Is fintech ready for a global regulatory sandbox?
In August 2018, the UK Financial Conduct Authority (FCA) announced the creation of the Global Financial Innovation Network (GFIN), in collaboration with 11 other international financial regulators. GFIN was established to “provide a more efficient way for innovative firms to interact with regulators” and “create a new framework for cooperation between financial services regulators on innovation-related topics.”
The launch of GFIN follows the FCA’s proposal from earlier in the year to create a “global sandbox.” Prior to the launch of GFIN, a number of international regulators had signed bilateral cooperation agreements with the goal of improving information sharing on fintech innovation-related topics. However, GFIN seeks to build on this existing collaboration by allowing information sharing between international regulators on a “deeper, larger and quicker scale.”
In a consultation paper published in conjunction with the launch of GFIN, its three main functions are outlined as follows:
- Network of regulators: to act as a community of regulators to collaborate and share experience of emerging innovations in respective markets, including emerging technologies and business models;
- Joint policy work and regulatory tools: to provide a forum for collaborative policy work and discussions, with a view to support the work of standard-setting bodies; and
- Cross-border trials: to provide firms with an environment in which to trial cross-border solutions across multiple jurisdictions.
The Consultation Paper notes that the role of GFIN has evolved since the FCA initially announced its global sandbox proposition. While the FCA has conceded that the prospect of creating a “full multilateral sandbox that allows concurrent testing and launch across multiple jurisdictions” is “ambitious,” the establishment of GFIN nevertheless marks an important first step towards achieving this goal in some form.
The path to a global sandbox: The launch of the first national sandbox initiative in the UK
The FCA is well established as a leading voice (if not the leading voice) when it comes to financial regulatory innovation and it is no surprise that it has been the driving force behind GFIN.
The FCA was a trailblazer back in 2016 when it launched the UK’s financial regulatory sandbox. The UK sandbox was the first of its kind, underlining the FCA’s commitment to fostering and embracing innovation in financial services. The sandbox was established as part of the FCA’s Project Innovate, with the aim of creating a safe space for fintech innovators to trial new products in a “live” environment. The trials, which are restricted to a limited number of real consumers, are closely overseen by the FCA and subject to a “customized” regulatory framework.
Firms wishing to participate in the UK sandbox must meet the FCA’s detailed eligibility criteria and complete an application process outlining (among other things): (1) how their idea is innovative, (2) how their idea is expected to benefit consumers and (3) an overview of expected timelines and milestones.
The first sandbox received 69 applications from a diverse range of sectors, locations and sizes, of which 24 were accepted, and 18 went on to complete testing. The sandbox program has continued to attract significant interest from a diverse range of applicants across the globe in the two years that followed and, to date, the UK sandbox has supported over 70 companies. The sandbox is currently trialling its fourth cohort of participants and the FCA is accepting applications for its fifth cohort through November 30, 2018.
The UK example: A test case for the sandbox model
The UK sandbox is generally viewed as a great success for the FCA and the UK fintech industry. In October 2017, the FCA published a comprehensive “Regulatory Sandbox – Lessons Learned Report,” in which it evaluated the progress of the sandbox during its first year of operation and concluded that it had so far provided the “benefits it set out to achieve.” These benefits are outlined in the Report as follows:
- Enabling new products to be tested: During its first year of operation, 41 innovative projects had been tested as part of the sandbox program. Approximately 90% of the firms that completed testing were proceeding to a wider market launch and around a third of the firms tested used the learnings they gained from testing to significantly pivot their business model ahead of launch in the wider market.
- Reducing the time and cost of getting innovative ideas to market: Sandbox participants indicated that the ability to engage directly with the FCA has helped them have a better understanding of “how the regulatory framework applies to them, accelerating their route to market and reducing expenditure on external regulator consultants.”
- Improving access to finance for innovators: At least 40% of participants that completed testing in the UK sandbox had secured funding either during or after testing. Feedback from sandbox firms indicated that participation in the program provided a degree of reassurance to investors who otherwise might be reticent to invest in nascent technologies.
