft end-state rules once it has observed activity in the PS and can consider the above suggestions from firms in the context of those observations. The Bank will engage and request feedback from sandbox entrants, DSDs and other industry participants to draw on their experience and revise the end-state rules accordingly.
6.42 The Bank confirms that the SAN shall cease to be relevant when a DSD exits the DSS. However, for the duration of the sandbox entrants or DSD’s participation in the DSS, the SAN will set out the extent to which the firm is approved to operate in the DSS on the Bank’s website. Where a SAN has been withdrawn or amended it will be marked so on the Bank’s website.
6.43 The Bank agrees that Article 34 of Chapter 2 as currently drafted still assumes that each aspect of CSD activity in the traditional sense ought to be disaggregated and priced separately, and that this is not in line with the expectations that hybrid entities graduating from the DSS will not necessarily be able to disaggregate prices and services. The Bank will review Article 34 of Chapter 2 and incorporate changes to it in the revised end-state rules as the DSS develops.
6.44 The Bank acknowledges comments from respondents who note that we should change our requirements for a more traditional approach to user committees in a DLT context and to – for example – enable non-executive members of the management body of the DSD to be drawn from the platform participant community, provided that such members meet the suitability requirement. While the Bank agree in principle there could be changes to such requirements, it would prefer to see live activity in the DSS and learn what risks and opportunities may arise before incorporating these changes.
6.45 The regulators can confirm that it is unlikely a DSD would be designated a CTP on the basis that firms which are already regulated under a regime designed to deliver similar outcomes to the CTP regime would not normally be designated as CTPs.
6.46 The Bank welcomes comments from respondents around changes to end-state rules on international open communication procedures and standards, including for messaging and business day obligations, but it deems these should be contemplated after live activity in the DSS has commenced and the Bank has had the opportunity to observe and understand DSS business models and their procedures.
6.47 The Bank does not consider it necessary to confirm a change to the rules at this stage as they pertain to Article 37.1 of Chapter 2 (integrity of the issue). The Bank will engage with firms as they progress through the DSS and may make use of its DSS powers to accommodate different business models. The Bank will also consider whether to amend the end-state rules on this issue.
6.48 The Bank welcomes comments from respondents around the drafting of Article 38 on the protection of securities of participants and their clients. While the Bank agrees that – based on the respondent’s comment – where digital securities are registered to a single participant, and if that participant holds those digital securities on an omnibus basis for multiple underlying clients, it would appear that it is the obligation of the participant to keep its own records as to the entitlements of the underlying clients. The Bank has decided not to change the drafting of the rules until the DSS is open to applications, it confirms it will be able to utilise DSS powers to issue a waiver where deemed appropriate. This may include cases where the particular business model of a DSD means that the requirement would be unduly burdensome and is not needed to protect the securities or participants and their clients.
7.1 The Bank proposed to keep the end-state rules for capital in line with current Article 47 of UK CSDR, while making the rule on capital less prescriptive at Gate 2 by allowing firms to use their own approaches to calculating the minimum level of capital to cover going concern risks and the cost of winding down, while setting a minimum capital level floor equivalent to nine months of operating expenses. The regulators also stated that DSDs subject to other prudential regimes must meet all applicable capital requirements, while aiming to avoid double-counting of capital and ensuring that capital requirements are proportionate to the risks from DSS activities.
7.2 A total of 14 respondents commented on the approach to capital. Seven respondents stated that the capital requirements in the DSS are too high and may present a barrier to small entities/new market entrants from participating. Some respondents stated that having to meet the capital floor at Gate 2 (set at nine months of operating expenses for DSDs) would require them to raise a significant amount of funding on top of the resources needed to run the business. Some respondents noted the general challenges of raising funding for start-ups. Three respondents agreed with the overall approach to capital requirements in the DSS.
7.3 Two respondents noted potential problems with linking the minimum capital requirement to operating expenses and how this may reduce the incentives to scale the business.
7.4 Three respondents noted the need to consider other potential mitigants as part of setting the minimum capital requirement and the importance of focussing on what happens to assets in wind down instead of ensuring the capital requirement is met.
7.5 Three respondents agreed with the proposed approach to setting capital requirements for hybrid entities and DSDs that might be part of banks where those firms are subject to more than one prudential regime. Respondents generally agreed that in those cases prudential requirements should not be applied on an ‘additive’ basis. But one respondent noted that an ‘additive’ rather than a ‘higher of’ approach may be more appropriate for certain business models, with a key consideration being whether it was possible to wind down DSS activities separately. One respondent agreed with the broader applicability of Rule 47 on capital to all DSS activities rather than DSD activities only.
7.6 One respondent asked whether DSDs will need to hold capital during the testing stage.
7.7 Two respondents queried whether operating a trading venue and DSD from the same entity would be an appropriate structure and said that having separate entities for the different activities would be preferred by customers, given that it would provide greater clarity on business continuity in the event of a wind down. It was flagged that this could also affect whether the trading venue was considered to pose a systemic risk. One respondent said that, where the activities are carried out by separate entities, then this would mean that regulatory capital should be considered at group level.
7.8 The Bank already proposed to make the calculation of minimum capital requirements more flexible by turning off the technical standards that remain in place at end-state. We also put in a nine-month operating expenses (OPEX) floor for minimum capital requirements which could have resulted in lower minimum requirements than in the end-state rules. We have considered our capital requirements and have decided to reduce the OPEX capital requirements for DSDs to six months of OPEX from nine months. The Bank could consider reducing this further in specific cases, should firms convince us that they can wind down quicker than six months and that key risks are being addressed in line with DSS requirements.
7.9 In order to ensure that the lower floor does not materially increase risks, the Bank will be reviewing wind down plans – and in particular the length of time that it will take to execute those plans and necessary operating expenses to cover that time period – to ensure that these can be executed in practice with the capital held by DSDs.
