A Global Regulatory Sandbox — Collaboration, Policies and Solutions for Cross-Border Compliance

The thought of a sandbox brings up ideas of creating things without worry, without repercussions. While not a child’s play area, a regulatory sandbox (or fintech sandbox) provides a similar benefit; a safe and prescribed area that is used for new ideas which does not face the same regulatory scrutiny or risk that a fully launched service faces.

As defined by the Consultative Group to Assist the Poor (CGAP), “a regulatory sandbox is a framework set up by a financial sector regulator to allow small-scale, live testing of innovations by private firms in a controlled environment.” With the rapid pace of development in RegTech, an environment where technology is testable without the risk of regulatory fines or sanctions, encourages innovation while maintaining oversight and risk-mitigation measures.

The first operational regulatory sandbox was set up by the UK’s Financial Conduct Authority (FCA), which went live in 2016. A total of 89 firms are running tests under four different “cohorts”, with a fifth cohort coming later this year.

The FCA mentioned three main benefits of operating a regulatory sandbox:

• Reduced time-to-market at a potentially lower cost
• Better access to capital
• More innovative products reaching the market

Regulators have been prodding affected industries to use more technology in their compliance. As Gary Richardson, managing director for emerging technologies at IT consultancy 6point6, remarks: “regulators are making a greater push for companies to have more automated processes and better risk reporting frameworks.”

Taming RegTech Risks

However, regulators also know that implementing new technologies has its own challenges and risks. There are implementation costs to consider, with new implementations bringing new, unknown processes and often, RegTech providers don’t have a long history to look to. Combine those with the fact that regulatory failures are potentially costly and embarrassing, it’s no wonder that compliance programs are wary of new processes and tools.

While well-established financial institutions (FIs) have their reasons to proceed cautiously, fintechs have to demonstrate that their technologies are able to meet compliance standards, often for the first time. For them, innovation is their raison d’être but they still have to demonstrate they can supply compliant solutions. Investors are wary of putting funds in areas that have questionable compliance parameters, which slows growth opportunities.

Regulatory sandboxes provide benefits to all parties. FIs can investigate deploying new technologies without fearing potential fines and reputational damage of non-compliance. Technology startups can test their new offerings without worrying failure will doom the company to a virtual graveyard. And regulators can ensure there is a framework for compliance embedded in new technologies so that innovation continues to flourish.

It’s not as if the operational sandboxes are a free-for-all, with no rules whatsoever. There are legal requirements to adhere to. For example, the FCA had to consider mandated EU legislation when it became operational. There are necessary safeguards to protect consumers and the financial system from dangerous actions. There are also barriers in place to prevent certain actions, which might be adjustable to fit the circumstances of the specific sandbox test.

From the FCA’s point of view, early indications are that the program is successful:

• Access to the regulatory expertise the sandbox offers has reduced the time and cost of getting innovative ideas to market
• Testing in the sandbox has helped facilitate access to finance for innovators
• The sandbox has allowed them to work with innovators to build appropriate consumer protection safeguards into new products and services

Global Financial Innovation Network

Globally, there are sandbox programs now running in 20 countries including Singapore, Australia, Hong Kong, Indonesia, Malaysia, Thailand, Netherlands, Denmark and Canada.

To help global firms interact with regulators, scale ideas and also create a framework for co-operation between financial services regulators, the Global Financial Innovation Network  (GFIN) was recently announced.

The (proposed) mission statement for GFIN is “a collaborative policy and knowledge sharing initiative aimed at advancing areas including financial integrity, consumer wellbeing and protection, financial inclusion, competition and financial stability through innovation in financial services, by sharing experiences, working jointly on emerging policy issues and facilitating responsible cross-border experimentation of new ideas.”

The organizations involved in the GFIN at present are:

• Abu Dhabi Global Markets
• Autorité des marchés financiers (Québec)
• Australian Securities & Investments Commission
• Central Bank of Bahrain
• United States Bureau of Consumer Financial Protection
• Dubai Financial Services Authority
• Financial Conduct Authority
• Guernsey Financial Services Commission
• Hong Kong Monetary Authority
• Monetary Authority of Singapore
• Ontario Securities Commission
• Consultative Group to Assist the Poor (CGAP)

Global compliance is an area rife with obstacles, pain-points and frictions slowing down international growth and opportunities. The potential for GFIN to improve the experience and offerings of the financial services industry serves broader society goals, such as financial inclusion.

Cooperation between financial services regulators also promises to enable better systems to fight fraud, corruption, money laundering and other financial crimes. To counter the sophistication of criminal enterprises who increasingly use cross-border activities to perpetrate and hide their actions, progressively more international coordination is required.

While other organizations do exist to help create better global financial regulations, the goal is to create a network of regulators to allow deeper, larger and quicker information sharing. A forum to propagate best practices, perform cross-border sandbox tests, and introduce companies and regulators to each other offers a new level of cooperation.

Christopher Woolard, FCA Executive Director of Strategy and Competition and Board member commented: “The creation of the Global Financial Innovation Network (GFIN) is an important next step for organizations like ours who are actively engaged in understanding and harnessing the benefits of innovation in financial services for consumers, while managing the potential harm.”

It’s still early of course, but a global regulatory sandbox is an idea whose time seems like it has come. The benefits of a regulatory sandbox expanded to global cross-border compliance offers substantial opportunities. GFIN, with the backing of most innovative global regulatory agencies, is a development that bodes well for the future of international financial services.