New and developing financial-tech companies must comply with a web of laws and regulations intended to protect consumers and financial markets and fight money laundering and the financing of terrorists. Various federal agencies have overlapping jurisdictions on this front, leaving fintech companies to deal with with fragmented and sometimes contradictory regulations.
Add to this the fact that many existing laws are a poor fit with new and emerging technologies and business models, and the cost to innovative fintech companies can be high.
But just this week, the Treasury Department released a long-awaited report addressing fintech and financial innovation in the US, in which it pointed to the importance of developing a unified regulatory sandbox as a potential solution to these challenges.
The Consumer Financial Protection Bureau’s (CFPB) announced recently that it is developing such sandbox. Earlier this month, the Bureau appointed Paul Watkins, the former Arizona Office of the Attorney General lawyer who led that state’s recent regulatory sandbox initiative, to head its new Office of Innovation, which is a further sign of the agency’s interest in supporting Fintech innovation.
Nonetheless, the idea of a CFPB regulatory sandbox is only aspirational at this stage. To be more than that, the CFPB will have to do something no other federal regulator thus far has been willing or able to do: expand the range of accommodations and protections it is willing to offer participants in the sandbox.
What is a regulatory sandbox?
A “regulatory sandbox” is a safe space for a company to test out its products and services with some explicit reduction in the risk of regulatory enforcement action. However, the term has been broadly used to mean a variety of things, not all of which include the type of robust protections and regulator engagement that most fintech companies would hope for. On one end of the spectrum, the United Kingdom’s Financial Conduct Authority’s Regulatory Sandbox offers fintech companies a single national financial regulator, clearly defined eligibility criteria and testing parameters, the opportunity to for the waiver of burdensome rules, and direct collaboration with regulatory staff.
On the other end of the spectrum, US regulators have used the sandbox concept to refer to limited initiatives that provide far less in the way of a protected space for development. The Office of the Comptroller of the Currency’s Fintech bank charter, the Commodity Futures Trading Commission’s LabCFTC, and even the CFPB’s prior Project Catalyst initiative, have been referred to as regulatory sandboxes, although in reality they lack important elements of regulatory relief that are the hallmarks of a true sandbox. Other federal agencies have so far rejected the idea of creating a sandbox, with one Commissioner of the Securities and Exchange Commission stating — with respect to Initial Coin Offerings — that she would rather take up the more distant position of a lifeguard on the beach than participate with innovators in a sandbox.
At the state level, Arizona began accepting applications this week for its newly-enacted regulatory sandbox, becoming the first state to do so. As yet untested, Arizona’s program will allow approved applicants to offer innovative products to a limited number of consumers for an initial two-year period without having to go through the time-consuming process of obtaining a license to operate in the state. Arizona’s sandbox also limits the extent to which state laws regulating financial products and services apply to sandbox participants. Of course, participating in one state’s sandbox will not protect a company from federal or other state regulations or enforcement activity.
What the CFPB’s sandbox will look like
Details about what the CFPB’s Office of Innovation will offer fintech companies with its regulatory sandbox are thin. The Bureau’s previously-launched Project Catalyst provided a program to collaborate with the financial industry in testing new products and financial disclosures — and through its no-action letter policy. But that project, which was initiated in 2012, resulted in just one no-action letter, issued last year to a California-based online lender proposing the use of alternative underwriting criteria.
The announcement of Watkins’ role suggests the CFPB may be taking the sandbox concept more seriously than it did with Project Catalyst. On the state level, where a fintech company must apply for and receive a license before going live, a waiver of that burdensome requirement is a material gain for innovators. The CFPB has yet to announce any specific “upgrades” to what it had offered through Project Catalyst. Going forward, an important indicator for the CFPB’s new program will be whether it will meaningfully reduce the cost of entry or regulatory enforcement risk fintech companies face.
Companies considering participating in the sandbox will want to see the following elements:
- a clear application process
- specific parameters relating to time periods for testing and scope of consumer participation
- reduced barriers to entry
- an established channel for communication with regulators
Until the CFPB offers a path for individual fintech companies to receive a clear reduction of their regulatory risk by offering some or all of these hallmarks of a regulatory sandbox, it’s unclear what benefits the sandbox would deliver to innovators.
I hope to see the CFPB take a strong role in coordinating and leading state efforts to develop individual regulatory sandboxes and, more importantly, to harmonize state laws and supervision activities to provide regulatory consistency across the country. While that will still leave a patchwork of other state and federal regulators with significant stakes in the activities of fintech companies, it would certainly be a significant step towards facilitating the innovation that is currently only for the very brave.
Laurel Loomis Rimon is a senior counsel at law firm O’Melveny & Myers. Based in Washington, DC, she represents clients on a broad range of anti-money laundering and fintech enforcement issues. She is a former Assistant Deputy Enforcement Director for the Office of Enforcement at the Consumer Financial Protection Bureau.