7.10 The objective of the Bank’s new capital requirements is to ensure that DSDs can wind down in an orderly manner and that firms have enough financial resources to ensure that this happens. While the Bank recognises the impact this can have on firms’ incentives, the Bank considers that the rationale for linking capital requirements to OPEX is sound – as firms need to have sufficient financial resources in order to run the business during a wind down.
7.11 The Regulators will maintain the proposed approach to setting capital requirements for DSDs which might also be subject to FCA or PRA capital requirements due to their other regulated activities. They will need to meet both the applicable FCA/PRA requirements and the Bank’s DSS rules on capital requirements for their DSS activities.footnote [15] The regulators’ intention is that a sandbox entrant holds sufficient capital to cover both the going concern risks and the cost of winding down all its activities in the DSS, and, in addition, to satisfy its requirements for any regulated activity outside of the DSS (where relevant). This will ensure that the sandbox entrant can operate safely in the normal course of business and provide for an orderly wind down of all DSS activities if required. The regulators will also have the powers to waive or modify the Bank’s DSS rules on a case-by-case basis if they create unforeseen disproportionate interactions with other capital requirements. The regulators will look to ensure that firms’ requirements are proportionate to the risks from DSS activities while aiming to avoid double counting of capital.
7.12 The Bank confirms that sandbox entrants do not need to hold capital while in the testing stage but do need to demonstrate that they meet the minimum capital requirement to pass through Gate 2 and move to the Go-live stage.
7.13 The regulators note that HMT’s consultation response said that the DSS should be flexible enough to accommodate different structures, and that this includes not only the ability to function as both a trading venue and a DSD, but also the ability to distribute functions in a different way. However, participating entities will need to adhere to the same regulatory principles as firms outside the DSS and will be supervised by the regulators according to their objectives. While the DSS therefore allows firms to test innovative business models in which the activities of trading and settlement are combined into one entity, firms will also need to ensure that they have fully considered any novel risks that this will pose. The regulators will also require authorised firms to take account of the risks posed by their business model, including how business continuity would be handled in a wind down scenario. The regulators recognise that some firms may decide that operating from separate entities better suits their proposed business model. In this scenario, the existing prudential regime, including as it pertains to groups, would continue to apply.
7.14 The Bank proposed a ‘pay as you go’ fee regime for the DSS. This included a £10,000 fee payable on application, a £40,000 fee payable on successfully passing through Gate 2 and regular fees to be paid annually during participation in the DSS, estimated at £85,000. The Bank also proposed that fees should be additive for hybrid firms that will also require FCA authorisation in the normal way as outside the DSS.
7.15 The FCA’s fee regime was not subject to the consultation.
7.16 A total of 23 responses commented on the proposed fee regime. The majority of these respondents thought that fees in the DSS were too high, especially when coupled with the minimum capital requirements and the potential need to obtain other authorisations from the FCA, which could create a barrier to entry for smaller firms and new entrants to the market. Several respondents asked for fees to be made more proportionate to the size and/or systemic importance of firms as well as their revenue. Two respondents said explicitly that the FCA and Bank fees should be reduced for hybrid entities.
7.17 A small number of these respondents supported the fee regime, noting it is necessary to ensure adequate regulatory resources to support the DSS. One respondent suggested that fees could be higher in order to fund a more bespoke supervisory approach.
7.18 One respondent suggested that fees should not be accepted at Gate 1 (application stage) unless there was certainty that the prospective sandbox entrant could also pass through Gate 2. Another respondent suggested having a single fee upon passing Gate 2 instead of two separate fees at Gate 1 and Gate 2 could help smaller entrants and another respondent asked for the Bank to reconsider the Bank’s proposal to share fees equally across all participants after Stage 3 and beyond.
7.19 The Bank notes the feedback around the fees being substantial for new entrants. As running the DSS is a new function for the Bank, it is important the Bank has the resources to operate it in the way we intend and to support any activity within it. The fees are in place to ensure that happens. Not charging fees would affect the Bank’s ability to perform its statutory functions. The Bank has therefore decided to leave the fees unchanged.
7.20 While the FCA acknowledges respondents’ feedback on its authorisation fee when combined with the Bank’s fee regime, the FCA is not proposing to make any changes to its process. Firms seeking FCA authorisation to operate an multi trading facility (MTF) or organised trading facility (OTF) will therefore continue to pay the existing Category 8 charge (which following the outcome of CP 24/6 will be £54,380) to ensure they contribute towards the FCA’s costs. However, firms will be eligible to apply for a Variation of Permission will pay 50% of a Category 8 charge. The FCA consults annually on changes to its fees and on 3 July, published its final regulatory fee and levy rates for 2024/25 (PS24/5), including feedback to its earlier consultation.
7.21 The processes around Gates 1 and 2 have been made proportionate to the effort required at these stages and this is reflected in the fees we will levy. The Bank considers that the level of effort to assess Gate 1 and Gate 2 applications will be similar across different types of applicants, we therefore do not see a case for varying fees at these stages. However, the Bank will reflect on the DSS fee regime, particularly the fees paid after Gate 2. The Bank’s other FMI fee regimes reflect the systemic importance of the FMIs in scope. It may be appropriate to apply the same principles in the DSS. However, it is too early to estimate the impact this may have on fees before we receive applications and observe activity in the DSS.
7.22 The Bank has noted that it would look to adjust fees for hybrid entities where we find there is an overlap with FCA activity. We do not think this will affect the Gate 1 and Gate 2 fees, given that the Bank and FCA will be assessing applications against their respective rules and regulations. However, this may be relevant for fees paid by hybrid entities after Gate 3 which will be supervised by both the Bank and FCA. As previously stated, the Bank will be monitoring the supervisory effort related to the DSS and make adjustments to fees if required. There may be certain areas when it comes to hybrid firms where the Bank’s supervisors find efficiencies such as by making use of the information obtained through the FCA authorisation process to then determine whether the applicant meet’s the Bank’s own requirements, or co-ordinating with the FCA in requesting further information or clarifications on the answers provided by the applicant. It should be noted that fees after Gate 2 are estimates and will be applied on a cost recovery basis, reflecting the actual amount of effort spent on DSS activity that is chargeable back to firms.
