22 October 2016
FinTech allows banks to provide different kinds of services to their customers. Photo: HKEJ
FinTech allows banks to provide different kinds of services to their customers. Photo: HKEJ

Regulatory sandbox: Harmonizing new tech and old rules?

The “regulatory sandbox” is a new approach to financial innovation.

Upon approval by regulators, eligible firms will be allowed to take advantage of specific policy concessions and experiment with new Fintech solutions on a limited scale within certain parameters.

Regulators will work with the firms closely, require consumer safeguards to be in place and keep an eye on the risks involved.

It is hoped that the regulatory sandbox can help propel the development of the financial services sector by functioning as a launching pad for innovations before they are ready to enter the market.

Several foreign economies are adopting or considering such a scheme.

The intake of firms has already begun in Britain, while Singapore also kick-started consultation in July this year.

Though a novel idea, the regulatory sandbox should not be viewed through rose-tinted glasses. Its potential limitations should be well recognized.

First, since a sandbox is a manipulated environment where the type and number of investors are strictly regulated, selection bias could be a concern.

For instance, sophisticated investors might be over-represented. Some participants might turn out to be more risk-seeking than usual, given that they can count on the additional safeguards provided by the firms.

If this is the case, then the investment behavior in a sandbox environment may not necessarily reflect reactions of the real market.

In theory, a sandbox can speed up the commercialization of Fintech by serving as a testing ground for premature but promising solutions.

However, it should be noted that regulators also play an important role here. Even if the firms hold up their end and the tests finish successfully, if regulators do not “pass the baton” by issuing relevant licenses in time, this could still drag down the entire process.

In addition, as Singapore’s consultation paper points out, while a Fintech solution may attract a lot of interested buyers, it might still fail to comply with existing rules despite the grace period offered by the regulatory sandbox.

How these popular but unlawful innovations should be handled is a question with no simple answers.

That said, the positive impact of the regulatory sandbox should still be appreciated. It does not only provide a tolerant environment for potential movers and shakers to try out their ideas, but also makes it easier for them to raise the necessary capital.

A study found that, as a result of regulatory uncertainty, the valuation of a Fintech solution could drop by up to 15 percent, undermining the financing for the project.

In this regard, the regulatory sandbox can come to the rescue by dispelling uncertainties and enhancing the confidence of innovators as well as investors, which can in turn boost investment in Fintech R&D.

As long as the risks are carefully managed and consumer safeguards remain sound, the regulatory sandbox could be a proactive but prudent move for us to forge ahead.

As a matter of fact, in recent years, the tide of peer-to-peer (P2P) economy has swept across not only the financial services industry, but also transportation, accommodation, retail and other areas, shaking the fabric of various sectors and posing unprecedented challenges for both practitioners and regulators.

No one can tell for sure the risks accompanying these new technologies and the best ways to cope with them.

Therefore, both innovators and regulators are constantly on the learning curve.

As a flexible platform, the regulatory sandbox can provide solid evidence for the society to deliberate on whether and how existing regulations should be reformed.

More importantly, it can hopefully bring regulators, practitioners and users into closer communication so that these stakeholders can narrow differences and work together to craft a regulatory regime that is in the long-term interests of society.

Perhaps, the regulatory sandbox itself is a plunge into uncertainty. There will probably be a few bumps on the road, but lessons drawn from sandbox testing will help us improve our regulatory regime continuously and go from strength to strength.

After all, innovation takes courage.

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

How a ‘regulatory sandbox’ can help FinTech innovation (July 21, 2016)

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