Barbara C. Matthews

FinTech Regulation Competition — Part I

It’s the hot new thing in FinTech….it seems like everyone has to have one…..the regulatory sandbox.

British policymakers set the tone a year ago in April. A flurry of followers flocked to found their own sandboxes in the autumn and winter. Today, policymakers in Japan let slip that they are also considering sandbox policy options.

Accepted wisdom in certain circles now holds that a competition is on. Those accustomed to the rhythm and patterns of past regulatory standard-setting assume (some insist!) that common international standards need to be developed. Some suggest that if a jurisdiction does not create a regulatory sandbox soon, then their domestic financial technology sector will either be left behind (as savvy companies fly to more inviting beaches) or burnt to a crisp (as savvy companies that tanned themselves in foreign sandboxes develop sufficient strength to scale globally without risk of sunburn abroad).

Let’s take a deep breath and grab the sunscreen. Now that nearly a dozen regulatory sandboxes exist around the world (with at least three more in the pipeline), we have some concrete facts that will help us all see past the hype. See the infographic below for details.

Today starts a 4-part blog series on FinTech Regulation Competition. The series asks the following question; are regulators indeed competing with each other internationally on sandbox regulatory standards? Spoiler alert — the answer will be: not always.

Sandboxes, Hopefully Not Sandtraps

In November 2015, the UK’s Financial Conduct Authority launched a new term into the regulatory policy lexicon. They launched a “Regulatory Sandbox” which they defined in the following terms:

“A regulatory sandbox is 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 the activity in question.”

This concept permits promising firms chosen by the government to provide certain innovative new financial technology services either directly to the public or to licensed financial firms without the usual costly compliance burdens. The concept has inspired nearly a dozen regulatory authorities around the world to follow suit.

The “safe sandbox” suggests images of carefree summer days. Finch firms will attest to the fact that participation in a sandbox is no day at the beach. Selection criteria are onerous. Operating requirements are challenging. Graduation opportunities are unclear. Australia’s decision to double the length of time firms are eligible to remain in the local sandbox (to two years) suggest a less than idyllic endless summer awaits at least some firms.

And then there is an emerging problem roughly equivalent to the “Middle Income Trap” well known to development economists. Once firms have become accustomed to operating with a lighter regulatory load, the question will arise as to whether they can operate profitably without government support structures. These support structures currently include not only holidays from full regulatory compliance but also, increasingly, direct subsidy support and indirect subsidy support from taxes and regulatory requirements imposed on their financial institution competitors. Will firms want to leave the sandbox and go back to school?

While some respected economists question whether or not the Middle Income Trap exists, the reality is that many developing countries remain dependent on development aid. Policymakers and FinTech companies can only hope that their experience at least will be different. Rather than remain stuck in a playground, the goal is to nurture innovation that will permit imaginations and growth-generating opportunities to set sail into the open ocean.

The Competitive Landscape

Before we can answer the question of whether (or not) policymakers are competing with each other, we need an overview of the potential competitive landscape. Analysis requires cold, hard facts regarding the geographic distribution of sandbox initiatives, the sectoral distribution of those initiatives, and the policy tools so far identified as being affiliated with sandbox initiatives.

Locations: The geographic distribution of the various sandbox programs indicates that this is predominantly an Asia-Pacific initiative even though the United Kingdom was the prime mover.

Industry Segments: The initial sandboxes covered all financial services sectors, including Islamic finance. More recent initiatives have been cautious, focusing on banking first and only recently expanding to include online trading and blockchain issues.

Regulatory Tools (ACFM): Superficial commentary regarding sandbox initiatives focuses on the licensingcomponent. They suggest that freedom from licensing as a regulated financial institution is the principal benefit of a sandbox initiative.

However, licensing is only the base of a very large pyramid of FinTech regulation which continues to growth with time. Relaxed rules regarding access to the financial services sector lately are being paired with other access benefits. Specifically, bilateral cross-border regulatory cooperation agreements (Hong Kong/London; Abu Dhabi/Singapore) hold the promise of easier access to foreign host markets as well as the local market.

Sandboxes also encompass relaxed or suspended compliance requirements regarding a broad range of conduct regulations which may or many not ultimately apply to FinTech firms regardless of whether they have a financial institution license. These include consumer protection rules at the retail level in the payments, investment, consumer credit, and mortgage market segments. Some components of the regulatory regime (e.g., reporting requirements and anti-money laundering compliance requirements) may not be waived even within the sandbox.

Towards the top of the pyramid we see tools that are only just emerging as key components of the sandbox policy toolkit. Last week, Australia deployed a full range of fiscal policy tools (increased taxes on regulated banks, increased fiscal support for sandbox initiatives) as part of its pro-FinTech draft 2018 budget. China and the European Union have indicated they intend to deploy generous direct subsidy/investment opportunities to qualifying FinTech companies. Finally, as policymakers begin to consider the growth potential of their FinTech firms, they are starting to consider whether and what types of new intermediation tools could create financial stability risks that require the application of macro prudential policy requirements from which sandbox firms are currently protected.

Regulatory Competition Landscape

The components in the infographic above establish the playing field on which sovereigns would compete. But are they really competing with each other on the substance of the rules?

Many FinTech companies operate in micro-markets and under-served markets for which little to no international competition exists. These are profoundly domestic markets whose customer behaviors share little with comparable cohorts in other countries. In addition, national policy priorities regarding particularly the extension of credit and capital formation will not disappear just because a technology platform has arrived on the scene.

Some market segments may lend themselves more towards standardization, particularly in the payments space which is already highly automated. But this does not mean that the classic ways of crafting cross-border policy consensus will apply in the current situation. International policymaking generally is very much under pressure from populist politics at present. Policymakers seeking to maximize their autonomy will charge forward, setting standards as fast as possible in order to keep pace with market developments at home.

FinTech innovations are changing much of what we know and think about the provision of financial services. We need to consider the possibility that the shape, focus, and direction of regulatory competition will also change.

This post originally appeared at BCM International Regulatory Analytics LLC uses proprietary, patented technology to quantify policy risk and anticipate outcomes. A technology platform automating that process is under construction. While the platform is being built, the process is being applied to analyze only one sector: the FinTech sector. Results are published weekly to subscribers of The FinTech RegTrends Report.

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