‘Sandboxes’ are all the rage with regulators since having been initiated by the UK’s Financial Conduct Authority in 2016. South Africa’s own Reserve Bank is in the process of establishing one which is expected to be operational in late 2019. Although regulators have a conservative mandate, it is also in their interests to encourage innovation. A ‘sandbox’ provides the regulator with insight into the types of innovation being explored by FinTech entrepreneurs, and the ability to provide guidance to them at an early stage. Here are my observations:
It’s not hard to create a sandbox
- Regulators already have the authority to relax certain regulations – they don’t need to ‘ask permission’.
- However, the regulator should have a good grasp of the benefits they intend to obtain in the longer-term from establishing a ‘sandbox’.
- This should not be seen as a PR exercise by the regulator, but as an important investment with a longer-term return to the regulator.
- This return can be seen as deeper insight into the activities of disruptive innovators (as the regulator will typically not see the data from entities outside of their purview). This data can form the basis of policy decisions and changes to regulatory parameters.
- Writing new legislation is very challenging — takes years to develop the white paper and it reams of lawyers to review for consistency with other laws and regulation. A ‘sandbox’ can be a mechanism to fast-track that process.
- The regulator will be building relationships at a key stage with the founders of FinTech entities — some of which will go on to become systemically important.
- The intensity of activity within a sandbox will quickly expose people’s true value systems and drivers. Malicious and selfish intent will become obvious, as will goodwill and generous behaviour.
- The shared experiences will build bonds between the participants in the sandbox. These relationships will foster respectful interaction between them over the remaining course of their careers, which in many cases will be in large regulated financial institutions.
Encourage diversity in your sandbox
- Regulators must also invite the incumbents (large banks, insurers) into the sandbox — so that their own internal innovation units can also experiment.
- FinTech entrepreneurs from neighbouring countries should be encouraged to participate. They are typically solving similar problems for a similar customer base.
Kids have differences
- A ‘sandbox’ is intrinsically discriminatory against the incumbents. Relaxing a regulation for a set of participants inside the sandbox gives them an advantage against the incumbents using the existing regulatory ‘straightjacket’.
- However, this is a necessary action to ‘level the playing-field’ for new entrants, as they do not have the array of market advantages that the incumbents enjoy (balance-sheet, credibility, customer base, tech capability, low marginal costs, etc).
Not everyone can play
- Both entry and exit criteria for access to the sandbox need to be established. Entry criteria must be relevant to a start-up (i.e. no financials, limited corporate documents), but it is fair to ask that they are domiciled in the regulators’ jurisdiction.
- Exit criteria are very important — at what scale must the sandbox participant now be forced to comply with regulations, and how is that process enforced?
Play must be supervised
- A sandbox does not provide freedom from rules, just a (temporary) relaxation of some regulations. Participants in a sandbox must still adhere to basic corporate governance and general law.
- Customers will be used as ‘guinea pigs’ and the regulator must still ensure that they are not exploited or harmed by the activities of ‘sandbox’ participants.
- It is essential that the regulator dedicate a team of people to manage the sandbox. They need to have this as their primary responsibility and they need to understand that this is not a short-term assignment, but effectively a new division of the regulator. This team must consist of a variety of skills and experience-sets.
- A sandbox intrinsically cuts across the organisational boundaries of the regulator. Therefore it needs sponsorship and executive support from the very top of the regulator, to resolve these organisational politics.
Sharing is caring
- The regulator can also play a role in sharing practices identified from within the sandbox, to the incumbents it oversees. These practices can improve the technical competence of these incumbents — thereby minimising systemic risk to the regulator.
- Entrepreneurs often copy innovative solutions from the international market into the local environment. By observing solutions being built in the sandbox the regulator can gain insight into these international best-practices and offerings.
- A valuable benefit the regulator can provide to ventures in the ‘sandbox’, is direct access to knowledgeable people inside the regulator. These people often have many years of experience in the industry and would provide a very valuable resource to entrepreneurs. Access to these resources is actually a unique selling proposition of a ‘sandbox’ to entrepreneurs…
- Entrepreneurs don’t play by the rules, and the regulators must expect that activity in the sandbox will not be linear and predictable, but organic and chaotic. Do not expect monthly progress reports or even project plans.
- A sandbox may also include an ‘incubator’ capability, which could be an office environment for entrepreneurs to work from. My own view is that there is a surplus of incubators, and the regulator often does not have the most attractive premises for start-ups.
Don’t hurt others
- As disruptive innovators often exploit process weaknesses and ‘arbitrage’ regulation, insights from the sandbox can help the regulator identify these ‘problems’. This can help them to either resolve these issues or guide the entrepreneurs towards ‘safe’ solutions.
- FinTech entrepreneurs operate in a very stressful environment, and naturally, emotions will be high. Expect occasional jubilation and also despair as funding runs out and closely-held ideas get proven incorrect.
- A key role for the regulator is to protect those inside the sandbox (often throwing sand) from the ‘grown-ups’ outside the sandbox. The regulator needs to persuade the incumbents of the longer-term and industry-wide value of FinTech innovation.
- The regulator will also be called on to protect the entities within the sandbox from each other. There will often be more than one participant working on the same problem, and the protection of IP may become a challenge. A smart regulator will help these businesses to see opportunities to collaborate together.
Take personal responsibility
- The success of participants in a sandbox is directly attributable to the skills and passion of the participant. There is no-one else to blame and ‘politics’ is pointless.
- The regulator will typically not have funds to provide to entrepreneurs as seed funding/acceleration and would tie themselves in red-tape trying to fairly allocate that.
- The provision of seed funding and acceleration capabilities (cloud computing facilities, legal and accounting services, etc) should best be provided by the existing FinTech ecosystem.
- The regulator could perhaps lobby the tax authorities for tax credits/benefits for small FinTech firms, or for the VC firms that supply them with capital — perhaps a tax rebate for angel investors who provide capital to VC firms or direct to FinTech firms?