The Sandbox Network
With poetic license and my apologies to Shakespeare and his fans.
"...2nd Regulator:
By the pricking of my brains,
Something delightful this way comes [Knocking]
Open Locks
Whoever knocks!
[Enter Fintech/Finserv Stakeholders]
Fintech/Finserv Stakeholders:
How now, you secret, black, and midnight lord!
What is't we can all do?..."
Something indeed delightful this way is coming. Something that could become essential to the financial services industry, to fintech. Something that is materializing thanks to the keen insights and ground breaking intent of the Financial Conduct Authority (FCA) - the United Kingdom's financial regulator. That something is the FCA's regulatory sandbox (the Sandbox), which is the very first experimentation of its kind.
To date, regulation has been a top down affair, with either legislative fiat or regulatory fiat brought down to the industry. Some will argue that the industry is usually consulted at the regulatory or legislative level. Some will even argue that lobbies meddle and influence legislative or regulatory fiat. They will be correct. Yet, this does not mean these feedback loops that help shape financial services regulation are bottoms up in their approach. Incumbents or lobbies represent an industry do not talk for the base, for innovators, disruptors. I view the FCA's Sandbox initiative as the first bottom up approach to regulation.
Indeed the stated goals and benefits of such an endeavor are impressive:
for startups and incumbents the potential benefits are =>
- to lower the barrier and costs to testing and experimenting with a regulatory framework
- to lower the risk of misinterpreting existing regulation
- to receive tailored regulatory guidance
- to receive temporary waivers, "no enforcement action" letters in order to test a business model or technology live
- to build a more optimal path towards compliance and regulatory approval
for a regulator the potential benefits are =>
- to get educated as to innovation, new technologies and new business models
- to optimize market structure
- to protect consumers
- to inform and shape future regulation
- to modernize their own operations
- to promote healthy competition
- to encourage innovation
I wonder if bitcoin and the bitcoin blockchain early days and development would have been altered, for the better, had there been a tier one sponsored Sandbox where startups, hackers and incumbents would have been able to experiment and share with regulators.
Now that the FCA is embarking on this Sandbox journey, what next?
I expect regulatory wisdom and foresight to spread by osmosis. From what I understand the Monetary Authority of Singapore (MAS) is working on a similar scheme, unsurprisingly. In the United States, the Office of the Comptroller of the Currency (OCC) which regulates banking, is working on its own project. So is the Federal Depositary Insurance Corporation (FDIC). I know of no other project in the works, which does not mean regulatory brains are not in neuron overdrive at this very moment. Thusly I expect sandboxes to crop up all over the world. How these sandboxes will be architected and how they may, or may not, interact with one another will be fascinating to witness.
These twin "How" questions force us to take a closer look at the FCA. Why was the FCA first to market? What makes the FCA so special?
The FCA is one of the most sophisticated and respected regulators in the world. It rules over one time zone and an industry/economy/eco-system essentially centered around the greater London area. What is a Sandbox if not a platform for constant and incremental testing! The FCA is also a very independent regulatory body - one may say one of the most independent body in the world, unencumbered by political interference. The FCA does not suffer from a proliferation of regulatory competition in the UK as it stands alone with the Prudential Regulatory Authority (PRA). Finally, the FCA is, from what I can gather, an organization that is guided by "philosophical" tenets. This latter point is essential to understand as it allows the FCA to be a pragmatic caretaker of financial regulation that is opened to a/b testing and experimentation.
Let's take the United States as a counter example - and I will leave aside philosophical arguments centered around market solutions vs government solutions, libertarianism vs central action. The USA financial services industry "suffers" from a very complex regulatory landscape: 50 state examiners for the insurance industry, 50 state bank regulators, the FDIC, the OCC, the Treasury, the Fed, the SEC, the CFTC, FINRA (yes I like to joke around), FinCen (within the Treasury), the CFPB to name but the main ones. These various agencies sometimes overlap and often "compete" against one another which creates either areas of confusion and misunderstanding or gaps where no regulatory clarity exists. There are four time zones (not counting Alaska and Hawaii) and more than one metro geography (NY, Chicago, San Francisco, LA, Boston, Washington DC, Seattle...) that matter. Some will argue that political interference indeed occurs with various regulatory bodies (think of how a new administration impacts how the SEC behaves for example). Finally, main US regulators are guided by "rules" which does not allow them easily to experiment and tinker like the FCA does.
Absent the benefits derived from what defines the FCA, what would be the right architecture for a Sandbox, one that would ensure optimal results? I believe a Sandbox would need to incorporate a) a strong strand of "innovation management" DNA, b) a level of neutrality to ensure collaboration among all stakeholders (between regulatory bodies and between regulators and the industry), c) a level of independence to make sure profit or special interests do not hijack the overall mission and d) a deep and broad sophistication around various subject matters (regulation, legal, technology, financial services business models, startups, innovation).
This translates succinctly into a not-for-profit organization with a stable sponsorship base and an inclusive yet independent governance framework.
Now, picture a universe of Sandboxes, some like the FCA, some independent not-for-profit organizations. Some focused on one country, others focused on a group of countries. A US Sandbox, a LATAM Sandbox, a Brazil Sandbox, the UK Sandbox, a EU Sandbox, a Western Africa Sandbox, an Eastern Africa Sandbox, a South East Asia Sandbox, a China Sandbox...
