The concept of the regulatory sandbox (“Sandbox”) was first introduced over 4 years ago by the UK Financial Conduct Authority (“FCA”) to offer:
“a safe space in which businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of pilot activities.”
Several other jurisdictions have followed the UK’s lead including Australia, Canada, Hong Kong and Singapore. However, as I wrote in my article last year[i], although each regulatory sandbox essentially has the same objectives, not all sandboxes are identical in structure and approach and not all have matured at the same pace.
The main objective of the regulatory sandbox is to create a more flexible regulatory framework that allow firms to test new products and services without being subject to full licensing requirements. A second and often overlooked benefit of this partnership is the information and knowledge exchange. One will often hear about the benefits of the Sandbox to Fintech and Regtech firms in working closely with regulators to understand regulatory boundaries, but regulators too benefit from this arrangement. Changing consumer behaviours and new technologies are pushing regulators to review their current regulatory frameworks to ensure their oversight approach effectively manages risks while encouraging business innovation. The regulatory sandbox provides a learning forum for regulators to understand how new technologies might impact current market structure and how it will be embedded into workflows and operate in practice. Essentially, it effectively acts as an enabler to regulatory model innovation itself. Done right, the ultimate output of this exchange should lead to improved supervision, better regulatory models and ultimately better products and services.
The overall effectiveness of a sandbox is dependent on its structure and maturity. Jurisdictions that have been most successful at leveraging the sandbox such as Australia, Singapore and the UK have well structured onboarding and approval processes re-enforced by ‘supportive action’ measures such as waivers or no enforcement action letters. In the case of Australia, many of these supportive measures were already in place and it was a matter of fine-tuning their process rather than starting from scratch.
As the founder of the concept, it is no surprise that the benefits of the regulatory sandbox are most transparent in the UK. Since inception, the FCA has received 276 applications and accepted 102 firms into their sandbox.[ii] Each cohort is comprised of firms with innovative products and services which are using new technologies such as distributed ledger technologies (DLT), machine learning, AI and biometrics. The FCA noted when describing its recent cohort, “we have accepted a number of firms that will be testing propositions related to cryptoassets to better understand how consumer benefits can be delivered – while effectively managing the associated risks”. [iii] The benefits and experience gained from previous cohorts are now showing up at the supervisory level. The UK has been a first mover in terms of open banking reform and have taken on a leadership role in leveraging technology to enhance their own activities. Recently, the FCA has been experimenting with ways to streamline regulatory reporting by testing ‘machine readable’ and ‘machine executable’ applications in tech sprints. [iv]
Furthering its global leadership role, the FCA proposed the concept of the ‘Global Financial Innovation Network (GFIN).[v] The network will seek to create an environment for firms to trial cross-border solutions while providing a forum for interested regulators to share experience and collaborate on policy reform. Although the FCA’s proposal is a novel and ambitious concept, the mandate seems too broad, at least as a place to start. An intimate forum outside other international bodies such as International Organization of Securities Commission (IOSCO) and Financial Stability Board (FSB), to improve cross border policy and standards is a very positive step and the sharing of sandbox experiences should lead to more consistent global regulation which will make it easier for firms to expand globally.
The GFIN mandate also proposes setting up a test environment or ‘global sandbox’ to trial cross border solutions. Although broadly interesting, there is a danger that this will require too much coordination effort and it will not be achievable within a reasonable time frame. Another approach, perhaps a logical step on the way to a global sandbox, might be to focus efforts more narrowly and build out a common regulatory framework to setting policy and standards and focus efforts on improvements to co-ordinated oversight using emerging technology. Cross-border supervisory solutions could be used as case studies to test the effectiveness of a cross-border testing environment. If this proves successful, the mandate could be extended to non-regulatory applications.
There is no doubt that the introduction of regulatory sandboxes has had a positive impact in supporting innovation and competitiveness within the financial services sector. It has also been the catalyst for a more collaborative approach between financial markets participants through the sharing of knowledge. Improvements in how regulators are approaching oversight are underway in several jurisdictions at the supervisory-level. The potential is there – staying focused on core mandates will be key for wide-spread success.
[v] 11 regulators have committed to the GFIN including: Abu Dhabi Global Market (ADGM), Autorité des marchés financiers (AMF), Australian Securities & Investments Commission (ASIC), Central Bank of Bahrain (CBB), Bureau of Consumer Financial Protection (BCFP, USA), Dubai Financial Services Authority (DFSA), Financial Conduct Authority (FCA, UK), Guernsey Financial Services Commission (GFSC), Hong Kong Monetary Authority (HKMA), Monetary Authority of Singapore (MAS), Ontario Securities Commission (OSC, Canada), Consultative Group to Assist the Poor (CGAP)
Written by Donna Bales