Regulatory Sandboxes Provide “Safe Spaces” for Fintech Payment Services Innovation

Regulatory sandboxes typically involve temporary relaxations or adjustments of regulatory requirements to provide a “safe space” for startups or established companies to test new technology-based financial services in a live environment for a limited time, without having to undergo a full authorization and licensing process.²

Some governments are implementing sandboxes as part of broader innovation initiatives, as they compete to create regulatory environments attractive to fintech innovators.^3,4 Pioneered in the U.K. in 2015, the sandbox approach is spreading rapidly; sandboxes are now at various stages of development and implementation in countries including Australia, the U.S., Hong Kong, Malaysia, Singapore, Switzerland, Thailand, and United Arab Emirates.^5,6,7

Here’s a roundup of several key national sandbox initiatives, highlighting the similarities and differences among them.

U.K. Sandbox Attracts Blockchain Payment Services

The U.K. was the first country to implement a regulatory sandbox, announcing the approach in 2015 and approving the first sandbox fintech services in 2016.⁸ In the U.K. process, companies must apply to the U.K. Financial Conduct Authority (FCA) to gain approval to test their services in the sandbox.⁹ If approved, each company is granted a customized authorization, including individual guidance and potentially including waivers to regulations if necessary, according to the FCA. The company can then test the service, with real customers, as long as it stays within the authorized parameters, the FCA says. Each firm has to report to the FCA during its sandbox test period.¹⁰ If, after sandbox testing, the firm wants to launch the service commercially, it can do so if it satisfies the regulatory conditions for that wider activity.¹¹

The U.K. uses a “cohort” approach that it likens to a technology accelerator, initially accepting two batches of applications per year with the first deadline in July 2016. The FCA assesses applications based on criteria including their innovativeness, benefit to customers, and readiness for live testing.¹²

From the first batch of 69 applications, the FCA approved a cohort of 24 services. These included cross-border and domestic payments solutions based on blockchain technology; several mobile apps that help consumers manage their finances; platforms for managing securities; and new lending products. Though many of the successful applicants are startups, some are established banks and other organizations.¹³

Australia Opens the Sandbox for Payment Services

Australia’s sandbox, introduced in December 2016, differs from the approach in the U.K. and some other countries in that it doesn’t require companies to apply for individual approval. The Australian Securities & Investments Commission (ASIC) issued an industry-wide waiver allowing eligible fintechs to test certain services without a license, as long as they meet specified conditions and inform ASIC.^14,15

The waiver only applies to a narrow set of services, however: they include distributing or advising on insurance products, some securities and some payment solutions from licensed financial institutions. The sandbox lets businesses test services for up to 12 months with up to 100 retail clients, as long as total customer exposure doesn’t exceed AU$5 million.¹⁶

For services that don’t meet these conditions, fintechs can apply for individual waivers under pre-existing guidelines, an approach that ASIC says is similar to the sandbox frameworks in other countries.¹⁷

U.S. Kicks off Sandbox Regulation

In the U.S., Congressman Patrick McHenry proposed sandbox regulation in September 2016 as part of a new bill, Financial Services Innovation Act of 2016 (H.R. 6118.), reportedly seeking to get the legislation passed in 2017.¹⁸ If enacted, the bill would create a framework with some similarities to the U.K.’s sandbox, with fintechs required to apply to regulatory agencies and demonstrate that their innovations serve the public interest, improve access to financial products and services, and do not impose undue risks to consumers or the financial system.

If approved, companies would receive a license to operate under an agreement that waives or modifies regulation that is out-of-date or unduly burdensome. However, the proposed framework would differ from the U.K. in that it would involve multiple agencies, including the Federal Reserve Board, the Treasury Department and the Securities and Exchange Commission. Each would be required to set up a Financial Services Innovation Office that identifies regulations that might be waived or modified for fintechs, works with fintech proposals, and approves them for the sandbox.²⁰

Sandboxes Proliferate Worldwide for Fintech Payment Services

Sandbox initiatives have also been launched or are in development in other countries in Europe and Asia. In November 2016, Switzerland’s government called for regulatory framework changes for fintech services including online payment solutions. The changes would enable fintechs to offer services without a license and without agency monitoring, as long as the total public funds accepted do not exceed 1 million Swiss francs.²¹ The same month, the European Banking Federation presented a vision paper recommending the creation of a Europe-wide fintech sandbox that would let companies experiment with new cross-border financial services.²² Singapore, Malaysia, Hong Kong, Thailand, and the United Arab Emirates have all proposed or created sandbox frameworks.^{23,24,25,26,27}

The Takeaway:

The sandbox approach is rapidly spreading worldwide as nations seek to attract fintech innovation. Different countries are exploring a variety of approaches, but all these regulatory initiatives are at an early stage. If successful, the sandbox approach has the potential to help speed the introduction of a wide range of new services, including online payment solutions.

