Regulatory Sandbox: Can Innovation and Regulation Coexist?

The financial technology (fintech) industry continues to heat up globally, as entrepreneurs seek to find new and creative ways to improve access to and delivery of financial services. Many different countries and regions are jockeying for position as the home of the world’s leading fintech hub, including Singapore, Sydney, and London.

In order to nurture further growth within the UK fintech community, the Financial Conduct Authority (FCA), the country’s financial regulator, announced in November 2015 the introduction of a regulatory sandbox that will allow businesses to safely test new financial products and services without having to fear facing disciplinary regulatory actions. This is part of the FCA’s year-old Project Innovate initiative that is intended to encourage innovation and promote competition for fintech in the UK.

Fintech Regulation: Help or Hindrance?

When the subject of industry regulation comes up in discussions about startups, a sense of tension often builds in the room as a result. In the United States, some startups have resisted and fought against regulatory actions because they believed it didn’t support free-market principles and stifled innovation. The Financial Crimes Enforcement Network (FinCEN), the U.S. financial regulator, announced in May 2015 that it was imposing fines on a fintech startup for failure to comply with anti-money laundering (AML) and counter-terrorist funding (CTF) requirements. It’s not surprising, therefore, that many startups are wary of the impact of regulations.

However, some startups have a more positive outlook on regulatory regimes. In the UK, in fact, fintech startups have gone so far as to implore the FCA to provide clear regulations for their industry. . Simply put, having regulations in place provides a greater sense of consumer trust.

Why Regulatory Sandboxes?

According to the FCA, there are three key potential benefits that the regulatory sandbox provides for both businesses and consumers.

Faster time-to-market for less cost
Research from other industries has revealed that delays resulting from the regulatory process has a very negative impact on innovative entrepreneurs. This friction can result in time-to-market increasing by nearly 33 percent and cost roughly 8 percent of lifetime product revenue.

Improved access to equity financing
Investors and venture capitalists may be wary of fintech startups due to the risk associated with regulatory uncertainty, thus hurting the prospects of these fledgling companies raising badly needed funds necessary at the growth stage. Insights have shown in other industries that this uncertainty may result in valuations dropping by 15 percent.

Putting more financial innovation in consumers’ hands
Sadly, due to the regulatory challenges faced by many fintech startups, innovative products or services are never tested and fail to see the light of day. It is the FCA’s hope that introducing the regulatory sandbox will provide the means for companies to manage their regulatory risk during the testing stage, which would allow more concepts to eventually be introduced to consumers.

An Idea Worth Copying?

Given the potential benefits that could result from allowing new financial products and services to be tested for compliance before receiving regulatory approval, is the concept of regulatory sandbox something that should be implemented in other countries?

At this point, it may still be premature to cast any judgments upon regulatory sandboxes, as the FCA is still accepting applications for the first cohort of companies to put their products through their paces. However, in principle, the whole concept of regulatory sandboxes makes a lot of sense. After all, one of the biggest hurdles that fintech companies must overcome apart from securing funding is ensuring regulatory compliance. What better way to address this concern than for regulators to provide an environment that allows entrepreneurs with the chance to address any shortcomings before the product is released to the public?

“Anything that supports industry innovation with the end consumer in mind should be welcomed, and credit should be given to the FCA for supporting disruptive technologies,” said Jon Jones, President at Trulioo. “The key will be whether or not a balance in reducing existing regulatory barriers whilst simultaneously maintaining appropriate safeguards can be found.”

It remains to be seen whether or not other jurisdictions will follow the UK’s lead. However, in order to remain competitive, it may be in the best interests of other countries for their regulators to closely track the progress of using sandbox environments. If successful, the regulatory sandbox could help elevate the UK to becoming the global leader for fintech.

Do you think that the regulatory sandbox is a good idea? Why or why not?