Regulatory Sandboxes: A new future for FinTech?

It’s no surprise that the Financial Technology (FinTech) sector has been booming over the last few years. Driven by deep pockets in venture capital and accelerated by the COVID-19 pandemic, consumers have been demanding and have seen FinTech infiltrate almost every aspect of their daily financial transactions – from browsing homes online to trading cryptocurrency from one’s sofa. The slogan, “there’s an app for that” has never been truer. While FinTech has been growing at breakneck speeds, certain infamous catastrophic failures in the sector, like that of the German FinTech, Wirecard and the UK’s Greensill Capital, have brought to light the desperate need for a new regulatory framework that neither sacrifices growth nor compromises the security of consumers. More importantly, since FinTech usage in the US and UK has exploded from 58% in 2020 to 88% in 2021, regulators need to do more to just catch up with the tech innovation; they must guide it.

Once such potential regulatory regime is the use of “regulatory sandboxes.” A regulatory sandbox is a framework set up by a regulator that allows for “time-bound testing of innovations under a regulator’s oversight.” The operating environment set up by such a sandbox allows regulators to foster innovation within a conducive framework with careful oversight and enables innovators to test out their enterprises without being subject to traditional financial, legal and regulatory scrutiny.

The world’s first FinTech regulatory sandbox was launched by the UK’s Financial Conduct Authority (FCA) in 2016 with a high degree of success. At first, the scheme operated on a cohort basis with the FCA taking applications every calendar year, but the success of sandbox led to an “always open” model in August 2021. The success of the UK’s scheme has been replicated across the globe with 73 regulatory sandboxes in 57 jurisdictions being launched in the past five years. The appeal of this regulatory answer to the FinTech problem is easy to see: a regulatory sandbox brings down the cost of innovation, reduces barriers to entry in the market, and allows regulators to collect data, monitor upcoming innovations, and identify any potential risks. In this regard, the European and British FinTech sectors have blazed the trail leaving the U.S. in the dust – thanks to booming FinTech scenes, underpinned by a strong regulatory regime that enhances innovation, protects consumers through better security and pricing, and drives competition.

In the US, adoption of regulatory sandboxes has been slow and rather lacking. At the federal level, several agencies like the Consumer Financial Protection Bureau (CFPB) and Securities Exchange Commission (SEC) have established FinTech focused offices, but none have led the charge on creating regulatory sandboxes. In particular, officials at these top agencies have cast doubt on the efficacy of a sandbox by expressing concerns that it could gatekeep or slow down innovation.

Without a centralized regulator and framework quite like the FCA, it has been up to individual states to implement their own sandbox regimes. Arizona was the first state to do so in March 2018 with Kentucky, Nevada, Utah, Wyoming, Vermont, Florida, West Virginia, Hawaii and as of last month, North Carolina. Nevertheless, hostility towards regulatory sandboxes persists and the evidence from Arizona is damning for any state looking to launch a regulatory sandbox: in Arizona so far only 10 companies have participated in the State’s sandbox. The reality of FinTech is that digital innovation rarely conforms to the geographical barrier imposed by regulatory regimes. For FinTech companies looking to expand across the US and even further, a one-state program is rather unappealing and unnecessarily complicates navigating through regulators. A FinTech company in any one state would be subject to only that state’s regulatory regime and would not be protected from another state or federal agency’s enforcement actions, “producing a level of uncertainty that collides with the goals of safe experimentation.”

Regardless of the United States’ reluctance to play in the sandbox, the data speaks for itself. A progressive, forward-thinking and open-minded regulatory regime is just what U.S. FinTech needs if it is to remain a dominant player internationally, having already been outpaced by European rivals. For such a regime to thrive in the US would require a multi-agency cooperative approach at the state and federal level led by Congress to ensure the most conducive environment for FinTech innovation – a Herculean task no doubt. However, at the end of the day, a well-organized regulatory sandbox led by a forward thinking, innovation-minded regulatory agency would “improve rulemaking, supervision and enforcement” to the benefit of the entire market while reducing uncertainty in a sector already in overdrive.

Iqra Bawany serves as a Graduate Editor of the NYU Journal of Law & Business. She is an LL.M. candidate at NYU specializing in International Business Regulation, Litigation and Arbitration where she focuses on regulation and dispute resolution. Prior to attending NYU, she studied Law at the University of Cambridge.