Digital Securities Sandbox Update
Introduction
The digital securities landscape in the United Kingdom is set to take another leap forward with the introduction of the Financial Services and Markets Act 2023 (Digital Securities Sandbox) (Amendment) Regulations 2025 (the Regulations). Laid before Parliament on 30 January 2025, the amendments made by the Regulations are set to come into force in less than a month, on 3 March 2025.
In overview, the Regulations amend the Financial Services and Markets Act 2023 (Digital Securities Sandbox) Regulations 2023 (the DSS Regulations) which govern the Digital Securities Sandbox (DSS) (see below) modifying the effect of the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLRs) and affecting various other amendments to the DSS Regulations.
For example, where an activity taking place in the DSS would otherwise be caught by the MLRs, the Regulations temporarily disapply certain provisions, while maintaining, and, in some cases, even enhancing other anti-money laundering (AML) obligations.
In this article, we consider what the DSS means for the UK’s digital asset landscape and map HM Treasury’s direction of travel in this area by outlining the key provisions within the Regulations.
The Digital Securities Sandbox: An Overview
Introduced in early 2024, the DSS allows firms to engage with developing technologies such as Distributed Ledger Technology (DLT) within a temporarily modified legal and regulatory framework.
HM Treasury introduced the DSS to address industry concerns that, while technologies like DLT could reduce risk and increase efficiency in post-trade processes (by, for example, reducing the number of intermediaries involved), existing legal requirements may impede their adoption.
The DSS is the first UK sandbox for financial market infrastructures (FMIs). Among the securities that can be issued, settled and traded by DSS participants are shares and bonds. Participants benefit from a temporarily modified regulatory regime for five years. A permanent regime is being developed alongside the DSS.
Procedural overview
In order to benefit from the DSS, firms must clear a series of stages, termed ‘gates’. At each gate, firms must demonstrate to their supervisors that they can meet increasingly rigorous regulatory standards. The requirements at each gate are as follows:
- A firm applies to become a sandbox entrant and begins testing
- The firm receives approval to begin live activities in the DSS
- The firm applies to increase the relevant limits with a view to scaling up their activities
- The firm receives clearance to operate outside the DSS (subject to a possible new permanent regime)
Engaging with the DSS is potentially transformative for start-ups and early-stage firms looking to innovate in the issuance, trading, and settlement of securities. For more information, see the Joint Policy Statement.
What’s changed?
The Regulations signal increased oversight while also temporarily disapplying certain MLR provisions in the context of the DSS. We set out the key amendments to the DSS Regulations below.
- Regulation 3 expands the definition of the appropriate regulator within the Financial Market Infrastructure Sandbox. The appropriate regulators for FMI activities will be the Financial Conduct Authority (FCA) and the Bank of England (BoE).
- Regulation 4 amends Part 1 of the Schedule to include modifications to the MLRs. This signifies a tightening of the regulatory framework surrounding AML and counter-terrorist financing within the digital securities space.
- Regulation 5 amends the UK Central Securities Depository Regulation to mandate the implementation of a whistle-blowing scheme by digital securities depositories. This scheme is designed to enable employees to report potential or actual infringements related to the DSS, thereby enhancing market integrity.
- Regulation 6 brings relief to authorised persons conducting FMI activities as digital securities depositories by disapplying section 20 of the Financial Services and Markets Act 2000 (FSMA 2000). In essence, section 20 makes it unlawful for a person (individual or corporate) to carry out or purport to carry out regulated activity when not authorised by the FCA or the Prudential Regulation Authority (PRA), or benefiting from an exemption.
- Regulation 7 inserts a new Part 6 into the Schedule, which outlines modifications to the MLRs. This part specifically disapplies various provisions related to cryptoasset exchange and custodian wallet providers.
Rationale
Those seeking to understand HM Treasury’s thinking in drafting the Regulations can refer to the Explanatory Memorandum. Broadly, the Explanatory Memorandum states that:
- In the absence of the Regulations, where DLT is employed by a firm in the DSS, this could be considered to be a cryptoasset service under regulation 14A of the MLRs and would therefore place certain obligations on those looking to participate in the DSS (such as registration with the FCA (even where a firm was already FCA authorised)).
- HM Treasury (i) deems this to be disproportionate and (ii) notes that were this state of play to continue, the regulatory burden on firms seeking to innovate would extend beyond that applicable to traditional regulated securities markets.
- HM Treasury’s solution is to temporarily exempt certain cryptoasset activity in the DSS from the MLRs. AML requirements relating to conventional non-cryptoassets shall continue to apply.
Ineligible firms
For firms unable to access the benefits of the DSS – for example because one or more of its eligibility criteria are not met – there is less in the way of guidance as to how the regulator may view their application for registration.
Among the benefits of the DSS are closer contact with the regulator during a firm’s application for authorisation, as well as the fact that, at the end of the process, participants can continue to rely on any FCA permissions gained during their time in the DSS to operate a trading venue.
It is therefore imperative to consider whether your firm falls within the eligibility criteria. A firm may be ineligible for the DSS if the FCA finds that a firm’s innovation does not fit easily within its existing regulatory framework. Such firms will not benefit from the tailored support available to DSS participants and will need to scale their business while navigating traditional communication channels with the regulator.
Discussing your regulatory position with experienced financial services lawyers can provide the clarity required to plan your next steps.
Next steps
The Regulations aim to enhance oversight, increase transparency, and improve compliance mechanisms within the digital securities ecosystem, while streamlining requirements in some areas.
From a regulatory perspective, the inclusion of both the FCA and the BoE as appropriate regulators for ancillary FMI activities signals a move towards a more integrated supervisory approach.
The modifications to AML and counter-terrorist financing regulations align with the broader global trend of tightening financial crime controls in the digital asset space. At the same time, the disapplication of certain FSMA 2000 provisions for digital securities depositories indicate a commitment to striking the right balance between promoting innovation and managing risk.
The introduction of whistle-blowing schemes must be placed in the context of the FCA’s broader transformation agenda, which centres culture and market integrity. The overall impact on the private, voluntary, or public sectors is anticipated to be minimal, with no significant disruptions foreseen because of these amendments.
As the Regulations come into effect, stakeholders in the financial services industry should remain informed and prepared to navigate the amended landscape.
Let’s talk
Firms aiming to leverage the potential of the DSS, as well as those seeking advice about their regulatory position outside its scope, are encouraged to contact Financial Services and Funds Team Partners Racheal Muldoon, Charlotte Hill, Richard Ellis, and Trainee Solicitor, Rebecca Wright.