7.23 The Bank consulted on draft Gate 2 requirements, set out in full in the draft Bank DSS rules instrument. In the draft guidance document, both the Bank and FCA set out their approach to supervision and enforcement in the DSS. The draft guidance document noted that the Bank was planning to take a proportionate approach to rule making and supervision for DSS firms.
7.24 Respondents requested further detail on Gate 2 requirements. One respondent said the draft DSS Guidance looks practical and reasonable. The same respondent stated that although the CP refers to resilience in several places, it might be helpful to set out further the processes for ensuring and maintaining continuity of DSD resilience, particularly at the point that the DSD transitions to the Go-live stage and conducts live activity.
7.25 The Bank has now published its final Gate 2 rules for DSDs. These are the first set of minimum requirements that apply to sandbox entrants that successfully pass into Gate 2 and become a DSD. Gate 2 requirements have been designed to support innovation by allowing for a phased approach, with regulatory requirements increasing as firms transition towards later stages of the DSS and increase their levels of live activity.
7.26 To support transparency with the industry, including potential entrants into the DSS and their participants, the Bank can share the following information about its approach to assessing firms at Gate 2. However, the Bank notes that it will amend its approach to supervision through the life of the Sandbox as it learns from the activity and business models in the DSS. It should also be noted that a sandbox entrant which is also regulated by the FCA, for activity inside and/or outside the DSS, will continue to be supervised for those activities by the FCA and need to satisfy any requirements which apply to it as an authorised person or RIE. The FCA’s approach to authorisation will continue to apply.
7.27 The Bank’s rules set out the standards for sandbox entrants it regulates in the DSS (see Section 6). The Bank notes that its approach to gaining assurance that firms are meeting these standards will be based on the objectives of the DSS, the financial stability risks that firms present at Gate 2, and a proportionate use of the Bank’s resources. In particular, its focus at Gate 2 will be to seek to ensure that:
7.28 In line with this approach, the Bank will require firms seeking to become DSDs to self-attest and explain how they comply with the DSS rules. The Bank will then focus its assurance work on:
7.29 In addition, it is the Bank’s expectation that any proposal that has retail clients directly participating in a DSD will attract substantive additional scrutiny, given the additional risks potentially arising from such a business model (see Section 8) and the Bank will require firms to demonstrate whether any incremental risks to non-professional clients, for instance around asset protection, as well as appropriate standards in respect of anti-money laundering (AML) and know your customer (KYC),footnote [16] have been appropriately addressed in the business model proposed.
7.30 The Bank will expect firms to demonstrate in their application at Gate 2 and subsequently, how they mitigate and manage these risks.
7.31 In the CP and draft DSS Guidance, the regulators outlined the design of the DSS which included setting out the gates and stages that would mark different progress points as an applicant moves through the Sandbox. This was outlined at a high-level and the regulators did not give specific timings for how long each part of the process was likely to take.
7.32 Four respondents raised a common theme: the need for transparency about timelines for assessing applications at the different gates in the DSS and the time between them. Respondents cited that better understanding the precise timelines would help with forward planning on two counts: 1) for capital generation to facilitate the necessary scaling needed at each stage; and 2) to gather the required evidence to meet the assessments for further gates and allow for smoother progression through the Sandbox.
7.33 A few respondents queried the assessment and response time in the DSS. One respondent stated that firms should have single point of contact for the regulators for all DSS related activities. Another respondent suggested that the regulators implement a mandatory response time of no more than 21 days for each stage and gate of the DSS application process. The respondent stated that if the Bank or the FCA fails to respond within this timeframe, then the default action should be to approve the application or request.
7.34 Four respondents raised concern about the time it could take to become authorised to operate a trading venue.
7.35 The regulators acknowledge the challenges that respondents have highlighted in their feedback, particularly the call for more transparency about the timelines for assessing applications for the different gates in the DSS. The regulators recognise the need for potential participants to have better certainty about the duration of the process for their intended business model, especially for the purpose of investment cycles.
7.36 The diagram below (Figure 1) is an illustration of how a firm that has existing regulatory permissionsfootnote [17] wishing to apply for DSD designation only, and a new start-up hybrid firm, might progress through the Sandbox and the assessment points along the way. The timings set out in Figure 1 are indicative only and, in both examples, assume that firms can comply with regulatory requirements and meet any supervisory requests in a timely manner. These timeframes also depend on the quality of the application submitted.footnote [18] Figure 2 expands on this, and provides indicative timings based on a firm’s high level business model.
Example timelines for a new hybrid firm and a firm with existing regulatory permissions wishing to be approved as a DSD (a)
7.37 As set out in the CP, the regulators will make different assessments at Gate 2 compared to Gate 1. It is important to note that the assessments at Gate 1 and Gate 2 have different purposes and so will be different in scope, and it is envisaged that the assessment at Gate 2 will consider a broader range of information. The Bank will assess DSD applicants against the requirements set out in the Gate 2 rules, while the FCA will assess applications as per the existing statutory process applicable for firms wishing to vary their permissions or obtain new authorisation to operate a trading venue. Where a firm applies to operate a hybrid entity, the regulators will, wherever possible, co-ordinate their processes, such as any requests for additional information from firms, to avoid duplication for firms. However, it is important to note that these will remain two distinct assessments by each regulator. To pass Gate 2, hybrid entity applicants will need to have received approval from both the Bank and the FCA.
7.38 There are no statutory timelines set out in the DSS Regulations obliging regulators to review applications to enter the DSS within a specified timeframe. However, the regulators understand the importance of assessing applications promptly for entrants to maximise the time available under the DSS Regulations. While the regulators do not believe it would be helpful to introduce a time by which approval or rejection of an application to the DSS must be determined, we have set out the timelines for reviewing Gate 1 and Gate 2 applications above with the aim of being open and transparent with prospective entrants. The regulators commit to reviewing the applications as promptly as practicable but remind prospective entrants that where applications are incomplete, the assessment timeframe may be longer.