Sources

1. In computer security jargon, a sandbox is a mechanism for separating and safely running untrusted or unverified programs without endangering the entire system. “Sandbox (computer security)", Wikipedia; https://en.wikipedia.org/wiki/Sandbox_(computer_security)
2. Regulatory sandbox, U.K. Financial Conduct Authority; https://www.fca.org.uk/publication/research/regulatory-sandbox.pdf
3. "U.S. House Bill Aims to Set Up ‘Sandbox’ for Fintech Innovation", The Wall Street Journal; https://www.wsj.com/articles/u-s-house-bill-aims-to-set-up-sandbox-for-fintech-innovation-1474539893
4. "Australia’s FinTech priorities", The Treasury, Australian Government; http://fintech.treasury.gov.au/australias-fintech-priorities/
5. "Overview of Regulatory Sandbox Regimes in Australia, Hong Kong, Malaysia, Singapore, and the UK", University of Oxford; https://www.law.ox.ac.uk/business-law-blog/blog/2016/12/overview-regulatory-sandbox-regimes-australia-hong-kong-malaysia
6. Financial Technology Regulatory Sandbox Framework, Central Bank of Malaysia; http://www.bnm.gov.my/index.php?ch=en_press&pg=en_press&ac=4273&lang=en
7. "Hong Kong to create fintech ‘sandbox’ allowing bank experiments", Financial Times; https://www.ft.com/content/38a662ee-740f-11e6-bf48-b372cdb1043a
8. Regulatory sandbox, U.K. Financial Conduct Authority; https://www.fca.org.uk/publication/research/regulatory-sandbox.pdf
9. Ibid.
10. Ibid.
11. Speech by Christopher Woolard, FCA Director of Strategy and Competition; https://www.fca.org.uk/news/speeches/innovate-finance-global-summit
12. Regulatory sandbox, U.K. Financial Conduct Authority; https://www.fca.org.uk/publication/research/regulatory-sandbox.pdf
13. "Regulatory sandbox – cohort one", U.K. Financial Conduct Authority; https://www.fca.org.uk/firms/project-innovate-innovation-hub/regulatory-sandbox#cohort1
14. "ASIC releases world-first licensing exemption for fintech businesses", Australian Securities & Exchange Commission; http://asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-440mr-asic-releases-world-first-licensing-exemption-for-fintech-businesses/
15. "Making sense of ASIC's regulatory sandbox", Fintech Business; http://www.fintechbusiness.com/blogs/581-making-sense-of-asic-s-regulatory-sandbox
    
16. Licensing exemption for fintech testing, ASIC; http://download.asic.gov.au/media/4112096/licensing-exemption-for-fintech-testing-infographic.pdf
    
17. "ASIC releases world-first licensing exemption for fintech businesses", Australian Securities & Exchange Commission; http://asic.gov.au/about-asic/media-centre/find-a-media-release/2016-releases/16-440mr-asic-releases-world-first-licensing-exemption-for-fintech-businesses/
18. "U.S. House Bill Aims to Set Up ‘Sandbox’ for Fintech Innovation", The Wall Street Journal; http://www.wsj.com/articles/u-s-house-bill-aims-to-set-up-sandbox-for-fintech-innovation-1474539893
19. "McHenry Introduces Financial Services Innovation Act of 2016", U.S. Congressman Patrick McHenry website; http://mchenry.house.gov/news/documentsingle.aspx?DocumentID=398355#sthash.RFyY4XD0.dpuf
20. H.R.6118 - Financial Services Innovation Act of 2016, U.S. Congress; https://www.congress.gov/bill/114th-congress/house-bill/6118/text
21. Reduction of barriers to market entry for fintech firms, Swiss Confederation; https://www.newsd.admin.ch/newsd/message/attachments/45938.pdf
22. EBF presents vision for banking in the digital single market, European Banking Federation; http://www.ebf-fbe.eu/wp-content/uploads/2016/11/EBF_024052-Press-release-EBF-Vision-for-Banking-in-the-Digital-Single-Market.pdf
23. "MAS FinTech Regulatory Sandbox", Monetary Authority of Singapore; http://www.mas.gov.sg/Singapore-Financial-Centre/Smart-Financial-Centre/FinTech-Regulatory-Sandbox.aspx
24. "Financial Technology Regulatory Sandbox Framework", Central Bank of Malaysia; http://www.bnm.gov.my/index.php?ch=en_press&pg=en_press&ac=4273&lang=en
25. "Hong Kong to create fintech ‘sandbox’ allowing bank experiments", Financial Times; https://www.ft.com/content/38a662ee-740f-11e6-bf48-b372cdb1043a
26. "Thailand sets up fintech sandbox", FinExtra; https://www.finextra.com/newsarticle/29475/thailand-sets-up-fintech-sandbox
27. "Abu Dhabi Global Market sets out proposal for fintech regulatory framework in the UAE", Abu Dhabi Global Market; https://www.adgm.com/mediacentre/press-releases/abu-dhabi-global-market-sets-out-proposal-for-fintech-regulatory-framework-in-the-uae/