- Ensuring appropriate safeguards are built into new fintech products and services: Working closely with the FCA had allowed sandbox participants to develop their business models with consumers in mind and mitigate risks by implementing appropriate safeguards.
In addition to these very measurable benefits for participants, the introduction of the UK sandbox has served to reinforce the FCA’s reputation as a leading (if not the leading) global regulator in fintech innovation. The Report notes that the FCA’s experience working with sandbox participants gave them “valuable insights on market developments that can be shared across the wider organization to inform our supervisory activity and policymaking.” In other words, the sandbox has proved to be a two-way street, with the UK regulator as well as the participants themselves, reaping significant benefits.
European Union developments: Moving towards an “EU Experimentation Framework”?
Because the UK sandbox program is widely regarded as a resounding success for the FCA, it is not surprising that many other countries, including Singapore, Australia, Canada, Hong Kong, Malaysia and several European countries, have since followed in its footsteps and have adopted sandbox initiatives based on the UK model.
In March 2018, in its Fintech Action Plan the EU Commission noted that 13 EU member states had some form of a “fintech facilitator” (i.e., a regulatory sandbox or an innovation hub). Notable EU sandbox initiatives include France’s UNICORN program, which aims to “provide a framework for ICO organizers to develop their transactions and to ensure the protection of participating players and purchasers” and the Dutch regulatory sandbox, which aims to offer “more room for innovation, in order to enable market participants to roll out their innovative financial products, services or business models.” Other EU countries that have introduced sandboxes or proposals for sandboxes include Spain, Lithuania and Malta.
However, not all EU regulators are sold on the sandbox concept. For example, BaFin, the German regulator, has publicly ruled out the possibility of “little buckets and spades” for German fintech companies.
Other EU countries have favored a more middle ground approach with the introduction of some form of innovation hub, rather than a fully functioning sandbox. This is no doubt driven in part by the desire to “wait and see” whether any action is taken at EU-level in this area.
Certainly, in the Fintech Action Plan, the European Commission appeared to indicate that a cross-border, European-wide sandbox could be a possibility in the future. The Commission acknowledged the prevalence and successes of regulatory sandboxes across the globe, particularly in Australia, Singapore and Canada, and committed to presenting a report on best practices for regulatory sandboxes by Q1 2019. The Commission suggested that follow-up actions could include promoting the establishment of innovation hubs in all Member States and coordinating their operations. This process could in turn “lead to considering an EU experimentation framework for adopting and adapting to new technologies.”
The European Bank (EBA) has also recently announced its plans to issue a report and guidelines on cross-border fintech innovation in December 2018, which will include recommendations for the “core design of a sandbox and innovation hub.” Elisabeth Noble, a policy expert at the EBA told Reuters at a briefing that “we hope this report will lead to a common and more coordinated approach, to help with cross-border scaling up of fintech firms, which needs sandboxes and innovation hubs working together.”
While we will have to wait for those reports to issue to see exactly what is envisaged, it is clear that the EU is actively looking at the possibility of some kind of coordinated “experimentation framework” at EU-level that may include a form of cross-border sandbox.
U.S. developments: States leading the way?
In the United States, various federal initiatives have been introduced to generally promote fintech innovation, including the U.S. Commodity Futures Trading Commission’s LabCFTC, Financial Industry Regulatory Authority’s Innovation Outreach Initiative and the Office of the Comptroller of the Currency’s (OCC) Office of Innovation. However, the fragmented regulatory environment at state and national level has so far generally posed a barrier for the introduction of a substantive sandbox regime at federal level.
In the absence of a comprehensive sandbox program at federal level, certain U.S. states, most notably Arizona, have moved to fill the vacuum. In March 2018, Arizona became the first U.S. state to pass a law allowing for the establishment of a fintech regulatory sandbox program. Under the Arizona program, possible relief from state licensure is available to businesses that offer “innovative financial products or services.” Under the program, companies will be able to test their products for up to two years and serve as many as 10,000 customers before needing to apply for a formal license. The program also includes a “passporting” provision, which allows a participant in the Arizona program to operate in other jurisdictions with similar sandbox programs, and also allows participants in another state’s sandbox to operate in Arizona.