7.39 The FCA recognises that firms applying to the DSS to operate a trading venue will wish to commence live activity as soon as possible after passing Gate 1 and that the DSS Regulations are time limited to a five-year period. The FCA notes that the DSS Regulations did not modify the framework under which a firm is authorised or recognised to operate a trading venue, as such any application to operate a trading venue in the DSS must be considered within the same legal framework as a non-DSS application. The FCA also notes that a key design feature of the DSS is the intention that the wider financial industry should be able to engage with a sandbox entrant in broadly the same way that they would do with a conventional FMI, and the maintenance of the existing trading venue framework will help to further this aim.
7.40 When assessing whether an applicant meets the Threshold Conditions set out in FSMA 2000, the FCA will undertake a proportionate and considered review of the firm’s business model, operations and people. The FCA does not take a ‘one size fits all’ approach and will take into account, among other factors, the proposed scale of the firm’s activity, the complexity of its products, its client base, its corporate structure and its links to other persons. What is deemed appropriate under the Threshold Conditions for a new market entrant in the DSS is therefore likely to differ from what is expected of an established firm with high levels of activity outside of it. The FCA is committed to helping new market entrants to navigate its authorisations assessment process as quickly and effectively as possible. Although the statutory timeframe under FSMA to determine an application in twelve months remains unchanged for the DSS, if the application is complete, the FCA will usually assess it within six months.
7.41 A high-quality, considered and complete application is therefore the most effective means of obtaining a timely determination and firms seeking to operate a trading venue in the DSS, but which do not have permission to do so, are encouraged to seek a pre-application meeting with the FCA ahead of submitting a Gate 1 application. Further information on the FCA’s Pre-Application Support Service can be found at UK wholesale markets pre-application support service. These meetings will give applicants advance notice of what is required of them to obtain authorisation at Gate 2 and allow them to ask the FCA any questions about the process, which should in turn help them to submit a more complete application.
7.42 To support a smooth assessment of the application and minimise requests to provide further information or clarifications, a firm should demonstrate that they are ready, willing and organised (please see the FCA’s website for more details on what this means for your application: How to apply for authorisation or registration).
7.43 The CP and draft guidance document set out the regulators’ supervisory approach at a high level. It explained that both the Bank and the FCA tailor their supervisory approach to the risks posed by firms, and this will continue to be the case in the DSS. The CP did not set out any specific proposals in terms of transparency or communications with sandbox entrants.
7.44 Some respondents asked for greater clarity on how the regulators will work together to deliver the DSS, with one respondent arguing that clarity, transparency, and collaboration between regulators and the industry is crucial. Nine respondents placed emphasis on the importance of regulators conducting ongoing communication and engagement to the market, sandbox participants and wider stakeholders throughout the sandbox lifetime.
7.45 Many of these respondents also called for regulators to provide transparency on potential legislative changes, DSS rule changes, the utilisation of limits, and changes to the thresholds around limits. One respondent put forward the proposal that regulators form an industry committee to consider jointly the experience and desired outcomes of participating in the DSS and provide cross-industry recommendations. Another respondent suggested that the Bank could consider some forms of centralised co-ordination or introductions between interested parties, while remaining neutral and not endorsing any particular solution.
7.46 One respondent stated that there should be a more consultative, transparent and flexible process for graduating out the DSS, and that they would have concerns if exiting the DSS resulted in separately regulated MTF and CSD businesses.
7.47 One respondent noted that the draft Bank DSS Rules Instrument at Gate 2 stated that technical incidents should be reported to the Bank, but sought further clarity on whether downstream participants would receive support if a particular platform is encountering issues prior to engagement, and what communications they would receive. One respondent urged regulators to establish reporting regimes both within and outside of the DSS and another respondent asked if the regulators intended to provide sufficient visibility to other market participants of any issues reported by a DSD or an exchange.
7.48 One respondent recommended the use of Digital Token Identifiers (DTIs) in addition to International Securities Identification Numbers (ISINs) for digital securities in the DSS for record keeping and transparency, arguing that they can uniquely identify a cryptoasset and link it to a DLT network, while another explained that ISINs and DTIs are two complementary and interoperable identifiers for securities. The respondent suggested using these identifiers would provide a holistic view of both security and token implementation details to supervisors and market participants.
7.49 Having considered the responses summarised above, the regulators recognise the need to continue to provide clarity on how they will engage with the industry, in particular, with sandbox entrants over the lifetime of the DSS. Once firms have entered the DSS, the regulators will hold periodic roundtable meetings with sandbox entrants to discuss issues pertaining to the DSS. These meetings will include workshop-type discussions to provide guidance on specific aspects of the application or assessment process where this may be considered necessary to facilitate sandbox entrants’ understanding of our regulatory approach. In addition, these meetings will also seek to provide clarity to firms regarding the evolution of DSS rules, including rules for Gates 3 and 4 ahead of periodic reviews by the Bank. Importantly, as noted above, the regulators will also seek to provide updates on the development of any possible new regime for non-systemic DSDs.
7.50 The regulators are keen to utilise such fora to discuss limits that are in place as well as to learn from sandbox participants about significant operational issues that might arise in the DSS, including practical barriers that firms are facing. The aim of these fora would be to facilitate open and transparent engagement but not detailed firm-specific engagement, which should continue directly with the regulators to avoid competition issues.
7.51 The regulators recognise that there may be a need for wider industry engagement on specific questions that might need to draw on the expertise of specific organisations or industry bodies. The regulators will hold occasional ad-hoc roundtables when significant legal or policy questions arise which may benefit from further engagement with industry bodies, or similar.
7.52 The Bank will publish periodic reports detailing the utilisation of capacity within the DSS for different asset classes by placing this information on the Bank’s DSS web pages. In addition, each DSD’s Sandbox Approval Notice (SAN) will be published on the Bank’s website, giving their participants and clients transparency on the limits within which the DSDs are operating and the activities that they are permitted to undertake.
