On 7 January 2019, the European Supervisory Authorities (ESAs) published a joint Report on innovation facilitators (regulatory sandboxes and innovation hubs). The Report performs a comparative analysis of innovation facilitators established within the EU as well as suggested best practices for the design and operation of innovation facilitators. It is a timely publication, as the next phase of evolution of the regulatory sandbox, the Global Financial Innovation Network (GFIN) begins to gain traction. The Report concludes that in many ways, despite the latitude given to Member States to shape the aims and operation of their regulatory sandboxes, they remain largely homogenised.
Scope of the Report
The Report addresses both innovation hub initiatives – to provide firms with a contact point with competent authorities regarding the application of regulations – and supervisory requirements to innovative business models, financial products, services and delivery mechanisms. Of these, the bulk of the Report focuses on regulatory sandboxes.
Regulatory sandboxes were first seen in 2016, with the first one being set up in by the UK. The positive responses from market participants meant that regulators in other jurisdictions quickly followed suit, both within and outside the EU, with Singapore's MAS being a particularly enthusiastic champion. The notable exception to this is the US, where the federal regulatory environment has made it more challenging to get consensus on roles and responsibilities in respect of regulatory sandboxes.
At the time of writing, there are five regulatory sandboxes operating in the EU, in: Denmark, Lithuania, the Netherlands, Poland and the UK. Austria, Spain and Hungary are considering following suit with their own regulatory sandboxes. All surveyed Member States confirmed that regulatory sandboxes were consistent with the statutory objectives of contributing to financial stability, promoting confidence in their respective financial sectors and protecting consumers, although only the UK cited its regulatory sandbox as fulfilling its objective of promoting effective competition in the interests of consumers.
The majority of the Report seeks to summarise features and approaches of EU regulatory sandboxes. Some of the more notable observations are as follows:
Level of regulation
A key commonality amongst the various regulatory sandboxes that potential participants need to be aware of is that they do not allow, even in the testing phase, the carrying out of regulated financial services without a licence. It therefore follows that if an applicant wishes to test a proposition which would involve the carrying out of a regulated activity and the applicant does not hold the relevant licence, the licence must be acquired as a part of the preparation phase for entering the regulatory sandbox.
The Report also emphasised that sandboxes are not a space of 'light touch' regulation and supervision, noting that, for example, if a regulatory sandbox participant were to undergo a change in control, the normal procedures for assessment would apply.
Timing of application
Potential regulatory sandbox participants should be aware that, whilst the UK and Denmark run their sandboxes on a 'cohort' basis, Lithuania, Poland and the Netherlands all allow applications to be made at any time.
The Report contains a helpful articulation of the approach which competent authorities take in assessing suitability for participation in a regulatory sandbox. The two key ones for potential applicants to be aware of are the need for testing in the regulatory sandbox which the Report articulates as existing "where the proposition does not fit easily into the existing regulatory framework, there is no alternative means of engaging with the competent authority or achieving the testing objecting in a live environment", and the readiness of the firm to test the proposition.
Protecting consumers during product testing phase
The Report notes that competent authorities place emphasis on protecting consumers during the testing phase. Therefore, applicants should consider how they would propose to safeguard this. The Report notes that appropriate measures will need to be decided upon on a case-by-case basis, but that the following elements would normally need to be considered:
- how to communicate with customers throughout the testing phase;
- testing parameters to mitigate risks (including consumer suitability tests);
- a clear exit plan setting out how consumers will be treated on exit; and
- compensation or redress measures should consumers suffer a loss during the course of testing.
Best practice recommendations
The best practice operating principles which the Report proposes for regulatory sandboxes are generally unremarkable, save that it remains to be seen how regulators in each Member State interpret the requirement that their regulatory sandboxes not allow the disapplication of regulatory requirements under EU law and how easily this can be applied in practice.
What lies ahead?
As noted above, the keen adoption of regulatory sandboxes has led to the concept of a global regulatory sandbox, first proposed in February 2018 by the UK's FCA, gaining traction. Terms of reference for GFIN were published on 31 January 2019, shortly after the Report, and the three stated functions cover both:
- innovation facilitation (to "act as a network of regulators to collaborate and share experience of innovation in respective markets, including emerging technologies and business models, and to provide accessible regulatory contact information for firms" and "to provide a forum for joint RegTech work and collaborative knowledge sharing/lessons learned"); and
- regulatory sandbox functionality (to "provide firms with an environment in which to trial cross-border solutions").
Whilst there are representatives from three EU Member States at GFIN currently (Hungary, Lithuania and the UK), the only EU member of the co-ordination group is the UK, which may present the EU with an interesting challenge following Brexit in terms of shaping the discussion. The EU will face this challenge in the context of calls for GFIN to become more geographically diverse in its representation. The current co-ordination group notably does not include representatives from India or China and whilst Africa is to an extent represented at the membership level (with members from South Africa, Kenya and Swaziland) the overall constitution of GFIN leaves vast numbers of consumers of innovative financial services notionally unrepresented.
Osborne Clarke comment
Regulatory sandboxes are more than just the flavour of the month and have already been delivering real benefits to regulators and firms. As financial services innovators become ever more globalised and jurisdictions become more and more competitive as places from which to launch offerings, the challenge which regulatory sandboxes will continue to face will be to balance the three-way tension of promoting their jurisdictions as providing a supportive regulatory environment, protecting consumers and maintaining a presence in the global regulatory landscape.