New regulatory powers Financial market infrastructure: regulatory sandboxes
Financial services are currently tightly structured and highly intermediated with a number of participating FMIs being governed by different regulatory and legal frameworks. For example, a form of FMI is a CSD. It is regulated by the Bank of England (the Bank) and its main regulatory framework is principally based on the Central Securities Depositories Regulation 2014 (CSDR), Uncertificated Securities Regulations 2001 (USRs), and Settlement Finality Regulations 1999 (SFRs). A second form of FMI is a multilateral trading facility (MTF). It is operated by an investment firm or a recognised investment exchange (RIE). The operation of MTFs by RIEs or investment firms is supervised by the FCA, and the main regulatory framework includes (without limitation) the UK MIFIR, FSMA 2000, related secondary legislation, technical standards and rules.
	FMI legislation is intended to be ‘technology neutral’. Inevitably, FMI legislation is based on and in some cases heavily tailored to the technology of the day. This potentially creates obstacles for FMI using new technology where the legislative requirements are heavily based on how existing technology works. What is unclear is whether emerging technology, such as distributed ledger technology (DLT), can always be accommodated within this existing FMI legislative framework or whether there will be legal ambiguity and a risk of inconsistencies as to whether the legislation is compatible with a particular emerging technology. An FMI sandbox is an opportunity to review the existing legislative framework in a technologically neutral way, that allows for the appropriate regulatory outcomes to be achieved.
	For example, provisions in CSDR may prevent FMI from undertaking certain activities and practices when using emerging technology such DLT. HM Treasury’s Call for Evidence to examine the application of DLT to FMI identified that operators of multilateral trading facilities (MTFs) could look to use their own DLT arrangements to settle tokenised securities traded on their market. A key obstacle to this was identified by industry in CSDR Article 3(2), which requires transferable securities traded on a UK trading venue to be "recorded in book entry form in a CSD or third-country CSD". This means that an operator of an MTF is prevented from being able to use its own settlement arrangements to settle transactions on its market.
	The CSDR includes other definitions and obligations that are based on how current FMI IT legacy systems function, which may raise questions about their application to DLT arrangements. For example, DLT coordinates the simultaneous updating of records held by multiple ‘nodes’ in a decentralised network- in this context, doubts have been raised around the compatibility of this with CSDR definitions and requirements in relation to ‘securities accounts’ or ‘book entry form’, which reflect the settlement of securities transactions being reflected by double or multiple book entry keeping on securities accounts at CSDs. Modifications to legislation may therefore provide clarity within CSDR around accommodating the functioning of DLT, in a way that meets the same regulatory outcomes but in a different way.
	Another example is the Companies Act 2006 (CA 2006), which is the main piece of legislation that governs UK company law. It seeks to modify, consolidate, and simplify company laws which, among other things, protect shareholder rights and simplifies certain formalities and administrative burdens imposed on UK companies.
	There is provision in the CA 2006 that certain formalities are complied with in the recording and registration of shares and access to shareholder information in a prescribed way that is intended to protect shareholders and creditors. The CA 2006 defines "company records" and specifies the form in which they are to be available for public inspection and how they are disseminated.
	The operation of technology, such as DLT, is not necessarily incompatible with the overall obligations identified above in the CA 2006, though there is a greater risk that DLT is incompatible with the existing means and mechanisms of delivering these obligations. Temporary modifications to the CA 2006 for the duration of a FMI sandbox may ensure that key provisions, such as shareholder and creditors rights and overall company transparency are preserved, as intended by the legislation, but in a way that ensures that emerging technologies, such as DLT, operate in a way that is compatible with the legislation.
	A further example is the USRs, which are intended to allow for title in securities to be transferred without the need for a written instrument – in what is described as "dematerialised" form. It has been highlighted by industry that the USRs are not drafted in such a way that contemplates DLT. The regulations are premised on the operation of centralised registers that are maintained by an operator using a "Relevant System" – colloquially described as providing the "golden record" – which maintains control over the maintenance and verification of records. This approach differs from how DLT is used. It is premised on a de-centralised operating system, with a number of the transactional functions, currently performed by system operators, being performed automatically within the architecture of the DLT framework concerned.
	The examples given above are not intended to provide a legal commentary on the application of UK law with regard to DLT systems. Rather they are cited because they have been flagged as potential obstacles by industry (and as legislation that may need to be modified within the context of an FMI sandbox relating to DLT). Absent any express amendments to legislation, such as those outlined above, it is possible that this form of technology could be interpreted as compatible with parts of existing legislation, but possibly in a way that strains the existing language and therefore risks causing ambiguity, particularly as different types of technology, with different characteristics, emerge and are applied to the legislation over time. As noted, in some other cases, the introduction of new technology and practices, may be clearly incompatible with existing legislation and therefore unambiguously in need of modification if the new technologies and practices are to be integrated into the operations of FMI.