Further, picture Sandbox cooperation, bilateral, multilateral, thereby creating a bottoms up network that would foster innovation, market structure optimization and financial inclusion by taking account of grass root technology and business models advances from startups, developers and incumbents. I know I am dreaming but, playing the FCA chess game several moves ahead I do not think such a vision is that far fetched, although the details when implemented may vary from my current crude vision.
Do remember that we do have top down multilateral cooperation around financial services regulation either at the State/Government level or international organization level. Why not multilateral cooperation from the bottoms up too, via Sandboxes, as powerful tools to augment the interplay between innovation and regulation?
ps: I enjoyed using as "props" both Shakespeare's Macbeth and an allusion to a movie about Mark Zuckerberg and Facebook. The supernatural phenomena that is Regulation and the omnipotent traits shared by a regulator and Zuckerberg will not have escaped readers.
On a mission to rid the world of grudge training
8 年The challenge for the FCA will be to balance the risk to the consumer if (when) something goes wrong with a sandbox initiative and the long term value driven by innovation. A great initiative that should encourage new entrants by lowering the upfront compliance barriers.
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8 年Thanks Pascal for a very interesting post. I was sitting back today thinking of concluding my draft of a fintech post addressing some recent announcements by the FCA and the ASIC. However your insightful post gave me cause to think. And I thought I would first start by penning my thoughts as a comment to your post. And if you don't mind I will carry on with the Shakespearean inspiration. The Sandbox - to quote Shakespeare - "What's in a name? That which we call a rose by any other name would smell as sweet". Poetry for fintech and regtech innovators. The FCA Sandbox opens its doors to applications on 9 May. Clive Christopher Woolard addressed the Sandbox regime in a speech earlier this month. In Woolard's words, "The firms that are successful will be able to test out their innovative ideas without immediately incurring all the normal regulatory consequences.". The FCA is tackling 2 main challenges: 1) the first one is how does it deliver a Sandbox that lowers barriers to testing within the existing regulatory framework; and 2) the second, how does it ensure that risks from testing novel solutions are not transferred from firms to consumers The Sandbox is not a panacea. Neither is it 'Much ado about nothing'. Firms still need to apply for authorisation and meet threshold conditions, but only for the limited purposes of the Sandbox test. So it is like getting a restricted driving license. Critically, this means authorisation tests, in the eyes of the FCA 'should be easier to meet and the costs and time to get the test up-and-running reduced.'. Then, and only then, after Sandbox testing, the firm can launch itself into full activity on a wider market PROVIDED IT satisfies the threshold conditions for that wider activity. So effectively, what we are talking about is INcremental PROportional REGulation, i.e. "regulation that starts in proportion to the scale of the concept being tested and can grow with the ambition of the full business model". [I claim founder's right in a new acronym, INPROREG!] There was indeed quite a lot of misguided talk within industry when the UK Sandbox was first muted, including that the FCA would remove authorisation requirements for Sandbox firms altogether. But this was never going to happen given the prominence of consumer protection. That's enough of the first challenge for this comment. And it provides the appropriate entry of the second challenge, i.e. how to ensure that the sandbox’s ‘safe space’ for firms does not transfer risks from firms to consumers. The FCA has broken this challenge into three elements: 1) It will only consider propositions where it is satisfied that there is a prospective direct or indirect consumer benefit. 2) There must be upfront testing parameters and customer safeguards agreed, appropriate to the propositions being tested and the types of customer and firm involved. 3) Every Sandbox firm MUST have a fair exit strategy for consumers. By way of example, a firm may just call a halt to business, or it may transfer customers to third parties. As to Pascal's point about the universe of Sandboxes, although we cannot point to any specific example of two regulators having forged a collaborative Sandbox, it will come. As Shakespeare wrote, 'We know what we are, but know not what we may be.' The good news is that under a world-first agreement, innovative fintech companies in Australia and the United Kingdom will have more support from financial regulators as they attempt to enter the others’ market. The agreement follows the creation of Innovation Hubs at the FCA and ASIC in October 2014 and April 2015. Provided the innovator business meets the eligibility criteria of their home regulator’s Innovation Hub, they can avail of support under the agreement. So for example, the ASIC will refer the innovator business to the FCA. Following the referral, but before the innovator business applies for authorisation to operate in the new market (see above), it gets access to a dedicated team who will help them to understand the regulatory framework in the market they wish to join, and how it applies to them. Following authorisation, the businesses will have a dedicated contact to turn to for a year. There is no mention of a joint Australian and UK Sandbox, but it stands to reason that that if the innovator business wanted to coincide the launch of its new innovative business model at the same time in both Australia and the United Kingdom, it might assign different aspects of the development to the UK and Australia. Thus lateral thinking by both regulators will be needed. For example, and its a crude one, think about developing a new robo-adviser offering. One would not want to see the development, at the Australian Sandbox, of infrastructure to distribute robo-adviser services to consumers being jeopardised by restrictions imposed at the UK sandbox on the technology or machine logic being develop used to confirm that the investment is suitable under consumer protection rules. In any event, it is great to see such regulatory collaboration between the FCA and ASIC, given that their respective fintech industries have (estimated) revenues of ￡6.6bn and ￡0.7bn a year, with both growing rapidly. So rapid in fact that we should end with these words from the literary great - "Wisely, and slow. They stumble that run fast."