Regulatory Sandboxes Chug Along, Find A Place In The Sun

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Initially conceptualized for fintech, regulatory sandbox programs have since expanded to other areas. These sandboxes benefit innovators by allowing government regulations to be exempted in usage of new technologies and innovations, until regulators can ascertain the product or service is useful. Buffeting specific themes for new products, sandboxes stimulate business growth and serve to launch up-and-coming companies.

UK-based Financial Conduct Authority (FCA) launched one of the world’s first fintech regulatory sandboxes in 2016. Since then, the number of jurisdictions with sandboxes has skyrocketed. Per World Bank’s 2020 Report, 73 fintech-related sandboxes were operating globally in 57 jurisdictions. Though most promoted innovation in delivery of financial services, several encouraged insurtech, blockchain and regtech solutions.

In insurance, sandboxes have helped businesses develop services outside the status quo and explore ideas that better serve customers. US states with insurance sandboxes include:

  • Kentucky, the first state with a comprehensive framework for an insurance “sandbox” in 2019 which is open until 2025.
  • West Virginia established a sandbox this July to encourage insurance businesses into the state that would otherwise be subject to regulatory hurdles.
  • This March, South Dakota signed into law a regulatory sandbox targeting insurers, where companies can offer their products or services in a controlled environment for up to two years.
  • Utah passed a bill this March to expand the scope of its sandbox program.
  • Vermont deployed an insurance sandbox in 2020, allowing its State Department to waive laws prohibiting the introduction of more innovative services.

Mandates under sandboxes typically require offered products to be available to fewer than 10,000 consumers or being limited to a 12-month period with a one-time 12-month extension. Successful applicants may be required to post a consumer protection bond or similar assets as security for potential losses suffered by consumers. In most cases, the sandbox is required to submit a final report to the applicable State agency at the end of its pilot.

The challenge in providing appropriate regulatory frameworks is that traditional regulation and rule-making processes haven’t kept pace with technology. Hence, regulators are evolving and collaborating with industry experts to implement flexible programs that balance consumer protection and foster innovation. North Carolina(NC) became the latest state when it signed the NC Regulatory Sandbox Act this month into law, making it the 10th state to launch a “regulatory sandbox”.

NC’s addition is important not only due to it’s large banking and technology industries but also because fintech sandboxes are all working to generate evidence for issues that could help build consensus for national standards.

Other advantages envisaged are to:

  • Facilitate market entry
  • Foster partnerships
  • Strengthen competition
  • Enable market development
  • Build regulatory capacity

Evidence shows that thematic sandboxes effectively encourage particular technologies or products to come to market. While  nearly 60% of sandboxes target general fintech innovations, some have adopted specific themes, such as enhancing blockchain technology, innovations in insurance or payment systems, or digital authentication technologies.

In hindsight, 22% of fintechs that participated in the FCA sandbox have since gone out of business. Participation in sandboxes doesn’t guarantee success. Of 108 fintechs across six cohorts, nine of 24 from the second and five of 29 from the fourth, shut down. To put in context, 60% of new businesses in UK fail within three years versus 22% among FCA’s cohorts, underlining the difficulty for startups to sustain with or without sandboxes.

However, fintechs continue to be enthused about sandboxes despite it not assuring market success. Studies have validated that sandboxes deliver real value to firms, be it from guidance for applying regulation or innovative propositions or stress testing business models. While regulators are not in the business of picking winners, the overwhelming feedback it that being accepted into the sandbox and proving the technology increases the credibility of firms with investors and customers alike.

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