Fintech review – the FCA’s regulatory sandbox

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The UK’s Financial Conduct Authority (FCA) has opened up what it is calling a regulatory sandbox or safe space where fintech businesses can try out innovative ideas without having to worry about regulatory consequences should the project fail.

The regulatory sandbox is the product of the FCA’s innovation hub Project Innovate which was instituted in November 2014. The project was designed to support businesses both large and small that are developing products that might improve the customers’ experience and outcomes.

In a speech in mid-April during the Innovate Finance Global Summit, Christopher Woolard, FCA director of strategy and competition, said the body had received over 400 requests for support and offered direct support to over 200 firms. “For us Project Innovate is a vital part of fulfilling our duty to promote competition, but it is also a project that is evolving and adapting as we gain more experience,” he said.

Woolard said the sandbox concept was a “bold and complex project” for any regulator, and that the initiative didn’t come without risks. “In many ways, it won’t just be the firms that are learning in the sandbox, we will be too,” he added.

The speech goes on to make a point that has been mentioned regularly with regard to gambling regulation and was certainly mentioned at the GamCrowd Pitch ICE Studio day in February – the cost of regulation before a product can be fully tested.

“On lowering barriers, we acknowledge that, to date, firms requiring authorisation have had to incur significant costs before they can meaningfully explore consumer appetite or if there are any significant risks posed to consumers,” he said.

“We are setting up a tailored authorisation process, which means that sandbox firms will first be authorised with restrictions, allowing them to test their ideas but no more. They still need to apply for authorisation and meet threshold conditions, but critically only for the limited purposes of the sandbox test.”

For the FCA, the move is all about proportionality, with the regulation process being in proportion to the scale of the concept being tested and able to grow alongside the move towards a full business model. The sandbox, in this sense, works like an incubator allowing firms to experiment while also meaning the companies in question should be able to work within the regulatory framework once they are out of the sandbox.

As with the whole of Project Innovate, Woolard said that companies which took the sandbox root would still need to be assessed by the FCA to see that it conformed with FCA consumer protection mandates. There are three qualifications here that Woolard mentioned. First, the FCA will only consider propositions where it was satisfied there would be a direct or indirect consumer benefit should the business proposition work out.

Second, the FCA will insist on upfront testing of parameters and customer safeguards appropriate to the propositions being tested and the type of consumer involved. Lastly, the FCA will require every sandbox firm to have a fair exit strategy for consumers. Depending on the test, these exit strategies may vary. By way of example, a firm may just call a halt to business, or it may transfer customers to third parties.

Clearly the FCA approach will develop over time and what is certain is that its officers and officials will become versed in the ways of fintech start-ups and fintech innovations. But as mentioned above, this process will likely start to look a lot like an incubator or accelerator programme. Indeed, as Woolard said in his speech it will indeed take a similar “cohort approach”. “This way we can learn what works and what doesn’t, and improve the sandbox for subsequent cohorts,” he said. “We will ask firms to submit applications explaining their proposition and how it meets the sandbox eligibility criteria.”

The criteria are vital. According to the FCA, they will look at whether the project is a genuine innovation; whether there is a benefit to consumers, either direct or indirect; whether the the idea is meant for the UK financial services market; a need for testing in the sandbox alongside the FCA; and lastly whether there is readiness to test – in other words, being in a sufficiently advanced stage of preparation to mount a live test.

Said Woolard: “This assessment will also be the final decision maker – we will choose firms with the most doable tests for the first cohorts. Thus, there is a competitive element to motivate firms to submit well-developed testing plans.”

GamCrowd will be asking gambling market participants whether the UK Gambling Commission or other global gambling regulators should look at replicating elements at least of the FCA’s Project innovate approach. Anyone with a viewpoint should contact the editor at GamCrowd.