Regulatory Sandboxes Arrive in the States
We’ll take a break from politics this week – though there were some fascinating special elections in New York and Arizona a few days ago that continue to suggest significant headwinds for the GOP in November – to discuss regulations. (Give it a chance before you roll your eyes.)
Many industries, especially in the financial services and healthcare sectors, deal with a litany of regulatory agencies, the rules and guidance they promulgate and the direct and indirect supervision they exert as they offer their products or services to consumers. But as technology has hastened the speed of innovation almost exponentially over the last several years, regulators around the world have been faced with a complex challenge: how to strike the right balance between protecting consumers and ensuring the safety and soundness of financial firms and the financial system more broadly while ensuring that, in so doing, they are not stifling innovation. This potential paradox can become even more confounding when one considers that the current United States’ financial regulatory system is almost a century old and never considered an ecosystem in which most consumers interact with their financial services providers using their mobile phones.
The challenge, of course, is not unique to the United States. As technology-powered tools attract ever more adoption among consumers across the world, regulators across the globe are confronting these issues. To seek the right balance between consumer and market protection and innovation, many policymakers globally have embraced the concept of a regulatory sandbox. The term, meant to evoke images of children playing in a soft, safe, controllable environment, is fairly apt: regulatory sandboxes allow financial services providers – new entrants and incumbents alike – to temporarily test innovative new products or services in a live market but at a relatively small scale without the requirement of having to undergo a full regulatory authorization or licensing process. In other words, the regulator is watching casually from a bench in the park a safe distance away, content that the children can’t get into too much trouble.
The United Kingdom’s Financial Conduct Authority (FCA) became the first major financial regulatory agency in the world to launch a sandbox program in 2016. The FCA sandbox required firms to first apply to the regulator to test its products in the live market, and, if approved, to provide regular reports to the FCA during its sandbox testing period. Once that period ends, and assuming the FCA has found no issue with the product or service being tested, the firm is provided with the ability to gain expedited FCA approval to launch its product or service on a wider scale. The program has been wildly successful: since its launch two years ago, fintechs and traditional banks alike have brought cross-border and domestic payment solutions, cryptocurrency and security platforms, and innovative new lending products into the FCA’s sandbox environment.
In our increasingly globally competitive world, quite a few other financial regulators took notice. Following the UK’s lead, regulators in Switzerland, Canada, Australia, Singapore, Malaysia, Thailand, Hong Kong – among other countries – have all launched or are in the process of launching sandboxes that promote innovation in a manageable, safe regulatory environment.
And, as of last month, we can add the United States to that list…sort of. Frustrated by the inability of United States’ federal agencies to implement regulatory sandboxes at the national level, Arizona Governor Doug Ducey (R) signed legislation into law in late March that a regulatory sandbox in the state – the first such sandbox in the country. Under the program, which will take effect later this year, companies will be able to test their products for up to two years and serve up to 10,000 Arizona consumers before needing to apply for formal licensure from the state’s financial regulator. And legislation backed by the state regulator is progressing in Illinois – a state with very different politics than Arizona – that would create a similar sandbox program in the Prairie State.
This burgeoning activity at the state level begs the question: in the dual interests of innovation and global competitive, why aren’t the United States’ federal financial agencies implementing sandbox regimes like their counterparts across the globe? One answer may be that the American financial regulatory system, in addition to being nearly 100 years old, is uniquely fragmented. Whereas the UK’s FCA is the sole regulator tasked with consumer protection and maintaining the integrity of the British financial markets, there are no less than seven federal regulators in the United States with at least some jurisdiction over the financial markets. Coordinating among these agencies to stand up a regulatory sandbox would be a herculean task.
But there are growing signs that there is interest in making a run at it. Spurred perhaps by legislation sponsored by Rep. Patrick McHenry (R-NC) in the House of Representatives that would mandate the creation of sandboxes at the federal regulatory agencies, Acting Bureau of Consumer Financial Protection Director Mick Mulvaney testified to Congress earlier this month that he has directed the Bureau to “try to figure out a way to create a…fintech sandbox, a new technology sandbox to try and figure out a way to allow these new industries to develop without the type of regulation that stifles and while still protecting consumers at the same time. It's a balancing act. But it is a priority for us. We are sending time on it.” Thus, while the sandboxes are largely being built in the states for now, a federal sandbox may not be so far off, after all.