The Illinois General Assembly is also currently considering a bipartisan bill which would create a fintech sandbox program. The bill is currently working its way through the Illinois legislative process, and if passed in its current form, would be effective from January 1, 2019. It differs from the Arizona approach, in that companies would only have a 12-month maximum testing period, and only 5,000 Illinois consumers could use the innovative product, a number significantly lower than the 17,500 users allowed in some cases under the Arizona law.
As states move to fill the gap in the fintech regulatory landscape, there are also some signs that the tide may be beginning to turn at federal level. In August 2018, the U.S. Treasury Department published a long-awaited report which addresses fintech and financial innovation in the United States. The report calls for a radical overhaul of existing U.S. financial technology regulation, a new national fintech charter and for the introduction of regulatory sandboxes. At the launch of the report, Treasury Secretary Steven Mnuchin emphasised that “America is a leader in innovation. We must keep pace with industry changes and encourage financial ingenuity to foster the nation’s vibrant financial services and technology sectors.”
The release of the Treasury Department report coincided with the announcement by the US Bureau of Consumer Financial Protection (BCFP) of plans to launch its “Disclosure Sandbox.” While the precise details of the BCFP’s sandbox are light at this point, the project is being driven by Paul Watkins – who previously worked on the launch of the Arizona state sandbox – which suggests that the BCFP is taking the sandbox project seriously. It is notable that the BCFP is also a participating party in GFIN.
That said, the road to a fully functioning federal sandbox (let alone a global one) in the United States may be a long one. Any proposal is likely to face significant opposition from state regulators, who historically have been resistant to federal attempts to introduce mechanisms to reduce the regulatory burden for fintech companies. For example, when the OCC introduced its proposal for a special purpose national bank charter for fintech companies (commonly known as the fintech charter), it encountered sharp criticism and even lawsuits from the New York Department of Financial Services (NYDFS) and the Conference of State Bank Supervisors (CSBS). NYDFS and CSBS viewed the charter as an attempt to allow fintech companies to escape regulatory scrutiny and as an unlawful encroachment on state powers. Maria Vullo, the Superintendent for Financial Services for the New York State Senate, has expressed similar resistance in relation to the sandbox concept, quipping that “Toddlers play in sandboxes. Adults play by the rules.”
Moving towards greater international collaboration
While it is clear that not all quarters are, as yet, convinced of the merits of a national – let alone global – regulatory sandbox, the need for collaboration, both between agencies and between states, in the field of fintech regulation, is becoming an increasingly discussed theme among regulators.
This was a common theme for international regulators at the Money20/20 in Las Vegas, in October 2018. Paul Watkins of the BCFP expressed the view that “coordination at federal and state level” was imperative in solving scaling issues for fintech innovators. Brent McIntosh, General Counsel at the U.S. Department of Treasury referred to the challenges posed by “regulatory fragmentation” and was of the view that “working in lockstep with foreign partners” is an “enduring imperative” for combating regulatory arbitrage.
This need for regulatory collaboration was also a core theme highlighted by the European Commission throughout the Fintech Action Plan. In the Action Plan, the Commission proposed the establishment of an EU FinTech Lab where EU and national authorities would be invited to engage with industry players with a view to “raising the level of regulatory and supervisory capacity and knowledge about new technologies.” In addressing the “worldwide phenomenon” of cryptoassets, the Commission noted that “international coordination and consistency” were “essential” and indicated that it would be working with “supervisors, regulators, industry and civil society, both within the EU and with partners internationally, to determine any further appropriate course of [regulatory] action.”
GFIN looks to deepen and formalize existing frameworks for international coordination in the fintech space by “providing a more efficient way for innovative firms to interact with regulators, helping them navigate between countries as they look to scale new ideas. It will also create a new framework for cooperation between financial services regulators on innovation-related topics, sharing different experiences and approaches.”The overall approach would be to “better understand and solve common regulatory problems, as well as being more helpful to firms who have aspirations to grow at scale in multiple markets.”
The path ahead – towards a global sandbox?
