25 October 2016
The Monetary Authority of Singapore has sought to create a flexible environment for FinTech companies to develop their businesses in the city-state. Photo: Bloomberg
The Monetary Authority of Singapore has sought to create a flexible environment for FinTech companies to develop their businesses in the city-state. Photo: Bloomberg

How a ‘regulatory sandbox’ can help FinTech innovation

FinTech’s growth is not only enriching the repertoire of investment options on the market, it is also helping enhance the efficiency of the financial services industry and create new business opportunities.

That said, the brand new products and services come with certain risks in terms of running afoul of existing regulations.

If the issue is not addressed, it could clip the wings of innovators and prevent some great ideas from coming to fruition.

To protect the interests of investors and spearhead the development of the financial sector, Britain, Singapore and some other economies are rolling out a “regulatory sandbox” for innovators to experiment with FinTech products and services in a carefully managed environment.

Simply put, a regulatory sandbox means that the government will allow eligible firms to test new solutions on a specified number of investors within a well-defined period (say, three to six months).

Successful applicants are obliged to report to the authorities regularly, but do not have to satisfy all existing statutory requirements immediately. Within the testing period, the firms can take advantage of the flexibility and concessions offered by the “sandbox” to gain experience and build on their strengths.

If an innovation proves successful, and the firms are capable of complying with relevant statutes after sandbox testing, the product can be deployed on a broader scale upon government approval.

While the regulatory sandbox is not yet full-fledged, a glimpse into the practices in Britain and Singapore will help us better understand how it works. 

Eligibility of applicants

Watchdogs in both Britain and Singapore assess applications according to a set of criteria, including, inter alia, the innovativeness of the proposal, benefit to the consumers or industry, necessity of sandbox testing and whether the firms are well-prepared for foreseeable risks and devote adequate resources to the project.

Another important factor that the authorities will consider is whether the applicant has plans for applying the solution in the wider community. 

UK’s regulatory body, the Financial Conduct Authority (FCA), notes that, before the change, some FinTech innovators, start-ups and SMEs in particular, would have found it too time-consuming or costly to obtain authorization. But now, a regulatory sandbox allows firms meeting certain “threshold conditions” to apply for “restricted authorization” for the purpose of testing.

To boost the confidence of innovators, there are three policy instruments the watchdog will employ on a case-by-case basis, namely, providing an individual guidance on the interpretation of rules, waiving or modifying certain requirements and, when ambiguities arise, issuing “no enforcement action” letters (NALs) to immunize testing activities from prosecution as long as they are conducted honestly and fairly within the agreed parameters.

The Monetary Authority of Singapore (MAS) stresses that such requirements as confidentiality of consumer information and anti-money laundering measures are here to stay. Depending on each case, however, the requirements of minimum liquid assets, board composition, credit rating, license fees, management experience and track record may be relaxed as appropriate.

Consumer safeguards

Regulators will work with applicants to hammer out appropriate parameters, performance benchmark and consumer protection measures, depending on the design and risks of each proposal.

Generally speaking, FCA has three standards in place. First, retail investors always have the right to complain to the Financial Ombudsman Service and, in case the firm fails, to apply for the Financial Services Compensation Scheme.

Second, some tests may be made exclusive to sophisticated investors who have agreed to limit their claim for compensation by “informed consent”.

Third, if necessary, the authorities may require firms to put in place additional safeguards (e.g. informing retail investors that the product or service is being tested in a sandbox). 

In addition, both Britain and Singapore require applicants to formulate a fair and clear exit strategy for customers (e.g. transferal to third parties) when the tests finish or come to an end by order of regulators.

Ben Lee and Germaine Lau are the co-writers of this article, which is the first of a two-part series on issues related to nurturing innovation in the FinTech sector.

Regulatory sandbox: Harmonizing new tech and old rules? (Aug. 2, 2016)

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