Regulators and Innovation: It's Not Just Sandboxes

Even as "safe spaces" for experimentation have gone global, regulatory agencies have developed multifaceted fintech programs

Friday, June 14, 2019

By Ted Knutson


Since 2016, when the U.K. Financial Conduct Authority and the Monetary Authority of Singapore launched sandboxes for financial technology startups, regulators in dozens of countries have gone the same route. In fact, the FCA and MAS are among more than 30 members of the Global Financial Innovation Network, which grew out of an FCA proposal last year to create a global sandbox. In the U.S., the state of Arizona and the District of Columbia have fintech sandbox programs.

“Regulatory sandboxes provide an environment of reduced regulatory constraints on innovative financial products and services,” said a report by consulting firm EY. “They enable financial services innovators - both incumbents and startups - to test new products and services in a 'safe area,' providing greater flexibility or even exemptions from existing regulation.”

Sandboxes were the subject of a panel discussion during the Institute of International Finance's Digital Finance Symposium on May 29. Participants included MAS chief fintech officer Sopnendu Mohanty; Pat Chaukos, deputy director, LaunchPad and policy, Ontario Securities Commission; and Jo Ann Barefoot, CEO of Barefoot Innovation Group.

Last November, the MAS proposed Sandbox Express, a faster track than the regular, bespoke application and approval process, “for activities where the risks are generally low, or well understood and could be reasonably contained within the specific pre-defined sandbox.”

“We have engaged with more than 150 fintech players since the sandbox was launched, and a number of firms have experimented in the sandbox,” Mohanty said at the time. “To facilitate quicker experimentation and faster introduction of innovative financial services to the market, we are now offering the option of Sandbox Express.”

“Safe Way to Learn Fast”

Barefoot, a longtime regulatory and policy adviser and a former U.S. deputy Comptroller of the Currency, in a March 2018 blog cited research about the rapid spread of sandboxes and “reglabs” and wrote, “The sandbox concept has caught on because it creates a tool that is otherwise missing from the regulators' toolbox, namely a controlled, contained, safe way to learn fast, through experimentation.”

She said that “regulators need this new device, because their traditional methods of learning are too slow for, and too remote from, the bleeding edge of the technologies reshaping finance . . . If regulators choke on such changes, the public will never benefit from their upside potential. If they stay hands off, some of these developments will cause harm - and will be hard to stop once they are rooted in and spreading throughout the market.

“Sandboxes can't solve all of this, but they are crucial to evaluating potential benefits and risks early, and helping industry and regulators develop shared thinking on how innovation should evolve.”

Encouraging Dialogue

More than a year later, at the IIF symposium, Barefoot pointed to other ways regulators can get up to speed for their own purposes and in the interest of supporting technology innovation, such as tech sprints or hackathons; issuing no-action letters to provide some developmental leeway; and inviting informal conversations and presentations during designated “office hours.”

Sopnendu Mohanty Headshot
Sopnendu Mohanty, Monetary Authority of Singapore

Most of the U.S. national regulators encourage such dialogue as part of their innovation programs - examples are the Office of the Comptroller of the Currency's Innovation Office, the Securities and Exchange Commission's FinHub and Commodity Futures Trading Commission's LabCFTC.

In April, the Financial Industry Regulatory Authority said it formed an Office of Financial Innovation “that will serve as a central point of coordination for issues related to significant financial innovations by FINRA member firms, particularly new uses of financial technology (fintech).”

In May, the U.S. Treasury's Financial Crimes Enforcement Network announced an Innovation Hours Program to “provide financial technology (FinTech) and regulatory technology (RegTech) companies and financial institutions the opportunity to present their new and emerging innovative products and services to FinCEN.”

Speaking on June 11 at the International Swaps and Derivatives Association's annual legal forum in New York, LabCFTC director Daniel Gorfine said that the unit has engaged with more than 250 entities through its GuidePoint program.

GuidePoint, a “point of contact” and feedback mechanism, complements other LabCFTC components CFTC 2.0, which promotes innovation initiatives within the agency, and DigitalReg, an internal fintech resource. Gorfine, who is also chief innovation officer of CFTC, noted that it has entered into fintech cooperation and information-sharing agreements with the FCA, MAS and Australian Securities and Investments Commission.

Challenge the Black Box

In an IIF session, on machine learning, Raj Singh, chief risk officer of Genworth Financial Global Mortgage Insurance, warned against becoming enamored with technology.

“You should not believe in the black box,” he said. “You should challenge it. You should test it.”

He also stressed the need for domain experts, and not just data scientists, in designing models. “It is not about the technology,” Singh said. “It is about solving business issues, which for risk professionals means balancing risks with rewards in areas such as capital and liquidity.”

GARP Editor-in-Chief Jeffrey Kutler contributed to this article.


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