7.53 The regulators will communicate information with prospective applicants, DSS participants and the wider market through their respective regulatory DSS webpages. However, the scope of information we can provide for these groups will differ. For firms which are outside of the DSS the information flow, while timely, is unlikely to be provided in real time and may be provided in the form of aggregated information, so that commercial confidentiality is preserved.
7.54 For DSS applicants and for those participants admitted to Gate 1 and subsequent gates; given the intention is to create a level playing field, regulators confirm that they are open to having dialogue with prospective applicants to clarify aspects of DSS regulations or supervisory assessment where this will support a wide range of applicant types. However, this will be balanced against the need to share information equally across all applicants. Direct individual firm engagement will focus primarily on assessment rather than on providing guidance or more general application support. Applicants will have access to a DSS e-mail address and will be in communication with DSS supervisors as they progress through the DSS. Where it becomes apparent that several firms have raised similar issues and may benefit from additional clarity on our regulatory and/or supervisory approach, the regulators may seek to arrange an additional, collective workshop or issue a written briefing shared collectively with applicants and/or participants. The regulators will also communicate updates through their DSS webpages, where it is appropriate for these to be communicated to a wider audience.
7.55 Where a sandbox entrant is supervised by more than one regulator, either on an individual or group basis, those regulators plan to work closely with each other to ensure that communications between the regulators and the firm are joined up. Co-ordination arrangements between regulators have been established for the DSS to support this, which includes the new Memorandum of Understanding (MoU) they have entered into for the DSS. The regulators are open to adjusting how we communicate with firms over the lifecycle of the DSS, for example it may be that bespoke communication arrangements are appropriate for specific firms.
7.56 As the DSS will allow for firms to create new business models pursuant to which sandbox entrants could be regulated by both the Bank and the FCA, as well as, in some cases, the PRA, the regulators will keep the arrangements for co-operation and co-ordination between regulators under review. We encourage firms to refer to the DSS Guidance document for further details on how regulators will approach regulatory oversight in the DSS. The Bank will be responsible for the regulation of a firm’s DSD activities, while the FCA, and the PRA where relevant, will remain responsible for the regulation of authorised persons. The regulators expect a sandbox entrant to engage with the relevant regulator in respect of any regulatory issues which arise.
7.57 The regulators will also discuss and assess DSS applications and maintain working-level co-ordination throughout the course of the DSS for those applicants with activities that span across different UK financial supervisory bodies.
7.58 DSS regulatory reporting is important to ensuring effective regulatory supervision of the DSS, and is a core mechanism for identifying risk, ensuring compliance and achieving the objectives of the DSS. The information that sandbox entrants will have to provide to regulators is likely to depend mostly on the regulatory permissions they hold. The FCA’s existing reporting requirements for firms with trading venue permissions are unchanged for firms in the DSS.
7.59 The FCA considers that existing reporting requirements are sufficient for the DSS, and also does not consider that the introduction of DTIs would be appropriate solely for DSS activity. However, the FCA will ensure that any unique characteristics of regulatory reporting for digital securities are monitored during the course of the DSS.
7.60 The Bank intends to ask DSDs with permissions to settle to share key information on their activities on a regular basis to build up a better understanding of the extent of FMI activity carried out in the DSS. The Bank intends to request data from firms as they progress through Gate 2. For example, information on a firm’s capital positions, operational performance, settlement volumes, and the ISINs of the securities held. Data gathered from sandbox entrants will be used to monitor sandbox activity against limits and improve the sandbox experience.
7.61 The regulators also note that HMT must prepare and publish a report on the DSS which sets out its assessment of its operation and the regulators will be required to support this process, including through analysis of this data.
7.62 Data requested by the regulators from sandbox entrants who are in the DSS does not remove the obligation on these entities to inform the regulators in a timely and fulsome manner of any rule or limits breaches or other significant operational issue.
7.63 One respondent requested clarification that a DSD will be exempted from authorisation for its DSS activities and will not require separate authorisation under FSMA 2000 if it is not acting as a hybrid entity.
7.64 The DSS Regulations modify section 285(3D) of FSMA 2000 so that a DSD is exempt from the general prohibition in FSMA 2000 in respect of any regulated activities carried on in connection with any of the FMI activities under regulation 3(5)(b) (those being the activities traditionally performed by a CSD) or ancillary FMI activities (as defined in the Regulations) for which it has approval in its SAN. Where a sandbox entrant wishes certain ancillary activities to be included in their SAN, they should make clear why they require these activities to benefit from the modified framework and the scope of the proposed activities, including whether they are for the purpose of enabling the core functions of the DSD. In some cases, we may include these activities in a firm’s SAN, subject to certain conditions (such as the firm having or obtaining relevant Part 4A permissions under FSMA).
8.1 CP respondents raised a number of other issues not directly relating to the questions set out in the CP and that have not been covered in the other sections of this PS. The regulators address these issues in this section.
8.2 Several respondents called for the existing requirements for a ‘Registrar of Government Stock’ in the Government Stock Regulations 2004 to be addressed as a means of enabling a distributed system to reduce complexity and cost.
8.3 The regulators have considered these comments, noting that these are matters for HM Government to consider. The regulators can confirm that, where permitted by the respondents, we have passed these comments to HMT.
8.4 One respondent stated that the Bank should consider accepting digital securities, including tokenised money market fund units, as eligible collateral within its Sterling Monetary Framework (SMF) to promote and support their widespread adoption in the UK financial ecosystem.
8.5 The Bank accepts a broad range of collateral in its SMF operations. In principle it accepts collateral which it judges it can effectively and efficiently take delivery of and risk manage. The Bank also takes account of how widely assets are held by SMF counterparties. Digitally native assets are not currently eligible, though the Bank continues to monitor market developments. Market participants are encouraged to engage with the DP on The Bank’s approach to innovation in money and payments published on 30 July 2024 as part of the Bank assessing the case for accepting digitally native assets as collateral.
