Regulatory Sandboxes & Consumer Protection [Fourth Branch]
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Regulatory Sandboxes & Consumer Protection [Fourth Branch]

Okay Google.
What is a regulatory sandbox? A regulatory sandbox is a new regulatory approach that
allows live, time restricted testing of innovations under a regulator’s oversight.
In other words, it gives businesses a space to play with new ideas and products within
certain boundaries before they bring them to market. Since the United Kingdom’s inaugural
launch of a regulatory sandbox back in 2015, the concept has gained traction on a global
scale. Arizona recently adopted a statewide version of their own. Several other states
and even the federal government seem likely to follow their lead, but questions abound.
What exactly is a regulatory sandbox? Who decides how it is run, and perhaps most importantly,
what are the pros and cons of implementing a regulatory sandbox? So, say there’s a mortgage lender that has a whole new algorithm and they say, “We can
get more people into houses living the American dream and kind of solve the housing and equity
gap,” and they make dozens of loans that turn into hundreds of loans that turn into thousands
of loans. Even if it’s just limited to one state, that’s all well and good until the
possibility that algorithm was wrong. So, then you have the potential ripple effect of foreclosures.
Now you have the company that says, “Oh, we made a mistake,” and it’s because of the sandbox
that would shield any type of remediation for the consumers or any type of liability
for the company that made that mistake. Whereas outside of the sandbox, those loans would
not have been made. Driving the debate about whether or not to
make use of regulatory sandboxes is a disagreement about the very idea’s definition, not to mention
worth. Many innovative products are required to undergo strict regulatory scrutiny before
being brought to market, and some never make it. A regulatory sandbox is touted as a reprieve
from regulation and a catalyst for innovation, but its value is contested.
In its simplest terms, regulatory sandbox is really a safe space by which companies –
startups, mature growth firms to financial services incumbents – are able to test their
innovative product or service in a limited setting.
So, I think regulatory sandboxes are critical at this point because I think we’re
kind of in an international race right now. Are companies going to go abroad and
only do business in certain areas where their regulatory structure is allowing
that to flourish or is the U.S. going to be part of the discussion?
Part of the trouble with defining a regulatory sandbox is that it can mean so many different
things and that it has different iterations across the world – on the state level, on the
federal level. They’re so new that it’s hard to make any conclusions over the end products
of the sandbox and how they can contribute to the greater economy.
In the UK in 2015, that was the only country that had a regulatory sandbox. Two years later,
17 countries had them. Today we have more than 50 countries that are looking at implementing
or have already implemented a regulatory sandbox. It’s pivotal that the U.S. presents a kind
of innovative front or else we’re not going to be writing the rules of the road.
If it’s justifying market participants getting around reasonable consumer oversight protections,
then that’s not only problematic, but it sets a stage for a dangerous narrative that somehow
civil rights, consumer protection laws and oversight are in the way of true financial
innovation to solve market inequities. And that’s one of the biggest concerns we
have in defining a sandbox in a broad term. Due to the intangible nature of regulatory
sandboxes, experts are divided about how they should be implemented, who should oversee
them, and even whether they should exist in the first place. As a relatively new idea,
the available data on these sandboxes are limited and open to interpretation. Because
of the lack of consensus, measuring the overall impact of launching a regulatory sandbox at
any level is challenging. I mean, I think the first question
that regulators really need to ask before they go into sandboxes is: do we even need
a sandbox, right? And then the second question is: why do we need a sandbox, right? What
are we trying to solve for? We would be proponents of handling it at the
federal level. We’re not in a state or local based economy. We’re in a very international,
integrated global economy. We should be thinking about, how can the UK and the U.S. work together to bring products to market. Laws like anti-discrimination laws – like the Equal Credit Opportunity Act, the Community Reinvestment Act, all passed in the Civil
Rights era – they were a direct response to market failures, which is a euphemism for
discrimination and racism in the market both. So, when we talk about these laws in the context
of a regulatory sandbox, it’s especially problematic when they’re reframed as obstacles to progress.
And we need to make sure that we’re keeping up with the different innovations and the
different tools that are at our disposal. One of the things that is a significant
problem for me on the regulatory sandbox front is that there’s a recent UN report
that came out on regulatory sandboxes, among other issues relating to fintech. And, what
they found was that of the sandboxes that they did a deeper dive analysis on, nearly
a quarter of them did not conduct a feasibility test on whether or not they should have a
sandbox and whether or not this is the right environment for a sandbox. That to
me shows there’s a lot of competition in this space. There’s a lot of, “Hey, let’s
just put out a press release and say we have a sandbox,” without actually understanding
do we really need a sandbox? And then the actual requirements that go into a sandbox.
I think that there’s a lot of different sides to the debate. I think that there’s
a lot of concern that a sandbox means that companies can run amuck and just
kind of ignore certain laws. That is definitely not the case and that’s never what we’ve
been advocating for. So, a regulator is not just going to let a company
