Regulatory Sandboxes: Fintech Innovation at the Cost of Deregulation?
At an international seminar on Regulatory Innovation for the Growth of New Technology and New Businesses in Seoul on November 15, 2019, AUWCL Associate Professor of Law Hilary J. Allen discussed the pros and cons of “regulatory sandboxes.”
The financial industry is highly regulated, and so technology entrepreneurs seeking to enter the financial services market often face significant regulatory barriers to entry. Responding to these challenges, several jurisdictions around the world have adopted “regulatory sandboxes” designed to allow innovators to conduct a limited test of fintech products and services in a lenient regulatory environment. The UK’s Financial Conduct Authority was the first to implement a fintech regulatory sandbox in 2016. Since then, a number of other jurisdictions followed its lead, including Australia, Bahrain, Brunei, Canada, Hong Kong, Indonesia, Malaysia, Mauritius, the Netherlands, Singapore, Switzerland, Thailand, and the United Arab Emirates.
There has been significant variance in the forms of the regulatory sandboxes. The term “regulatory sandbox” often means different things in different places. Depending on the jurisdiction, sandboxes may be adopted in order to support financial innovation and fintech firms who are seeking to offer innovative new products, services or business models; foster a financial services system that is more efficient and manages risks more effectively; understand how emerging technologies and business models interact with the regulatory framework and where it may lead to barriers to entry; promote effective competition in the interest of consumers; and promote financial inclusion for consumers.
Except in the immediate aftermath of a crisis, many countries lack constituencies advocating in an organized and systematic manner for improved consumer protection and financial stability regulation. To the extent that regulators agree to roll back consumer protection and financial stability regulations for firms conducting sandbox trials, regulatory sandboxes can be viewed as a type of deregulation that can harm an unrepresented public. It might be theoretically possible to replace consumer protection and financial stability rules with alternative arrangements, such as principles-based regulatory regimes, that are less burdensome on innovators but have some degree of effectiveness in protecting consumers and financial stability. However, principles-based regimes can easily devolve into deregulation if they are not properly staffed and resourced. Such an outcome is particularly likely if the subject matter of the regime is highly complex and thus may defy regulatory understanding and incentivize deference to the regulated industry. This may become a real concern when dealing with complicated financial algorithms and other fintech innovations. Sandboxes thus have very real deregulatory potential, but they can also afford some benefits to financial regulators seeking to promote consumer protection and financial stability. All such regulators share the need to understand the technology that is used to provide financial services, and the most beneficial aspect of a regulatory sandbox is that it provides a partial solution to the informational challenges that financial regulators face when dealing with new technologies. Therefore, Professor Allen concluded that sandboxes should be carefully designed to maximize information production and sharing, and to minimize harms to consumers and the financial system.