FCA and Bank of England open discussion into future of tokenisation

The authorities have set out a joint vision (28-page /507KB PDF) for how UK wholesale financial markets could adopt tokenisation and distributed ledger technology, as they look for industry views on how their approach to regulating digital integration into these markets should look.

The call for input seeks views on the overall end-state vision and regulatory approach to issuance, trading, settlement and safekeeping of digital securities; the prudential treatment of tokenised assets; and, for wholesale settlement remaining anchored in central bank money, how digital asset ledgers would be able to settle in innovative central bank money,

Josie Day, financial services regulation expert with Pinsent Masons, said the consultation built on a range of work already underway in the sector, including the Treasury’s ‘digital gilt instrument’ pilot.

“The paper contains six priority areas for which the FCA and Bank of England set out their overall ambition and current work commitments,” she explained.

“The aim with these is to give industry more clarification by outlining work to date and current commitments on these identified foundational areas: including regulating the issuance and settlement of digital securities, the prudential treatment of tokenised assets and, on a more specific point, confirmation that the FCA is not taking forward its proposal to apply CASS 17 to specified investment crypto asset custody.”

David Heffron, a financial services regulation expert with Pinsent Masons, added that the consultation represented an important opportunity for firms to help shape the regulatory framework for digital innovation in the wholesale financial markets from the ground up.

"The call for input is an opportunity for industry to share its thinking with the FCA and the Bank of England on use-cases, and on the regulatory principles and vision they put forward,” he said.

“Industry is asked for its thinking on issues such as where the greatest benefits to the UK market from tokenisation lie, and why; and whether it agrees with the principles for regulation and priority areas contained in the paper.

“If current regulation is limiting firms by impeding innovation that is another area the FCA and the Bank of England are keen to hear about, as well as how interoperability across tokenised and non-tokenised infrastructures is significant for them.

“So, it will be useful if firms share their thinking on areas in current regulation where there are ambiguity or blockers and how interoperability relates to use cases.

“The FCA and the Bank of England have emphasised that they seek to support the co-existence of both new tokenised infrastructures and non-tokenised ones, although moves towards tokenisation does not mean all markets will become fully tokenised in future. How the regulatory framework applies and how infrastructure works in such a hybrid environment needs to be considered.”

The paper calls for input on the parameters around market functioning and issuance, designing the safeguarding framework for specified investment crypto asset custody, alongside how best to support HM Treasury’s digital gilt instruments pilot programme.

The FCA and the Bank of England said indications from the financial sector were that companies required more certainty about future regulatory approaches with respect to tokenisation in wholesale markets and infrastructure, as well as the Bank of England’s plans as a supplier of payment services and liquidity. The report aims to clarify priority areas, it said.

Additionally, the paper sets out not only the FCA and Bank of England’s vision for safe and resilient tokenisation in UK wholesale markets, anchored by central bank money settlement, but also the regulatory principles they consider should apply to this long-term vision. It includes an initial roadmap of initiatives contributing to the transition process, and also sets out the ongoing initiatives to support the transition to this end state.

The authorities say their vision for tokenisation would be a digitally-enabled, wholesale financial markets safe ecosystem allowing tokenised securities, cash and collateral to move more efficiently through the trade lifecycle, with tokenised and non-tokenised asset infrastructure interacting smoothly and supported by common rules and standards.

New digital infrastructures would be created to supplement existing market ones, with robust regulation and resilience standards to restrict financial crime opportunities and high levels of accountability where investors can be confident to transact in tokenised assets. Achieving this goal will allow tokenisation to support more liquid capital markets by broadening the range of assets traded, generating new models for distribution, and bolstering the real economy through more efficient credit creation and debt and equity issuance.

“The benefits of operational efficiencies and transparency that tokenisation may bring to the wholesale financial markets ecosystem, along with understanding and mitigating risks, and how to address regulatory and operational issues, will all need to be factored into the resulting roadmap,” added Day.

“Although the joint vision is focused now on tokenised securities, such as bonds, shares and fund units, the paper indicates the FCA and the Bank of England plan to look more widely in future.

“The joint vision also highlights the regulatory aims, with a clear focus on accountability – including making sure an identifiable person is accountable for financial services regulated activities conducted in the tokenised wholesale financial markets ecosystem, the maintenance of operational resilience, and ensuring anti-money laundering rules and sanctions implementation are maintained in the process.”

The consultation runs until 3 July, and will inform the FCA’s and the Bank of England’s shared strategic direction ahead of a final cross-authority roadmap to be issued later in the year.

Simon Walls, executive director of markets at the FCA, said the technology could reshape how assets are issued and settled in the UK.

“We want to support firms in adopting this technology to lower costs, reduce risk and unlock new services, and our partnership with the Bank of England will ensure a common approach across all parts of wholesale markets. 

“UK markets have always embraced new technology, and that will be central to ensuring the UK remains at the forefront of global wholesale markets.”