Innovation implies challenging the status quo. Such status quo, at least in densly regulated sectors like banking and finance, is often propped by standards and regulations intended to safeguard consumers' interests as well as the wellbeing (and stability) of the market. However, hefty regulation often implies a barrier to entry for new undertakings, especially those working with edge technologies and innovatory concepts.
Regulatory sandboxes propose a temporary relaxation of such regulatory requirements, allowing innovating entrepreneurs a chance to develop products in strongly regulated sectors. As of late, fintech has become a common term.
The ‘sandbox’ concept has migrated into regulatory from tech, where software developers usually test out their code in isolated sandbox environments before going into live production. This enables the identification of critical oversights and ironing-out most bugs before going live, after which all such glitches may translate into higher costs for fixes and higher potential reputational damage due to the larger scale roll-out and systemic dependencies created.
The first regulatory sandbox program was implemented in the UK by the Financial Conduct Authority (FCA) and opened for applications in 2016. Since then, a series of jurisdictions have also debuted sandbox-type programs, such as Australia, Canada, Singapore, Hong Kong, South Korea, as well as the state of Arizona. Recently, the FCA announced its intention for a global sandbox program, giving companies the opportunity to engage in testing their products in multiple jurisdictions and encouraging cross-border cooperation between regulators.
How regulatory sandboxes work
A regulatory sandbox allows companies to test their business concepts directly on the live market, without the full and immediate regulatory hurdles usually imposed on products or services related to banking, remittance, financial services, or other products or services operating in heavily regulated sectors. The interest of consumers is safeguarded via the close observance and hands-on approach employed by the regulating authority running the sandbox.
Usually, companies undergo an application process to qualify into a regulatory sandbox. After being admitted, the business model, product, or service is tested on the live market with observance to the recommendations and safeguards pre-tailored by the regulating authority, which maintains a close and engaged contact with the business and closely monitors the development and the outcome of the exercise.
What good can come out of regulatory sandboxes?
Companies working with edge-technology concepts can go live faster and test out their prototypes under direct regulatory oversight. This renders faster market insight and facilitates more agile product development as well as faster capital accumulation. Additionally, startups can benefit from reputation gains: such close contact with authorities may provide reassurance to potential investors and may prove a competitive advantage in the later stages of product development.
Sandboxes can prove an efficient way of taking to market novel products which are hard to circumscribe under an existent regulatory framework, such as products based on distributed ledger technology (DLT). According to the FCA, the most popular technology employed across sandbox tests utilized some form of tech based on DLT. Firms tested digital corporate governance tools, debt instrument issuance, and cross-border payment systems, which were all based on blockchain tech. In some cases, the FCA worked to prevent potential risks, imposing, for instance, that DLT-based money remitters had put in place proper guarantees, in the event the digital tokens used to transfer value would unexpectedly disappear from the digital ledger.
Government and innovators working side by side
A general attribute of regulatory sandboxes is that government regulators must work closely together with innovators. This can prove to be a win–win: one the one hand innovators hit the regulatory ground running, getting a good overview of possible upscale requirements, whilst on the other hand regulators benefit from an innovation feedback loop, gaining the ability to anticipate imminent changes on the socio-economic scene. Early contact with disruptive technologies and new economic concepts can prove beneficial to governments as one could argue that we have passed the era in which regulating Uber, Airbnb, or cryptocurrencies out of existence was an option on the table.
Sandboxes allow regulators to understand and foresee new product trends and directions of market evolution and can grant proactive regulators a head-start in adapting the incumbent regime to better suit both the needs of entrepreneurs as well as consumers. One FCA report on the regulatory sandbox program relays that FCA agents working with sandbox companies which employed DLT gained first-hand experience with regard to this new technology and managed to identify possible risk points, such as digital currency volatility risk. Of course, this implies a willingness from regulators to step away from the classic approach employed in most legislatures and assert positive involvement as well as assume responsibility in delivering regulatory guidance to innovators.
An added benefit is that regulators gain valuable insight regarding the hurdles of sandbox innovators. For instance, the FCA reported that it has learned from sandbox experiences that innovators in the financial sector face significant barriers imposed by ‘derisking’ measures employed by certain banks, to the detriment of innovating companies which work with edge technologies. In the future, raised awareness regarding such practices might determine government action.
At the time of writing we were not aware of any intention or effort undertaken by Romanian authorities to implement any type of regulatory sandbox program or any other means of facilitating innovators and start-ups to navigate through meandering regulatory requirements.
From a policy standpoint, at least regarding fintech and other emerging sectors, there should be a vibrant competition between EU member states over which would offer the most useful regulatory sandbox framework, or the leanest regulatory track to take a product from concept or MVP to a ‘go-to-market’ fully-compliant product. Come Brexit, member states which offer such facilities would have a significant advantage in becoming the next EU innovation hub from where innovators could passport their services throughout the single market.