An Area to Play Freely
Fraudsters are the most innovative! Society always has questions to ask of regulators: where were you when the fraud was being perpetrated?
It is no wonder that the second most innovative player, the fintech, makes regulators nervous, too. If anything goes amiss, the same question will be asked!
If things go well, then a large new concept or player emerges making the regulator nervous about that, too! (Bitcoin, Apple Pay, Google Wallet etc.)
That is where regulatory sandboxes and innovation hubs come into play. A sandbox is a place where one leaves kids to play freely. And a regulatory sandbox?: that’s an area where the regulator allows Fintechs to play freely!
The idea is for the regulator to get a perspective on innovation in the financial space. This is important because fintechs have shown that innovation can lead to explosive growth. And for a fintech to experiment without wondering about a regulator later clamping down on the innovation it came up with. It is also true that the guys who know a lot about leveraging technology do not know, (or do not care to know) enough about all things financial.
At the “Innovation Hub” the fintech can check out an idea or a business model with a regulator. It can get some of its basic questions answered.
In the “Regulatory Sandbox”, the fintech’s concept is run as it would in real life and tested. Within the sandbox, real-world rules are not strictly applied. Regulators might approve things to help with the experimentation. That does not mean the regulator has agreed to waive regulations if and when the product is launched.
The European Banking Authority reviewed the experience with innovation hubs and regulatory sandboxes and released a report on January 7th, 2019. The principles it has laid out in that report might be more relevant for regulators.
But the document gives a good overview of the process fintechs must follow to use a Regulatory Sandbox:
1. Apply to participate in a sandbox
2. Prepare the testing parameters
3. Engage in the Test Phase where everything plays out under observation
4. Evaluation of outcomes
The end result is that the regulator might remove or add restrictions; or indicate the conditions under which the fintech can go full steam ahead!
The report presents a country-wise list of hubs and sandboxes available across Europe from different regulators and you can access the report here.
Clearly, the EU does not intend to be left behind in innovation; or maintaining a regulatory view on innovation. This is a wholesome view. If something is useful, let us not later end up shutting it down, after economic resources have been spent.
Of course, the American approach is quite different. (Though there, too, the same concept of sandboxes has been tested.)
In the USA, across sectors, there is almost always flat-out innovation, followed by blood-letting and then consolidation. The entity that emerges from the dust and smoke is often a super-corporation that dominates the space.