Last month, the UK Financial Conduct Authority (FCA) published its "Regulatory Sandbox – Lessons Learned Report". In the Report, the FCA evaluated the progress of the UK financial regulatory sandbox during its first year of operation and tentatively concluded that the initiative has so far been a success.
The UK regulatory sandbox was the first of its kind and its introduction has helped to bolster the FCA's reputation as a leading global regulator and London's reputation as a global center for fintech innovation.
Other leading fintech hubs have been quick to follow in the UK's footsteps, with jurisdictions like Switzerland, Dubai, and Singapore each introducing their own forms of regulatory sandbox based on the UK model. Canada also introduced its version of the sandbox earlier this year and, in September, Quebec's Autorites des marches financiers (AMF) became the world's first regulator to oversee an initial coin offering (ICO) as part of a sandbox program, with the high profile launch of the Impax Coin ICO.
Even a number of smaller jurisdictions - including the Netherlands, Lithuania and Malta - have recently launched or announced sandbox plans – no doubt in an effort to ensure they don't miss out on the opportunities presented by the current wave of monumental growth in global fintech innovation.
The US is notably absent from the list of countries that have adopted or are in the process of adopting a sandbox regime. While various federal initiatives have been introduced to generally promote fintech innovation (such as the US CTFC's LabCFTC, FINRA's Innovation Outreach Initiative and the OCC's Office of Innovation), a proposal for a substantive regulatory sandbox regime in the form of the Financial Services Innovation Act of 2016 died in the previous Congress and has not been reintroduced. According to Bloomberg Law, an attorney from the Federal Reserve Bank of San Francisco recently acknowledged that US financial regulators are behind their counterparts in other jurisdictions, including the UK and suggested that sandboxes are not something that "we in the United States are going to be using much in the near future".
At EU-level, in a report on its vision for banking in the EU's Digital Single Market in November 2016, the European Banking Federation (EBF) called on the European Commission to adopt an EU-wide approach to regulatory sandboxes. While Olivier Guersent of the European Commission's financial services and capital markets directorate told Law360 last year that EU officials are "tentatively weighing a scheme to help firms road-test ideas and formulate strategy away from the glare of regulators", the EU's executive arm has yet to take any definitive steps towards introducing a substantive EU-wide sandbox regime.
With the UK Report indicating positive results for the UK sandbox so far, perhaps now is the right time for the European Commission to step up its efforts and really focus on getting an EU-wide sandbox initiative off the ground.
The Benefits of a Sandbox Initiative
The UK Report concluded that the UK sandbox was so far providing the "benefits it set out to achieve". These benefits are outlined in the Report as follows:
- Enabling new products to be tested: As part of the UK sandbox program, 41 innovative projects have so far been tested. Approximately 90% of the firms that completed testing are 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. The projects tested cover a wide range of sectors and technologies, including distributed ledger technology, robo-advice, biometrics and more.
- 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 secured funding either during or after testing. Feedback from sandbox firms indicated that participation in the program provided a degree of reassurance to investors that 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 has 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, the introduction of the sandbox has served to reinforce London's position as a global center for fintech innovation, with the program attracting fintech projects not just from the UK, but also from Singapore, the US and Canada.
Equally, it has reinforced 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 organisation to inform our supervisory activity and policymaking".
No doubt these insights will help to ensure that the FCA remains at the forefront of fintech supervision and policymaking into the future – which will be more important than ever for the UK in a post-Brexit environment.
The Case for an EU-Wide Sandbox Initiative
The introduction of an EU-wide sandbox initiative would similarly help to position the EU – as a bloc - at the center of global fintech innovation.
We have already seen several countries within the EU introducing sandbox proposals at national level. With countries like France, Germany and Ireland now vying to position themselves as the fintech capital of Europe in anticipation of the UK's exit from the EU, we will no doubt see other EU countries following suit in the near future. Indeed, just last week, we saw France's financial regulator launch its UNICORN program for ICO organizers - which is being viewed by some as France's sandbox for ICOs.
While this is a positive development at national level for the countries involved, most fintech companies doing business within the EU do not operate at national level only. Distributed ledger technology, in particular (which has been the most popular form of technology trialled to date in the UK sandbox), is international in nature. To that extent, the ability to access customers across the EU is generally an important factor as these companies grow and scale. An EU-wide sandbox regime could allow for "sandbox passporting" across the EU such that a project admitted to a sandbox in one EU jurisdiction could be tested on customers throughout the EU. For fintech innovators, this would mean access to a larger and more meaningful market for testing and introducing new products, which should ultimately help to drive innovation and reduce the time and costs involved in getting products to market.
With countries introducing sandbox initiatives at national rather than EU-level, certain EU countries will inevitably emerge as more "innovation friendly" (or, depending on your perspective, "light touch"). While this is not necessarily a bad thing of itself, it creates a patchwork and uncertain business environment for fintech companies operating on a cross-jurisdictional basis in the EU.
A country-by-country approach can also lead to patchwork consumer protection standards for EU citizens. Implementing a set of baseline safeguards that apply to sandboxes throughout the EU would serve the dual purpose of providing certainty for fintech innovators doing business on a cross-border basis (which in turn should ultimately reduce the costs and time involved in getting products to market), while also ensuring that EU consumers are subject to minimum protections throughout the EU.
The UK sandbox program has so far provided a jumpstart to over 41 projects – ranging in nature from distributed ledger technology to robo-advice, biometrics and more. Almost all participants have progressed to a wider market launch and over 40% have secured investment. Anecdotally, participants have indicated that participation in the program is seen as a "stamp of approval" by investors who might otherwise be reluctant to engage with fintech companies working with nascent financial technologies.
From the UK regulator's perspective, working closely with participants has allowed it to ensure that appropriate safeguards are incorporated into new technologies. It has also gained invaluable market knowledge and insights that it will use to inform "ongoing policymaking and supervision work". This insight and experience will no doubt help to ensure that the FCA - and the UK - remain at the forefront of fintech innovation and fintech policymaking into the future.
Overall, the initiative has been a clear success for the UK, and regulators around the globe have already recognized this, with many countries, including within the EU, introducing sandboxes of their own, based on the UK model.
While these developments will no doubt have a positive impact for the fintech industry, a country-by-country approach also presents challenges for fintech businesses, which are frequently inherently international in nature. A patchwork, country-by-country approach can create uncertainty and complexity, and ultimately drive up the timeline and costs of getting innovative ideas to market.
An EU-wide framework, that offers certainty for sandbox projects across the EU, should help to reduce the complexity, timeline and costs of launching new and innovative ideas across the EU and ultimately should accelerate the pace of fintech innovation. The ability to test products on a cross-border basis should also facilitate more meaningful testing which should in turn lead to better quality and more effective products and services when it comes to a wider market launch. The adoption of an EU-wide framework would also ensure that consumers across the EU are protected by minimum safeguards during sandbox testing and that appropriate safeguards are incorporated into products and services after testing concludes.
With the UK's pending exit from the EU, global competition to attract the world's leading fintech innovators is set to become tougher than ever. The adoption of an EU-wide sandbox regime will help to ensure that the EU – as a bloc – remains front and center in that competition.