The GFIN Consultation Paper notes that the operational model for GFIN has evolved since the FCA initially proposed the global sandbox proposition. The Paper indicates that the sandbox concept is a “component of the group’s function,” but “only one tool available.” GFIN acknowledges that the “degree to which different regulators are involved in each part of the sandbox could vary” and that there may also be an opportunity for “those regulators currently without sandbox type environments” to participate in certain functions. While this seems to be a more watered down version of the ground-breaking global sandbox proposition originally put forth by the FCA, it is nevertheless a first step towards achieving that goal in some form.
Following the launch of the Consultation Paper, GFIN is now in a preliminary phase and seeking feedback on a number of matters, including its core objectives and key priorities. The organizations involved in GFIN at present are: Abu Dhabi Global Markets; Autorité des Marchés Financiers (Québec); Australian Securities & Investments Commission; Central Bank of Bahrain; U.S. BCFP; Dubai Financial Services Authority; the UK Financial Conduct Authority; Guernsey Financial Services Commission; Hong Kong Monetary Authority; Monetary Authority of Singapore; Ontario Securities Commission; and Consultative Group to Assist the Poor (CGAP). The press release launching GFIN notes that “the eventual membership of the GFIN that take this project forward is still to be determined.” It specifically contemplates that other international regulators may get involved in the future, noting that GFIN is intended to be an “inclusive community of financial services regulators and related organisations.”
The fact that regulators from some of the world’s largest jurisdictions, such as the United States, Canada and the UK, are already involved in GFIN is important because their buy-in and support will be critical to GFIN’s success. It is particularly positive to see that the United States is involved – via the BCFP – and given Paul Watkins’ experience with the Arizona sandbox project, he would certainly seem to be the right person for the job to drive GFIN’s sandbox agenda forward. Commenting on the BCFP’s decision to join GFIN, Acting Director of BCFP, Mick Mulvaney, stated that the decision “demonstrates the Bureau’s commitment to promoting innovation by coordinating with state, federal and international regulators. We look forward to working closely with other regulatory authorities – whether in the United States or abroad – to facilitate innovation and promote regulatory best practices in consumer financial services.”
With the exception of the UK, other EU regulators are notably absent from the GFIN table. With the UK’s departure from the EU pending, this will effectively leave the EU unvoiced in GFIN. With the EU actively and publicly looking at the possibility of an EU-wide “experimentation framework” their absence in GFIN seems unusual. It is unclear what is driving the lack of participation, but perhaps it may be motivated in part by some reticence on the part of EU regulators to join an FCA-led project while the UK’s relationship with the EU post-Brexit (in particular from a financial services regulatory perspective) is still (at the time of writing) unclear.
Irrespective of the UK’s future relationship with the EU, GFIN has brought together many of the world’s leading regulators in a collaborative forum. Its core goals of facilitating international regulatory collaboration and providing scaling opportunities for fintech innovators are in line with key focus areas expressly highlighted by both the EU Commission and the EBA. One would certainly hope, in that context, that a potential outcome of the EU Commission’s “best practices” report and/or the EBA’s fintech innovation guidelines might include a recommendation or decision that one of the European supervisory authorities (ESMA, EBA or EIOPA) would take a seat at the GFIN table. This is something that could perhaps be explored as part of or in conjunction with the EU Fintech Lab.
It is yet to be seen how GFIN will operate in practice and it is far from clear given its “evolved” operational model that it will ultimately develop into a fully functioning global sandbox. Nevertheless, it is an important first step towards achieving that goal in some form and, to the extent that GFIN will support responsible cross-border experimentation, even to a limited degree, the potential benefits for innovative fintech companies doing business on a cross-border basis are huge. The potential benefits for regulators in terms of sharing and learning from each other’s experiences in their respective markets are also significant. In that context, the more international regulators we can see grabbing their “little buckets and spades” and taking a seat at the GFIN table in the years ahead, the better.
To follow the latest developments on FinTech regulatory initiatives, see Bloomberg Law’s FinTech Regulatory Relief Tracker.
This article was written by Gina Conheady, Corporate and M&A. First published by Bloomberg on November 21 2018 - Reproduced with permission from Copyright 2018 The Bureau of National Affairs, Inc. (800-372-1033) www.bna.com.
Date published: 27 November 2018