kind of run amuck. They’re going to have solid guardrails and there’s always enforcement
opportunities and there’s private rights of action. I mean the U.S. is a very, very robust
regulatory environment. You get the engagement, right, and you get
the one-on-one, oftentimes, communication. You get the oversight from a regulator and you
get the understanding of what regulatory regimes within that country apply to your
product and service. It gives kind of real- time data and insights to a regulatory authority
that may never have been able to access such information.
We’re waiting for the CFPB to come out with their idea of what a sandbox would be but
regardless, I think it is definitely something that has the strong protections – both investor and consumer protections – in place and then, guardrails around it to ensure
that there isn’t any harm happening to the different populations.
Success metrics that we’ve been seeing in the regulatory sandbox space… time
to entry in the market, right? And, that’s a big one to go through. A traditional
process can take months, if not years, to enter a market. The second thing that we’ve
seen in terms of successes is: have you been able to raise capital, right? And, what
we’ve seen from this is that a number of companies have raised capital during the testing period.
The idea that kind of the up and running sandboxes on the global scale are somehow models that
we can readily take on to solve implementation issues has a lot of problems. It really is
an apples to oranges comparison. The structure of the U.S. regulatory system is vastly different
from the UK or Singapore. So, to use those sandboxes as a model that can just be taken
off the shelf and implemented is a bit idealistic. Back in the 90’s when the internet was created,
we took kind of a wait and see approach and that’s why it is what it is today. And, so,
I think that if we quash this innovation, in the banking space before we understand
where it’s going to go or in the blockchain space where there’s tons of different
uses from food supply to agriculture to food safety, I think that
we’re doing ourselves a disservice both from an American competitive standpoint and from being able to see what these innovations are actually going to come to.
There might need to be some reform or there might need to be some strengthening, but we
have the tools to do this in a transparent and equitable and multi-stakeholder way. The interplay between innovation and consumer protection has always been rocky,
yet both continue to be crucial focuses for regulators. While some are convinced of the
benefits, others remain concerned and ask, “What is the real cost of a regulatory sandbox?” You have a structure in place and I think before we can just summarily dismiss it and
say, “No, actually what we need is a sandbox,” there’s a really big assumption there that
I think has gone unquestioned in the broader narrative. And, I don’t think that has been
enough of a robust discussion in that space to really kind of double down and say we need
the sandbox to be competitive and we need the sandbox to solve our financial inclusion
issue. We need the sandbox to drive or increase the number of banked individuals. So, I think,
the jury’s still out on that premise. I think that it’s going to be better for consumers
if we all work together on this and that, first and foremost, consumer protection
and then also working with the companies to see what are some innovations that
are gonna make consumers’ lives better? Possibly make them more financially
literate, save more, have better disclosures. A lot of companies are thinking
of innovative ways that may not fit within the legal construct currently that is going
to actually be better for consumers. The sandboxes are just one tool in the regulatory
toolkit. There’s all sorts of other tools. We have guidance waivers, no-action letters.
Now we’ve seen the creation of innovation offices, testing pilots, which was a bit different
from the actual sandbox itself. So, that question of, “Do we need a sandbox?”
I think regulators need to kind of go back to the drawing board and say, “Well, here’s
what we have, here’s what we’re missing and does a sandbox kind of fit to address those
challenges of our’s?” So, innovation in the financial services marketplace is not only unavoidable,
we’re already in the middle of it, but when it comes to financial innovation,
nobody is out there saying we need to turn the clock back and go back to writing checks,
sending things through the mail, and sending faxes to your broker to make a stock purchase.
The real question is: how is that innovation interacting with current civil rights and
consumer protection laws and what are the structures that allow that interaction to
really produce effective and strong consumer protection regulation, but also encourage
innovation and the kind of market evolution. The conversation between regulators and the
regulated is already occurring. I’ve been very excited to see that. So, a couple of years
ago working on this, there was just huge question marks and there were just buzz words being
thrown around. Now, I think that companies are feeling comfortable enough to go into
the regulator. We’re still early on in the sandbox
process or sandbox regimes that are being implemented around the world, right? I mean,
it’s still to be determined whether these sandboxes ultimately offer some really
interesting success stories. So, again, we’re still very early on at this stage. It should be an ongoing dialogue between the
two and if we figure out that an issue or an idea is not viable,
then that’s one thing. But then working with a regulator, you kind of find the best regulatory
tool to get where you want to go that can better serve consumers.

One Comment

  • Jim Woods

    Many regulations and other govt programs that exist today are based upon reasons or rhetoric that no longer applies. Often I have conversations with my adult kids where they ask why does this or that stupid thing happen to which I explain how a condition that existed before I was born or when I was a child led to govt action that caused what they see as stupid. Very often that cause relates to past racial discrimination that is no longer relevant.

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