Innovation via the regulatory sandbox

February 2017  |  FEATURE  |  BANKING & FINANCE

Financier Worldwide Magazine

The ability to innovate requires a diversity of skills and a looking for the light bulb mindset, not to mention time and space in which ideas can be explored and possibilities unlocked.

Happily, an initiative designed to do just that – the Financial Conduct Authority’s (FCA) regulatory sandbox (aka ‘Project Innovate’) – is now underway in the UK, providing financial innovators with the room to innovate.

As outlined by the FCA, the regulatory sandbox is intended to be a “safe space” where companies can test different financial services innovations in a live environment with consumer protection in place, but without the full burden of regulation. Furthermore, with the FCA having recently announced the names of the 24 companies that make up the first regulatory sandbox cohort, the testing of new products can begin.

Innovation without restrictive regulation, the regulatory sandbox, according to some, is set to propel the UK toward becoming a bona fide FinTech hub.

Dialogue, collaboration and openness

Chris Ward, a research manager at Mapa Research, believes the regulatory sandbox will allow firms to expediently deliver products and services that will be beneficial to customers. “The sandbox is especially great for FinTechs, for whom regulation is a massive stumbling block,” he says. “Lots of start-ups have great ideas about how to create fantastic new tools and products, but often lack the experience to navigate the comprehensive regulatory framework in which they are going to have to operate. The sandbox is not about changing regulatory or enforcement models, but about helping firms try out their products in a safe environment. It should be a win for firm, regulator and consumer.”

Sam Pearse, a partner at Pillsbury Winthrop Shaw Pittman, hopes that the sandbox will promote greater dialogue, innovation and openness. “The FCA has a fine line to tread in not abusing that openness, otherwise future applicants will be spooked,” he suggests. “Regulatory change will only occur if there are sandbox firms which become too significant to ignore. In other words, the changes are defensive, rather than permissive.” Ultimately, the sandbox is an acknowledgement that the regulator needs to change tack if it is to keep pace with innovation and adequately protect consumers.

Real-world rules

One of the main advantages for FinTech companies is that the standards firms will be tested against are very much real-world rules. This means that if the product or service fails to comply in the test environment, there are no consequences for the innovators (or consumers). Instead, the FCA will provide feedback explaining why they have failed, which the innovator can then use to make necessary changes.   

One potential issue, says Mr Ward, is that regulations, as well as a firm’s proposition, may change, therefore, passing the sandbox testing means that firms are compliant only at that particular moment in time. “If the product or service changes, or the FCA makes a new ruling, the situation may change. This is why the sandbox needs to do more than just test a firm against existing regulation; it needs to help install a comprehension of the sentiment and purpose of regulation that will help firms comply in the long-run.”

For Mr Pearse, the outcome of the sandbox will be determined by two key factors: the quality of the applicants and the reaction of the FCA to the cohorts and their products. “The FCA must resist temptation to become ‘Big Brother’ and instead remain faithful to wanting to promote competition and innovation,” he says. “Overbearing or poorly conceived regulation will be very damaging to the viability of the sandbox and reputation of the UK as an innovation-friendly jurisdiction.”

Ecosystem for innovation

With the financial services industry notoriously slow to adopt the disruptive technologies that positively impact other industries, opinion is mixed as to the impact the regulatory sandbox is likely to have in the years ahead.  

“I do not think the existence of the sandbox will have a fundamental effect on the strength of the UK FinTech ecosystem,” states Angus McLean, a partner at Simmons & Simmons LLP. “We already have a very strong and vibrant ecosystem that is the envy of most would-be FinTech hubs across the globe. The launch of the sandbox is just the latest step in the evolution of that ecosystem. We cannot afford to be complacent, however, for there are a host of centres around the world that have ambitions to overtake the UK.”

Others, though, are more hopeful, pointing to the time and money spent by the FCA as an encouraging sign that the sandbox will play a vital role in creating a robust ecosystem for innovation in the UK.

Should the regulatory sandbox prove its worth, expand well beyond its initial cohort of 24 companies and transform the UK into a FinTech hub, one question may arise: will it be big enough for everyone that wants to play in it?

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Fraser Tennant