Regulatory Sandbox Models-Part I


Introduction:

Silicon Valley has (finally?) caught up with Wall Street. As the use of technology dis-intermediates the traditional banking model (that constitutes bundling up liquidity transformation and payments and generally upends/changes the financial sector through use of blockchain, alternative currencies among other things, the “Bee watchers” (H/T Dr. Seuss) of the financial sector globally, the regulators, are gearing up to stay lockstep with the developments. One innovation that has gained a lot of traction in the past few months is a “Regulatory Sandbox”.


What Is A Regulatory Sandbox?

It is trite that financial markets are heavily regulated including through “gatekeeping” instruments like minimum capital, licensing and so forth. While these policy tools act as natural hedge and play a role in maintaining stability/resilience of the financial system, their presence acts as a market barrier for enterprising founders to “shake things up” and thus chills innovation. This entrenches the incumbents and can have anti-competitive impact, potentially even hurts financial inclusion.

Enter the Regulatory Sandbox. It is, “a safe space for firms to test new ideas without incurring all the normal regulatory consequences.” In other words, a Regulatory Sandbox will exempt new ideas from some of the regulatory “eligibility conditions” conditions (and mandate other more fundamental ones) to permit innovation in a “controlled environment” for a limited time. This has two direct benefits. For the innovators, the Regulatory Sandbox initiative operates to reduce the market barrier. For the regulators, it enables them to be proximate to innovation and stay lock-step with how technology can facilitate banking/finance transactions, potentially reduce some risks and also increase formalization. Moreover, proximity to change will likely mitigate the risk aversion on the part of regulators. As Justice Brennan said in another but related context, “sunlight is the best disinfectant”.

A Cross-Country Comparison Of Sandbox Models

Regulators in Singapore, UK, Australia, HK and Malaysia have notified a framework for Sandbox. Although at an altitude, a regulatory sandbox is a great idea. But upon studying the several countries that have implemented it, there’s devil in the detail. Here’s a comparison of the respective frameworks


United Kingdom

Significant UK Nexus:The firm must be looking to deliver innovation that is a regulated business in the UK fin. Services market, or supports a regulated business in the UK fin. services market.

Genuine Innovation:The innovation should be a significantly different innovation in the marketplace.

Consumer Benefit: The innovation must offer a good prospect for identifiable benefit to the consumers.

Need for Sandbox: A genuine need for sandbox would be if the innovation cannot be offered to real customers unless exempted from some regulatory eligibility requirements.

Testing-Ready:The firm should have the resources for live-testing including risk-mitigants for consumers’ funds if the latter’s money is on the hook.