Regulatory Sandboxes Come in all Shapes and Sizes

The digital wave is hitting the financial service industry at an extraordinary rate creating opportunities but also challenges for the financial services ecosystem. Consumers have higher expectations and want better access, transparency and delivery options. New technologies such as blockchain are unravelling traditional workflows and have the potential to represent the next evolutionary jump in process optimization. Digital currencies and asset value exchanges are disrupting how value and assets change hands. Each of these innovations are upsetting the current market structure and regulatory framework and create their own set of unique challenges in terms of governance, risk management and standards.

To use a common phrase – ‘change is good.’ So despite the pace of change, governments and regulators around the world recognize the positive benefits innovation provides in promoting competition, attracting top talent and generating revenue for the economy. However, there is also widespread recognition that current consumer and investor protection measures cannot be compromised and that any supportive framework should be balanced.

One of the ways that governments and regulators are trying to manage the changing financial landscape while minimizing risk is through the introduction of the ‘regulatory sandbox’ concept. The first regulatory sandbox was introduced by the Financial Conduct Authority (FCA) in the UK in 2014 and it refers to:

“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 pilot activities.”

The idea behind the sandbox concept is to create an environment or framework where firms can work in parallel with regulators in the early part of the product development lifecycle to lower the costs and time for market entry and reduce risk by reducing regulatory uncertainty.

Several other jurisdictions have followed the UK’s lead and announced plans to implement a regulatory sandbox including Hong Kong, the Bailiwick of Jersey and the Ontario Securities Commission (OSC) in Canada. Australia, Malaysia and Singapore are consulting with the industry to determine the appropriate sandbox structure.

In essence a regulatory sandbox simply creates regulatory boundaries that allow firms to test new products and services without being subject to full licensing requirements. This is not an entirely new concept. It is not unusual for regulators to accommodate innovation through supportive measures or by allowing for a lighter-touch regulatory approach to support competition. This was quite common when new alternative venues entered the equity market to compete against incumbent stock exchanges. While working on a joint venture for a new alternative venue in Asia with Chi-X Global and the Singapore Stock Exchange I experienced this first-hand. The Monetary Authority of Singapore (MAS) granted the joint venture a conditional license so that marketing and product development efforts could continue while the MAS continued their due diligence on the new venture.[1] The Australia Securities and Investment Commission (ASIC) currently has supportive action in place such as a modular licensing framework and no-action enforcement letters to accommodate new market entrants.[2] In their consultation they ask the industry whether additional measures are needed to facilitate innovation or to maintain the status quo.[3]

It is worth noting that although each regulatory sandbox essentially has the same objective, not all sandboxes are identical in structure. Australia has structured their sandbox to be suitable for certain products (e.g. listed securities, simple managed investment schemes and deposit products) whereas Singapore and the UK allow for small and large firms to participate as long as they fit certain prescribed criteria. Singapore makes it clear in their consultation that they will not relax any requirements in relation to anti-money laundering and anti-terrorist financing activities (AML/ATF) or threaten the confidentiality of customer information.  The recently announced OSC Launchpad simply creates a forum to open the dialogue with the securities regulator, share information about new business models and medium to learn from each other.

The rate and breadth of change within the financial service sector will be, in part, influenced by how flexible governments and regulators are to change. As the financial services ecosystem reshapes, it will be the jurisdictions with more flexible policies and regulatory approach that will benefit the most. If implemented correctly the regulatory sandbox can be a useful tool to assist innovation. However, it is important that the sandbox framework is not overly structured or prescriptive and that it addresses the market structure nuances and particular innovations being introduced within the jurisdiction.

Donna is the author of the Canadian “An Examination of the Regulatory Sandbox” position paper

[1] Chi-X Global and Singapore Stock Exchange collaborated on a dark-pool venue in 2009

[2] ASIC also has the power to modify law on an industry-wide basis.

[3] ASIC Consultation Paper 260, Further measures to facilitate innovation in financial services, June 2016

 

 

Leave a Reply

Your email address will not be published. Required fields are marked *

* Copy this password:

* Type or paste password here:

About The Author

Donna Bales
is a product development professional with a proven track record of managing complex capital market industry initiatives during times of significant market change and market structure reform. Donna is the founder of Balmoral Advisory, a boutique advisory firm that works with exchanges, regulators, technology firms, market participants and market data vendors to identify and evaluate business opportunities, understand and respond to changing industry/market dynamics and develop and implement strategies and solutions that make sense now and in the future. In addition she acts as a strategic advisor to an international consultancy firm, CollegeHill Asia and sits on the Board of 3Q Innovation, a non-profit that focuses on retraining and replacement of older workers following protracted unemployment. Originally from Canada, Donna holds a bachelor degree in Economics from the University of Western Ontario.