FinTech Sandboxes and the Measure of Success

As the Federal Reserve Bank of New York and the Bank for International Settlements (BIS) launch a regulatory sandbox for FinTech companies, it’s worth looking at just what they are and how they aim to foster and nurture innovation.

Announced on Monday (Nov. 29), the New York Innovation Center (NYIC) will trial and investigate new financial technologies including central bank digital currencies (CBDCs), stablecoins and cross-border payments with a focus on supervisory and regulatory technology, financial market infrastructures, the future of money, open finance and — given bitcoin mining’s country-size power demands — climate risk.

The UK Leads the Way

FinTech sandboxes are relatively new — the first was created by the U.K.’s Financial Conduct Authority (FCA) in late 2015. They offer a controlled and closed testing environment in which firms can try out their technology with a small set of customers in close cooperation with and scrutiny by financial regulators. They are, essentially, safe spaces for companies to try out new business models that have gotten ahead of existing financial regulations.

Last November, the BIS concluded that companies that were part of the FCA sandbox — particularly smaller and younger firms — had a 50% “higher probability of raising funding and an increase of about 15% in the average amount of funding raised.”

Comparing them to similar firms that did not participate in the sandbox, the study found that participation in the sandbox brought potential investors more information about companies (“reduced asymmetric information”) and reduced both regulatory costs and uncertainty.

That’s not to say they guarantee success, as more than 20% of the FCA sandbox’s graduates have gone out of business.

A major study of Asia-Pacific FinTechs found that sandbox participation promoted financial innovation and new business models, dialogue with regulators, faster and less costly business development, publicity, successful licensing of participants, and the establishment of financial and legal frameworks.

Making a Statement

Like the NYIC, not all are sponsored by national governments. In the U.S., the Consumer Financial Protection Bureau (CFPB) has its Compliance Assistance Sandbox.

Arizona, Kentucky, Nevada, Utah, Wyoming, Vermont, Florida, West Virginia, Hawaii, and North Carolina have state-created sandboxes in the U.S. — but not all have been successful. As of June, only 10 companies had participated in Arizona’s sandbox, and not all had passed their graduation test. At that time, neither Arizona nor Florida, Utah or Wyoming had any companies enrolled.

That said, Arizona’s sandbox has had its successes. FinTech software developer Clutch’s CEO Nicholas Hinrichsen told the Phoenix Business Journal in October that the “sandbox allowed us to basically experiment in the space without having to build up the whole regulatory machine. And then, very quickly, we noticed, hey, instead of going direct to consumer and being lenders, there are much better lenders out there, so let’s build software for them.”

Sandboxes are best seen as a way to signal that the state is open to experimentation and more generally has a business-friendly environment, Lee Reiners, executive director of the Global Financial Markets Center at Duke University School of Law, told the Arizona Mirror in June. Some supporters regard them as a way for regulators to learn about new financial products and services.

The EU Lags Behind

The EU is not as far along in sandboxes. On Nov. 11, Mairead McGuinness, the EU’s Commissioner for financial stability, financial services and the Capital Markets Union, said the EU plans to finalize plans for a bloc-wide sandbox for blockchain products by year’s end.

Italy opened its regulatory sandbox on Oct. 1. Austria, Denmark, Greece, Malta, the Netherlands, Spain and Sweden are among the counties that already have one.

Currently, there are sandboxes in more than 50 countries, including Australia, Brazil,  Hong Kong, India, Mexico, Nigeria, Russia, Switzerland, Singapore and Thailand.