Sandboxes and Quicksand

John Collins
Jun 11, 2018 · 4 min read

I’ve written before about how I believe regulatory “sandboxes” for financial services innovation serve a useful function and, in absence of federal action, states should establish them.

Since that time Arizona passed legislation to establish a “sandbox”, other states are trying and there are continuing and active discussions in my home state of Delaware around how to support financial services innovation.

Last week I had the opportunity to testify before the Maryland Financial Consumer Protection Commission, chaired by former CFTC Chair, Gary Gensler. The hearing was intended to gather information regarding cryptocurrencies, cryptocurrency exchanges, ICOs, and blockchain technology. You can read my full, written testimony, here. I took the opportunity to talk about those things and give a plug for regulatory “sandboxes” because I think crypto and blockchain projects are excellent candidates for such programs.

[I’ll note that my fellow panelist — Jonah Crane, former Deputy Assistant Secretary at the U.S. Treasury and now Executive Director of the RegTech Lab in DC — also discussed “sandboxes” in his testimony. The RegTech Lab released a lengthy and excellent analysis of sandboxes across the world last week. I’ll be writing a separate post discussing that report.]

With that in mind, I read with great interest Maria Vullo, the new Superintendent of the New York Department of Financial Services’, speech to the Exchequer Club delivered last Wednesday. The speech touches on a number of different topics across the financial services landscape (including the BitLicense) and is largely a rebuke of the current Administration, its policies, and its overall regulatory worldview. It’s an excellent and provocative speech and I urge everyone to read it.

However, one passage in particular caught my attention.

There are those who argue that the mere utilization of financial
technology alone somehow grants them an exemption from the rules that
banks and other financial institutions follow to manage risk and protect
consumers. I have been highly vocal on myriad fronts in my opposition
to this view, which would permit any company that calls itself a fintech to engage in a form of regulatory arbitrage, either with no regulator or in
a so-called sandbox. A sandbox is where toddlers play. Adults play by
rules and if you engage in banking activities, that means you are
responsibly regulated in order to protect the customers. Period.

I don’t disagree with the overall sentiment of Ms. Vullo’s statement: financial services is highly regulated for a reason and the responsibilities of a financial services company should be higher than that of a photo sharing app. (I stole this from Jeremy Allaire.)

Where I disagree with Ms. Vullo is in the representation of so-called “sandboxes” as a no-mans land of unregulated financial services offerings and the companies who want to discuss new ways of testing financial technologies as “toddlers”.

No one serious is arguing for that type of construct — and if they are, they should stop. And while many of these companies have too many people riding scooters, they aren’t toddlers.

Her description of “sandboxes” sounds more like quicksand. It’s dangerous. In my view, it doesn’t accurately reflect what market participants need or desire — and it doesn’t accurately represent what governments are implementing around the world.

I’ve come to the conclusion that the term “sandboxes” is a bad one. It reinforces the visual that Ms. Vullo portrays in her speech and it portends a lack of seriousness that is needed when discussing about financial services.

I have stolen the term “Greenhouse” from Rob Morgan and my former colleagues at ABA. I think it more accurately represents what is being attempted. Namely, it’s a place that financial technology solutions can be safely seeded, fed, and controlled.

Those that grow to potential are moved to the real world.

Those that fail are filled in with new seeds.

And the weeds — are cut down.

Fundamentally, these greenhouses aim to relieve the tension between innovation and technology. As technology has (for the most part) finished its disruption of unregulated industries — it has now moved on to the regulated ones.

Testing is inherently necessary for the development of good technology. Disallowing it inhibits innovation, increases the chance of poor technology, and pushes innovators into gray areas that provide little or no transparency for regulators and makes fulfilling their mandate more difficult.

Rather than a “trust but verify” model whereby the regulator accepts an application, allows the business to operate, and checks compliance after operations begin — a greenhouse allows for the solution to be examined in real time.

A few months ago, the UK FCA published a report detailing their “lessons learned” from their experiences over the past several years.

There are certainly problems in the implementation and execution of such programs — Jackson Mueller ofthe Milken Institute has opined on some of these issues, which include: picking winners and losers, maintaining fairness, finding solutions that actually need such a construct in order to do testing, etc.

Primarily, however, it appears the exercise promotes a two-way conversation between regulators and industry, forces government to make guidance easier to find and understand, and helps companies lower the cost of compliance or quickly pivot away from solutions that might not work, avoiding the waste of time and precious investment dollars.

These are all things we should be promoting — no matter what we call it.

— —

Thanks to a myriad of colleagues who informed this piece at one point or another, including, Rob Morgan, Brian Knight, Jackson Mueller, JC Boggs, Megan Hannigan, PJ Hoffman and many others.

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