8.6 The Bank set out in the CP that DSDs would not be required to obtain designation under the Settlement Finality Regulations (SFRs) during the course of the DSS. However, the Bank did anticipate this would be required in a possible new permanent regime.
8.7 Two respondents queried the Bank’s proposals not to mandate firms to obtain a settlement finality designation under the SFRs at Gate 2. While one said that it agreed in principle, it also noted that it appeared unclear as to what protection to participants in Article 39 of Chapter 2 of the DSS Rules meant in this context, as in the absence of a settlement finality designation, DSDs appeared to have to rely on contractual provisions.
8.8 Another respondent described the requirement for default management procedures (Article 41 of Chapter 2 of the Bank’s DSS Rules Instrument) as outdated, given that in prefunded markets there is no default risk.
8.9 The Bank can confirm that without a designation under SFRs, ‘protection to participants’ refers to contractual protections and/or rulebook provisions or similar that determine when a transaction is final, and it has for this reason made a modification to Article 39.1 of Chapter 2 of the Gate 2 rules to make it clear that adequate protection to participants includes protection by contractual arrangements. The Bank acknowledges that is not possible to protect against insolvency rules without an SFR designation and it is possible that insolvency provisions could seek to unwind transactions in a DSD’s system, notwithstanding any contractual or rulebook provisions to the contrary. Users of a DSD should take this into account when choosing to engage with a DSD and a DSD will be expected to inform users if it is not a designated system.
8.10 The regulators note that there is no guarantee that only prefunded models will exist in the DSS, and therefore consider that requirements for default management procedures may still be necessary in many cases. The regulators note that prospective participants may apply for waivers if specific rules are incompatible with their business model.
8.11 Four respondents asked for clarity on the scope for retail participation. Three respondents asked for this in respect of trading venues and securities placement activities and one respondent asked for clarification on whether the definition on ‘participants’ in CSDR could be clarified to include retail participants in DSDs.
8.12 For firms seeking to operate a trading venue in the DSS, the FCA does not consider the current framework to rule out direct retail participation, provided that operators comply with the existing regulatory FCA frameworks, including requirements in the FCA Handbook rules where applicable. As such there is no change to standards for permitting retail participation in DLT systems, for trading venues, relative to such activities outside the DSS for non-DLT systems, and where FCA permission is given to operate a trading venue, approved client types will be included on the Financial Services Register.
8.13 For firms seeking to operate a DSD in the DSS (whether as a standalone DSD or as part of a hybrid entity), the Bank recognises that there is some ambiguity around direct ‘retail’ (individual) access and the definition of ‘participant’ could potentially be clarified in the DSS. However, the Bank would need to carefully consider how this might impact the levels of protection offered to retail investors using DSD services. Given the Bank considers there may be potential for different and additional risks for non-professional clients were they to access DSDs directly (relative to the ways such users currently access FMIs utilising tested technologies), additional scrutiny will need to be applied where DSS participants propose direct retail access to a DSD.
8.14 The Bank confirms that it is willing to review DSS rules in the course of its learning about new DSD models proposed in the DSS and to propose amendments to the DSS regulations to HMT that may be necessary to support innovation. But in the case amendments to the DSS rules and/or firms’ SANs that clarify or widen participant scope to permit retail activity directly in a DSD, the Bank will require firms to first demonstrate whether any incremental risks to non-professional clients, for instance around asset protection, as well as appropriate standards in respect of AML and KYC, have been appropriately addressed in the business model proposed.
8.15 The FCA is required by sections 210 and 395 of FSMA 2000 to publish statements of its policy on the imposition of sanctions under Part 14 and its procedures for issuing warning and decision notices. These are published in DEPP in the FCA Handbook. The DSS Regulations apply a modified version of FSMA to the DSS (‘DSS FSMA’). The requirements under sections 210 and 395 to publish statements of policy and procedures also apply under DSS FSMA, and therefore the FCA proposed to make minor consequential amendments to DEPP to apply the existing statements of the FCA’s policy and procedures to the imposition of sanctions and the issuing of warning and decision notices under DSS FSMA.
8.16 The proposed changes were annexed to the CP for information and no feedback was received.
8.17 The instrument amending DEPP (FCA 2024/30) came into force on 26 July. Please see paragraphs 2.28–2.34 of Handbook Notice 121.
8.18 Several participants mentioned the importance of the DSS being used to develop systems that are interoperable with existing ledgers (CSDs) and that are interoperable with other ledgers and systems. For example, one respondent stated in their response that regulators may have a view to promote interoperable systems and fungible tokens so that DSS projects can move beyond siloed proof-of-concept experiments. Several participants mentioned that not doing so may lead to fragmentation and inefficiency.
8.19 The regulators have considered these comments and consider that further work is necessary within the DSS and internationally to explore how interoperability between ledgers can be delivered in practice. The regulators agree that interoperability is important to ensure that liquidity is not fragmented, and inefficiencies are not created due to siloed ledgers and systems. In addition, the regulators consider that views on this issue are likely to evolve as DLT is used for digital securities, and that proposals from industry groups, and joint work with regulatory bodies and international standard-setters will be important.
8.20 Four respondents requested that the regulators set out a digital asset taxonomy for the DSS highlighting the need for consistency. One respondent stated that providing definitions in the DSS may reduce regulatory and legislative risks.
8.21 The Bank and FCA are considering the merits and risks of providing a digital asset taxonomy for the DSS. However, at this stage they are of the view that any such taxonomy would need to be developed through building international consensus.
8.22 Two respondents noted the importance of clarifying the prudential treatment of digital assets under the capital framework for banks.
8.23 The draft DSS Guidance set out with the CP noted that the implementation of the Basel standard for the prudential treatment of cryptoasset exposures was to be taken forward by the PRA separately from the DSS. The PRA will follow its usual rule-making process which will include a consultation. Respondents should engage with that process at the appropriate time.
