Exploring Distributed Ledger Technology: A Comparative Study of the EU DLT Pilot Regime Regulation and the UK Digital Securities Sandbox

Distributed ledger technology (DLT) is a novel approach to sharing and recording transactions or data across a decentralized network of participants, attracting considerable attention in recent years. Advocates highlight several potential benefits over traditional centralized ledgers, such as enhanced auditability and transparency, faster transaction settlement, reduced costs due to shorter custody chains without multiple intermediaries maintaining overlapping databases, and the possibility of automation through smart contracts. As a result, both the European Union and the United Kingdom see value in further exploring DLT's applications in financial markets. Legislators believe that regulators should have the opportunity to study both the advantages and risks of this technology before making changes to existing financial laws. Thus, both the EU and UK have adopted a regulatory sandbox approach, creating a controlled environment with exemptions from current rules where companies can experiment, test, and validate their innovative services, products, or business models for a limited time.

In a recent paper, I compare the EU DLT Pilot Regime Regulation and the UK Digital Securities Sandbox (UK DSS) which fundamentally have the same goal, namely to allow market participants to experiment with the technology in a regulatory sandbox. It has been documented by eg Allen (2020) and Lim and Low (2021) that regional regulatory sandboxes can raise the concern of potential regulatory arbitrage and a ‘race to the bottom’ competition among jurisdictions, which necessitates a detailed examination of whether one sandbox is more flexible or easier to experiment with compared to another. The jurisdiction with a more lenient approach may attract a larger number of participants and gain a competitive edge; however, it could also face greater risks due to less rigorous prudential or investor protection requirements. While a significant portion of EU financial market regulations was 'on-shored' in the UK to reduce post-Brexit withdrawal risks, both pilot regimes were developed independently. The UK version, released a year after the EU’s, may have been shaped by the political objective to enhance the competitiveness of its financial markets, whereas the EU prioritized deeper capital market integration to minimize fragmentation and create a more unified and resilient financial system.

The article concludes that the UK Digital Securities Sandbox (DSS) offers greater flexibility to UK authorities, as the Bank of England and the FCA have more discretion to adopt a case-by-case approach in determining which requirements can be relaxed. Unlike the EU DLT Pilot Regime, which grants exemptions (meaning legacy requirements remain unless explicitly exempted), the UK DSS disapplies certain rules entirely. This means applicants don’t need to request exemptions from existing requirements, though authorities still retain the ability to impose them if deemed necessary.

Secondly, the UK DSS regime is much broader than the EU DLT Pilot Regime because a) it refers to ‘developing technologies’ rather than explicitly to DLT, b) the type of participants that can enter and the type of activities that can be performed are defined broader, and c) the type of financial securities that can be experimented with is also broader with higher thresholds.

However, this paper does not conclude that the UK DSS is generally less stringent than the EU DLT Pilot Regime. While the UK framework allows for more regulatory flexibility, this also means that some authorities, like the FCA, may choose not to relax certain rules, such as those for trading venues experimenting with the technology. In contrast, the EU DLT Pilot Regime offers specific exemptions, like allowing natural persons as participants, which the UK DSS does not permit. Additionally, participants in the UK sandbox must pass a series of ‘gates’ over time to continue, or risk being shut down by regulators.

Note that the comparison was based on the consultation paper published by the Bank of England and the FCA on 3 April 2024, alongside draft guidance on the operations of the DSS, the Bank of England’s draft DSS rules, the Bank of England’s draft DSS rules summary table, and the FCA’s amendment of the decision procedure and penalties manual. The intention of the UK regulators is to publish a response to the consultation after the summer of 2024, which might somewhat modify the initial conclusion of this blog post.

The author’s full article can be accessed here.

Randy Priem is Professor of Finance at UBI Business School (Middlesex University London) and at Antwerp Management School.