Time for a “New Generation” Financial System that’s Fit for London: BoE Mills

A senior Bank of England official gave digital assets and DLT technology a vote of confidence and said it’s time to start working on the next generation of financial systems that’s fit for London’s global hub status.

Sasha Mills, executive director of Financial Market Infrastructure at the Bank of England, said in a speech in London that the UK needs to embrace digitalisation, stablecoins and tokenisation and move away from the current, antiquated set-up that relies on 1970s technology.

“It is time to move away from talking about potential and one-off demonstrations of the technology, and for all of us to start working together to deliver a new generation of the financial system that is befitting of London’s place as the heart of the global financial system,” she said.

Mills noted that the Bank’s most recent survey about post-trade processes revealed that 75% of infrastructure spend is going towards “keeping the lights on” rather than investing into innovative practices, despite today’s market operating in an analog fashion. She pointed to securities existing as physical certificates and market participants relying on manual processes or ones that are centred around “end of day” when processing millions of messages post-trade. “That is increasingly at odds with a 24/7 global financial system,” she said.

“While the existing infrastructure is increasingly obsolescent, there is reticence to invest in new technology at scale without having a better sense of what the future might look like. At some point, it makes more sense to build new structures than try to modify the existing ones. In our view, this point in time is fast approaching, if not already here,” she added.

Mills added that UK authorities need to legitimise the utility of tokenised assets and payments to support growth in the financial system, including stablecoins as a settlement asset, because DLT has the potential to deepen markets and to change how capital moves around the financial system. Still, she cautioned that innovation should take into account lessons learned in the past to make sure risks don’t increase.

“As we build this new ecosystem, we should not forget the hard learnt lessons of the past. Money requires confidence to support economic activity and growth in good times and bad,” she said.

Mills noted that a lack of trust signals financial instability and highlighted that market participants require certainty of settlement, both in terms of ownership and payment, without which there could be “cascading failures.”

“Building the new ecosystem should protect these principles to maintain financial stability, adhere to [the] same risk, same regulatory outcome and give space to innovators to compete to deliver solutions. That is what we are here to ensure,” she explained.

Mills pointed to progress, underscoring the “considerable interest” in the UK’s Digital Securities Sandbox (DSS) and the Government’s Digital Gilt pilot (Digit), which will issue government debt on a distributed ledger. “Some firms are also exploring how tokenisation of assets could make it more straightforward to move assets around the financial system,” she said. “This can remove operational and technical barriers, open up activity that was not previously possible like intraday repos, and can also expand the pool of assets in the system that can be utilised as collateral.”

Meanwhile, DLT infrastructure is deepening markets in corners of the financial system that were not well served by legacy systems, such as gold, fund management, and private markets, she observed.

Stablecoins but with Limits

The Bank of England will launch a consultation about the UK’s systemic stablecoins regime, following on from its discussion paper published in November 2023 and it will sit alongside the FCA’s paper on non-systemic tokens.

Mills emphasised the importance of taking a forward-looking approach towards stablecoins and said it’s increasingly clear that at least some of the assets that back stablecoins have to be put to work to produce a return, as keeping all the backing in bank deposits is not a viable business model for this space. “We are now minded to allow for a proportion of backing assets to be remunerated. We consider that this should happen by allowing a proportion of backing assets to be invested in High Quality Liquid Assets (HQLA). We think this will support innovation in the UK while maintaining confidence in money and allow for a smoother transition from FCA to Bank requirements within the UK stablecoin regime” she said.

The Bank is also considering introducing limits for stablecoin holdings, at least temporarily, to mitigate financial stability risks stemming from large and rapid outflows of deposits from the banking sector as payments systems scale up.

Currently, the limits being considered are in the region of £10-20,000 for individuals and £10 million for businesses. Mills added that while the Bank is clear on central bank money being used as the primary settlement system, it is open minded to stablecoins providing roles in the wholesale market.

Tokenised deposits are also a promising innovation, Mills said, as they offer a pathway to innovation that aligns with financial stability and maintaining trust and confidence in money. “Tokenisation of assets will allow for rationalisation of processes and systems through normalising how asset classes are represented, and for smaller portions of these assets to be mobilised,” she suggested. “Resolving certain legal and regulatory questions can unlock more efficient use of a wider range of high-quality assets, including those held on balance sheets, to support market activity.”