1. BPX
2. FlatStone Capital Markets Inc.
3. Franklin Templeton
4. Liquidity Digital Assets
5. Nymlab Srl
6. SLIX
7. The Centre for Financial and Regulatory Technology
Available at: Guidance on the operation of the Digital Securities Sandbox.
We do not believe that the changes to our approach explained in this PS materially affect the analysis of how our proposals interact with our statutory objectives, which was set out in our joint CP.
The FCA’s proposals to implement and operate the DSS are primarily intended to advance the FCA's operational objective of enhancing market integrity, whilst promoting effective competition. The DSS also serves to advance the FCA’s secondary international competitiveness and growth objective by positioning the UK as one of the countries which has taken proactive steps to enable the use of developing technologies, such as DLT, in traditional markets. The proposed approach, which is intended to facilitate innovative business models, should allow for HMT and regulators to more easily determine the permanent changes needed to accommodate the wider adoption of such technologies. As such, the DSS will help the FCA to play a leading role in setting international standards for digital securities. The DSS will also support the FCA’s business plan commitment to strengthen the UK’s position in global wholesale markets.
The FCA considers a strong level of participation in the DSS to be important to achieving its aims, as it allows for the potential benefits of developing technology such as DLT, and any novel risks associated with it, to be tested in real world conditions. The design of the DSS is therefore intended to encourage meaningful industry uptake and allow a variety of innovative business models to be developed, whilst ensuring that the wider market have confidence to engage with sandbox entrants and the digital securities which are recorded, traded and settled on their FMIs. The DSS should therefore accommodate both existing regulated firms and new market entrants, whilst maintaining high standards of market integrity and consumer protection. The FCA will also seek to ensure that the transition to any new permanent regime at the end of the DSS is as smooth as possible for participating firms.
In developing this PS, we have considered the environmental, social and governance (ESG) implications of our proposals and our duty under ss. 1B(5) and 3B(c) of FSMA to have regard to contributing towards the Secretary of State achieving compliance with the net-zero emissions target under section 1 of the Climate Change Act 2008 and environmental targets under s. 5 of the Environment Act 2021. Overall, we do not consider that the final proposals are relevant to contributing to those targets. However, we will keep this issue under review during the term of the DSS.
Automated Market Makers (AMMs) – A decentralised exchange that uses algorithmic mechanisms to facilitate the trading of digital assets.
Bank – Bank of England.
Bank DSS Rules Instrument 2024 – The rules instrument containing the rules that apply to sandbox entrants in the DSS (Bank DSS Rules Instrument).
Central Bank Digital Currencies (CBDC) – Defined as digital money a country’s central bank can issue alongside cash.
Central Maintenance – Defined as providing and maintaining securities accounts at the top tier level.
Central Securities Depository (CSD) – traditionally an entity that centralises and manages settlement risk across key financial markets. CSDs undertake Financial Market Infrastructure (‘FMI’) activities, such as providing notary, settlement and maintenance functions for financial securities such as shares and bonds.
Central Securities Depositories Regulation (CSDR) – Regulation (EU) No 909/2014 of the European Parliament and of the Council of 23 July 2014 on improving securities settlement in the European Union and on central securities depositories and amending Directives 98/26/EC and 2014/65/EU and Regulation (EU) No 236/2012.
Digital Securities – The financial instruments in scope of the DSS as specified in Regulation 3(7) of the DSS Regulations and defined as ‘FMI sandbox instruments’. For the purposes of this PS, such financial instruments are referred to as ‘digital securities’.
Distributed Ledger Technology (DLT) – A type of technology that enables the sharing and updating of records in a distributed way.
Digital Securities Depository (DSD) – Has the same meaning as the definition given in regulation 2 of the DSS Regulations: “a sandbox entrant permitted to engage in one or more DSS activities referred to in Regulation 3(5)(b) as a result of the FMI sandbox arrangements”.
Digital Securities Depository Link (DSD Link) – An arrangement between (i) DSDs; or (ii) DSDs and CSDs whereby:
(a) a DSD becomes a participant in the securities settlement system of another DSD or a CSD; or
(b) a CSD becomes a participant in the securities settlement system of a DSD; to facilitate the transfer of securities from the participants of the latter DSD or CSD to the participants of the former DSD or CSD.
or an arrangement between (i) DSDs; or (ii) DSDs and CSDs whereby:
(a) a DSD, accesses another DSD or a CSD indirectly via an intermediary; or
(b) a CSD accesses a DSD indirectly via an intermediary.
DSD links include standard links, customised links, indirect links, and interoperable links.
Digital Securities Sandbox (DSS) – This is the first financial market infrastructure sandbox in the UK that allows firms to use developing technology such as DLT in the undertaking of activities traditionally performed by a Central Securities Depository (CSD) and in the operation of trading venues under temporarily modified legislation.
DSS activities – In relation to a sandbox entrant means the activities approved in the SAN issued to the sandbox entrant (as defined in Regulation 2 of the DSS Regulations).
DSS CSDR – The modified version of the CSDR that applies in the DSS (as set out in Part 2 of the Schedule to the DSS Regulations).
DSS Regulations – The Financial Services and Markets Act 2023 (Digital Securities Sandbox) Regulations 2023. These Regulations created the temporary framework under which sandbox entrants and regulators will operate.
DSS USRs – The modified version of the Uncertificated Securities Regulations that applies in the DSS (as set out in Part 5 of the Schedule to the DSS Regulations).
Equality Act 2010 considerations – Considerations relating to the legal framework to protect people from discrimination in the workplace and in wider society.
European Market Infrastructure Regulation (EMIR) – Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties and trade repositories.
FCA – The Financial Conduct Authority.
FSMA 2000 – The Financial Services and Markets Act 2000.
Fund tokenisation – There is no formal definition, but it generally refers to representing or turning an investor’s share or unit in a collective investment scheme (or ‘fund’) into a digital token recorded on a smart contract-enabled blockchain, a highly programmable, automated and cryptographically secure database shared between parties.
