With poetic license and my apologies to Shakespeare and his fans.
By the pricking of my brains,
Something delightful this way comes [Knocking] Open Locks
[Enter Fintech/Finserv Stakeholders]
How now, you secret, black, and midnight lord!
What is’t we can all do?…”
Something indeed delightful this way is coming. Something that could become essential to the financial services industry, to fintech. Something that is materializing thanks to the keen insights and ground breaking intent of the Financial Conduct Authority (FCA) – the United Kingdom’s financial regulator. That something is the FCA’s regulatory sandbox (the Sandbox), which is the very first experimentation of its kind.
To date, regulation has been a top down affair, with either legislative fiat or regulatory fiat brought down to the industry. Some will argue that the industry is usually consulted at the regulatory or legislative level. Some will even argue that lobbies meddle and influence legislative or regulatory fiat. They will be correct. Yet, this does not mean these feedback loops that help shape financial services regulation are bottoms up in their approach. Incumbents or lobbies represent an industry do not talk for the base, for innovators, disruptors. I view the FCA’s Sandbox initiative as the first bottom up approach to regulation.
Indeed the stated goals and benefits of such an endeavor are impressive:
for startups and incumbents the potential benefits are =>
– to lower the barrier and costs to testing and experimenting with a regulatory framework
– to lower the risk of misinterpreting existing regulation
– to receive tailored regulatory guidance
– to receive temporary waivers, “no enforcement action” letters in order to test a business model or technology live
– to build a more optimal path towards compliance and regulatory approval
for a regulator the potential benefits are =>
– to get educated as to innovation, new technologies and new business models
– to optimize market structure
– to protect consumers
– to inform and shape future regulation
– to modernize their own operations
– to promote healthy competition
– to encourage innovation
I wonder if bitcoin and the bitcoin blockchain early days and development would have been altered, for the better, had there been a tier one sponsored Sandbox where startups, hackers and incumbents would have been able to experiment and share with regulators.
Now that the FCA is embarking on this Sandbox journey, what next?
I expect regulatory wisdom and foresight to spread by osmosis. From what I understand the Monetary Authority of Singapore (MAS) is working on a similar scheme, unsurprisingly. In the United States, the Office of the Comptroller of the Currency (OCC) which regulates banking, is working on its own project. So is the Federal Depositary Insurance Corporation (FDIC). I know of no other project in the works, which does not mean regulatory brains are not in neuron overdrive at this very moment. Thusly I expect sandboxes to crop up all over the world. How these sandboxes will be architected and how they may, or may not, interact with one another will be fascinating to witness.
These twin “How” questions force us to take a closer look at the FCA. Why was the FCA first to market? What makes the FCA so special?
The FCA is one of the most sophisticated and respected regulators in the world. It rules over one time zone and an industry/economy/eco-system essentially centered around the greater London area. What is a Sandbox if not a platform for constant and incremental testing! The FCA is also a very independent regulatory body – one may say one of the most independent body in the world, unencumbered by political interference. The FCA does not suffer from a proliferation of regulatory competition in the UK as it stands alone with the Prudential Regulatory Authority (PRA). Finally, the FCA is, from what I can gather, an organization that is guided by “philosophical” tenets. This latter point is essential to understand as it allows the FCA to be a pragmatic caretaker of financial regulation that is opened to a/b testing and experimentation.
Let’s take the United States as a counter example – and I will leave aside philosophical arguments centered around market solutions vs government solutions, libertarianism vs central action. The USA financial services industry “suffers” from a very complex regulatory landscape: 50 state examiners for the insurance industry, 50 state bank regulators, the FDIC, the OCC, the Treasury, the Fed, the SEC, the CFTC, FINRA (yes I like to joke around), FinCen (within the Treasury), the CFPB to name but the main ones. These various agencies sometimes overlap and often “compete” against one another which creates either areas of confusion and misunderstanding or gaps where no regulatory clarity exists. There are four time zones (not counting Alaska and Hawaii) and more than one metro geography (NY, Chicago, San Francisco, LA, Boston, Washington DC, Seattle…) that matter. Some will argue that political interference indeed occurs with various regulatory bodies (think of how a new administration impacts how the SEC behaves for example). Finally, main US regulators are guided by “rules” which does not allow them easily to experiment and tinker like the FCA does.
Absent the benefits derived from what defines the FCA, what would be the right architecture for a Sandbox, one that would ensure optimal results? I believe a Sandbox would need to incorporate a) a strong strand of “innovation management” DNA, b) a level of neutrality to ensure collaboration among all stakeholders (between regulatory bodies and between regulators and the industry), c) a level of independence to make sure profit or special interests do not hijack the overall mission and d) a deep and broad sophistication around various subject matters (regulation, legal, technology, financial services business models, startups, innovation).
This translates succinctly into a not-for-profit organization with a stable sponsorship base and an inclusive yet independent governance framework.
Now, picture a universe of Sandboxes, some like the FCA, some independent not-for-profit organizations. Some focused on one country, others focused on a group of countries. A US Sandbox, a LATAM Sandbox, a Brazil Sandbox, the UK Sandbox, a EU Sandbox, a Western Africa Sandbox, an Eastern Africa Sandbox, a South East Asia Sandbox, a China Sandbox…
Further, picture Sandbox cooperation, bilateral, multilateral, thereby creating a bottoms up network that would foster innovation, market structure optimization and financial inclusion by taking account of grass root technology and business models advances from startups, developers and incumbents. I know I am dreaming but, playing the FCA chess game several moves ahead I do not think such a vision is that far fetched, although the details when implemented may vary from my current crude vision.
Do remember that we do have top down multilateral cooperation around financial services regulation either at the State/Government level or international organization level. Why not multilateral cooperation from the bottoms up too, via Sandboxes, as powerful tools to augment the interplay between innovation and regulation?
ps: I enjoyed using as “props” both Shakespeare’s Macbeth and an allusion to a movie about Mark Zuckerberg and Facebook. The supernatural phenomena that is Regulation and the omnipotent traits shared by a regulator and Zuckerberg will not have escaped readers.