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UK introduces new regulations for Digital Securities Sandbox

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The United Kingdom introduced new regulation providing the country’s financial sector watchdogs with the rules for supervising a Digital Asset sandbox (DSS) for tokenized securities, according to an official publication on Monday.

When the Sandbox comes into effect on January 8, 2024, it will allow companies to test new tokenization solutions and products under the supervision of the Financial Conduct Authority (FCA) and the Bank of England (BoE).

The regulations aim to create a controlled environment, allowing companies and authorities to test new technology in financial markets, overcoming existing regulatory obstacles and, hopefully, fostering innovation in the digital asset industry, explained an accompanying memo.

“The DSS will allow firms and the regulators to test the use of new technology across our financial markets,” the memo read. In particular, it facilitates using distributed ledger technology, such as digital assets, to perform the activities of a central securities depository or trading venue.

“It will enable participating entities to be subject to modified legislative requirements, where the existing requirements act as a barrier or an obstacle to using new technology,” the explanatory memo continued. “The DSS will enable the Government and regulators to test and then make changes on a permanent basis to accommodate new and developing technologies.”

Specifically, the new regulations set out the activities and financial instruments in the scope of the DSS, as well as the relevant regulator for those activities; the eligibility criteria to apply to participate in the sandbox; the arrangements to ensure that regulators are able to appropriately supervise the DSS; termination and wind-down arrangements for DSS activities; and the relevant legislation being modified, disapplied or applied to new entities in the DSS.

In general, firms taking part in the DSS “will be subject to a schedule of disapplied and modified legislation,” and the new rules essentially set the limitations on what can be carried out within the sandbox and which participants are eligible for involvement.

The DSS results from a consultation launched by His Majesty’s Treasury in July, which ended August 22. The U.K. Chancellor of the Exchequer, Jeremy Hunt, then outlined plans for the DSS in his Autumn budget statement, stating that he hoped it would facilitate the expansion of the digital assets sector in the country.

“The government will lay a statutory instrument to implement the Digital Securities Sandbox, delivering on the Edinburgh Reform announcement to implement a Financial Market Infrastructure Sandbox in 2023,” according to the Autumn budget.

The new DSS regulation is one of the first changes to come as part of the U.K. government’s Financial Services and Markets Act 2023 (FSMA), which was passed on June 29 with the goal of integrating digital assets into the U.K.’s financial services regulation.

FSMA 2023

As opposed to bringing in an entirely new regulatory regime specifically molded to digital assets, such as the EU’s landmark Markets in Crypto Assets Regulation (MiCA), the FSMA aims to integrate digital assets into the U.K.’s already well-functioning financial service regulatory regime.

The passage of the bill in June extended the banking rules of the FSMA—such as maintaining adequate capital to withstand financial shocks, implementing robust risk management practices to identify and provide clear and transparent information to customers—to stablecoins and digital assets, making digital assets officially recognized under U.K. law for the first time.

Crucially, it also gave the FCA and Prudential Regulation Authority (PRA)—the country’s top financial sector regulator and the banking watchdog, respectively—the necessary powers to begin implementing the HM Treasury’s goals set out in its February 2023 consultation on the Future Regulatory Regime for Cryptoassets.

These included establishing an issuance and disclosure regime tailored to digital assets, strengthening the rules that apply to financial intermediaries and custodians of digital assets, and adopting a bespoke, digital asset-specific market abuse regime.

The FSMA 2023 also provided HM Treasury with powers to disapply, modify, or apply to new entities elements of existing legislation, as well as the ability to confer powers onto the Bank of England and FCA to operate and supervise a financial markets infrastructure Sandbox, such as the DSS.

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