Gates – The DSS is structured in five main stages and four ‘gates’ between those stages. To progress through the DSS, a firm will need to pass through a series of gates. At Gate 1, an applicant will be assessed against the eligibility criteria. At subsequent gates successful applicants will be required to demonstrate their enhanced ability to meet the expected regulatory standards to supervisors. Each gate has different requirements that are a pre-requisite to moving onto the next stage (see Table B for individual gate details).
Go-live limit – The allocated portion of the overall capacity of the DSS that each DSD is given for certain asset classes once they have successfully got past Gate 2 and have been given permission to undertake live activities. There are rules (see Bank DSS Rules Instrument) that DSDs have to meet with respect to limits.
HMT – His Majesty’s Treasury.
Hybrid entity – A sandbox entrant which has been allowed to undertake both the functions of a trading venue and those traditionally performed by a CSD. Such a firm would be supervised jointly by the FCA and the Bank.
Modified framework – The temporarily modified legislative and regulatory framework created by HMT through the DSS Regulations to allow firms to apply to become a DSD and to carry out activities within the DSS.
Memorandum of understanding (MoU) – A statement of serious intent – agreed voluntarily by equal partners – of the commitment, resources, and other considerations that each of the parties will bring.
Money Laundering Regulations (MLRs) – The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017, which set out the obligations of private sector firms working in areas of higher money laundering risks to prevent criminals using professional services to launder money.
Money Market Funds (MMFs) – An open-ended investment fund that provides short-term finance to investors by investing in cash, cash equivalents and short-term debt securities, which in the UK are authorised by the FCA under the UK Money Market Fund Regulation.
Open banking technology – To be understood as a banking practice that provides third-party financial service providers open access to consumer banking, transaction, and other financial data from banks and non-bank financial institutions through the use of application programming interfaces (APIs).
Principles for Financial Market Infrastructures (PFMIs) – The international standards for financial market infrastructures issued by the Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO).
Real Time Gross Settlement (RTGS) – The infrastructure that holds accounts for banks, building societies and other institutions.
SAN – A ‘sandbox approval notice’ as defined in Regulation 2 of the DSS Regulations. The SAN sets out the approval for a sandbox entrant to participate in the DSS.
Sandbox entrant – As defined in Regulation 2 of the DSS Regulations: ‘a person that makes an application to participate in the FMI sandbox arrangements and has its application approved under Regulation 5(2)(a) or (b)’.
Scaling stage – DSDs that successfully meet the Gate 3 requirements at the review points will be able to move onto the Scaling stage. In the Scaling stage, firms that enter this stage will have access to higher limits. At this point, DSDs can increase their activity within the higher limits and begin to consider how they meet end-point requirement after the DSS.
Securities Settlement System – A securities settlement system as defined in the DSS CSDR, or a system operated by a DSD that settles transactions in financial instruments against payment or against delivery, irrespective of whether that settlement system is a system in relation to which a designation order made under Regulation 4 of the Financial Markets and Insolvency (Settlement Finality) Regulations 1999 is in force.
Stages – The DSS is structured in five main stages and four ‘gates’ between those stages. The stages represent the different stages which a firm will pass through from first applying to become a sandbox entrant to operating in a possible new permanent regime outside of it.
Stablecoins – A form of digital asset that can be used to make payments, backed by a specified asset or basket of assets which they use to maintain a stable value against that asset.footnote [19]
Sterling Monetary Framework (SMF) – The Bank’s framework for operating in sterling money markets.
Tokenisation – Generally used to refer to the representation of traditional assets – eg, financial instruments, a basket of collateral or real assets – using digital tokens on distributed ledger technology (DLT) or similar technology.
USRs – The Uncertificated Securities Regulations 2001.
Digital Securities Sandbox joint Bank of England and FCA consultation paper published on 3 April 2024. Under the Financial Services and Markets Act 2023 (Digital Securities Sandbox) Regulations 2023 there is no duty to consult on the regulators’ proposals to implement and operate the DSS. While the regulators are choosing to consult on their approach to implement and operate the DSS, they may choose not to consult in the future on further rules or guidance.
Regulation 3 of the Financial Services and Markets Act 2023 (Digital Securities Sandbox) Regulations 2023 sets out the FMI activities that can take place within the DSS. See also Section 3 of this PS for more detail.
UK regulatory approach to cryptoassets and stablecoins: consultation and call for evidence.
This is defined in the DSS Regulations as meaning a firm which is constituted under the law of any part of the United Kingdom and having, for the duration of the FMI sandbox arrangements, a registered office or a head office in the United Kingdom.
As set out in the ‘Non-GBP securities’ section, in certain cases such as the issuance of non-UK sovereign debt instruments, the UK regulators may require that relevant authorities in other jurisdictions approve of the transaction.
Standalone DSDs will usually benefit from the exemption in section 285 FSMA (as modified by the DSS Regulations) and therefore may not need Part 4A permission.
The Financial Services and Markets Act 2000 (Regulated Activities) Order 2001.
Consultation on the first Financial Market Infrastructure Sandbox: The Digital Securities Sandbox.
Future financial services regulatory regime for cryptoassets.
Permanent amendments to modified legislation would require HMT to lay a statutory instrument after having reported to Parliament on the DSS.
The PRA expects banks to take responsibility for ensuring that the capital they hold is adequate at all times and covers risks from any new activities, with the Individual Capital Adequacy Assessment Process being an integral part of meeting this expectation.
‘Customer due diligence’ and ‘know your customer’ are sometimes used interchangeably.
The assumption here is that a firm with existing regulatory permissions will already have the established boards, controls and processes required to operate within particular regulatory perimeters, and therefore will not need to do this additional leg work ahead of applying at Gate 1 and Gate 2 (where applicable).
Regulators would encourage prospective applicants to engage with pre-application sessions which are being offered by the FCA to aid this.