In the previous lecture,
we talked about how several US regulatory agencies have responded to FinTech innovation.
In this lecture, we will look beyond the US and assess
how regulatory agencies in other countries are responding to FinTech.
We will spend most of our time discussing
one popular approach known as a regulatory sandbox,
which was first rolled out in the UK,
and has since been adopted by over a dozen countries and even one US state.
Regulators abroad have addressed the emergence of
financial innovation through various means including establishing innovation offices,
establishing mechanisms for allowing FinTech firms to conduct
trial operations, holding innovation competitions,
providing funding for firms through business accelerators,
and using various methods to coordinate with
other regulators domestically and internationally.
As I mentioned, one of the more common approaches that have emerged,
it's what's known as a regulatory sandbox,
which can be thought of as a safe space in which businesses can
test innovative products, services, business models,
and delivery mechanisms without immediately incurring
all the normal regulatory consequences of engaging in these activities.
At a basic level, a sandbox works for the following four steps.
One, FinTech firms apply to participate.
Two, if accepted by the regulator,
the firm agrees with the regulator on
the parameters of how products or services will be tested,
such as the number of consumers or transactions included in the test,
with a time frame of the test.
Three, the firm secures
the appropriate licenses if applicable and begins testing their product,
and four, the firmer regulators interact regularly throughout the testing process.
The first regulatory agency to launch a FinTech sandbox
was United Kingdom's Financial Conduct Authority or FCA.
The FCA is the conduct regulator for
financial services firms and financial markets in the UK,
and they have a specific mandate to promote
effective competition in the interests of consumers,
which is what drove the decision to launch the sandbox.
The FCA stated they launched a sandbox in order to
reduce the time and cost of getting innovative ideas to market,
enable greater access to funding for innovators,
allow more products to be tested and introduced into the market,
ensure appropriate consumer protection safeguards
are built into new products and services,
and facilitate better outcomes for consumers.
The FCA was also concerned about national competitiveness and launched
the sandbox that help the UK maintain its status as Europe's leading FinTech hub.
In order for a firm to be admitted into the FCA sandbox,
they must prove that their product is a genuine innovation that
offer an identifiable benefit to consumers and is ready to be tested.
Firms admitted into the sandbox may receive several possible benefits.
The most sought after is a restricted authorization to operate.
Any firm seeking to provide Consumer Financial Services in the UK must be
authorized or registered by the FCA unless certain exemptions apply.
The FCA created a tailored authorization process for firms accepted into the sandbox,
whereby any authorization or registration will be restricted
to allow firms to test only their ideas as agreed upon with the FCA.
Sandbox firms may also receive individual guidance,
whereby the FCA clarifies rules and regulations that apply to the product being tested.
Or a waiver or modification to existing rules if the firm is
concerned that their product being tested may breach one of the FCA's rules.
The FCA would only grant a waiver modification if they felt
the rule is unduly burdensome or not achieving its purpose.
The final possible benefit for sandbox firms is
referred to as a no enforcement action letter,
which is an agreement between the firm and the FCA that provided
the firm capture the agreed upon testing parameters and treated customers fairly.
The FCA accepts that unexpected issues may
arise and would not expect to take disciplinary action.
The US's fragmented regulatory structure makes implementing an FCA type of sandbox
impossible as there are 10 federal agencies
involved in the regulation of FinTech in some capacity in United States.
Furthermore, unlike the FCA,
most of US financial regulators do not have a mandate to promote
competition or the authority to initiate a sandbox program.
That said, some federal agencies have adopted various elements of a regulatory sandbox.
For instance, in 2017,
the Consumer Financial Protection Bureau issued a no action letter to Upstart Network,
a company that uses alternative data to assess credit worthiness and underwrite loans.
As part of the letter, the CFPB agree they would not recommend
initiation of supervisory or enforcement action against Upstart,
with respect to the Equal Credit Opportunity Act,
provided that Upstart regularly reports
lending and compliance information to the CFPB to mitigate risks to consumers,
and informs the CFPB about the impact of alternative data on lending decisions.
Securities and Exchange Commission and
the Commodity Futures Trading Commission have
also issued no action letters to FinTech firms.
While the hurdles to implementing a national FinTech regulatory sandbox are high,
several states have debated launching their own form of sandbox.
In March of 2018,
Arizona became the first US state to do so.
At the time, Arizona's governor, Doug Ducey,
said that quote, "FinTech is going to
fundamentally transform banking, finance, and technology.
We're going to be the first in the state to embrace it."
Arizona sandbox is going to be administered by
the State Attorney General's office and will
be opened to businesses bringing new products to
market for activities that would normally require licenses issued by
Arizona's Department of Financial Institutions such as consumer lending,
mortgage lending, and money transmission.
FinTech companies in Arizona sandbox will be able to test their products for
up to two years and serve as many as 10,000
customers before needing to apply for formal licensure.
I expect more states will soon follow Arizona's lead.
Lee Reiners, CFAExecutive Director, Global Financial Markets Center
