Fintech is unique because it is disruptive. That’s why it is important that we have the expertise to keep a sharp eye on potential pitfalls and that we are careful about how we set our policies
By Rattan Khushiram
In its move onto the Fintech journey, this year Government had budgeted plans to set up a National Regulatory Sandbox Licence Committee to consider all issues relating to Sandbox licensing for Fintech activities.
What is a regulatory sandbox? A Fintech regulatory sandbox can be defined as: A framework set up by a financial sector regulator to allow businesses/private firms to test new products, services, business models and delivery mechanisms within a controlled environment agreed between the participant and the regulator, usually under a special exemption, allowance, or other limited, time-bound exception. It is a kind of “lighter-touch” regulatory environment, which allows start-up firms to operate without a financial services licence, but under minimum constraints, for a limited period. The lighter-touch regulatory environment is however a structured and controlled one within which regulations can be formulated at a fast enough pace, while giving companies some breathing room to develop new innovations.
The range of products that can be issued by firms in the sandbox usually include payment systems, the tracking of physical as well as digital assets, customer databases, storage systems, money management systems, advisory services, identity verification procedures and transaction record, and many other types of products and services.
Governments know that Fintech has the potential to deliver economic benefits, by lowering the cost of operations and enhancing competition, and societal benefits, by boosting financial inclusion and delivering more convenient financial services. As a result, regulators around the world are targeting “optimal regulation” — an environment that encourages providers to harness emerging technologies without weakening the financial system or eroding consumer protections.
Thus Fintech regulatory sandbox seems to be the optimal regulation to benefit customers, Fintech start-ups (innovators), investors and even regulators as it supports in identifying appropriate consumer protection safeguards to build into new products and services.
But recently, there have been some concerns there is “a kind of race to the bottom among global regulators to set up the most ‘light-touch’ possible regimes so as to attract start-ups to their jurisdictions — whether or not they are offering consumers and investors anything useful.”
Unique – and disruptive
Fintech is unique because it is disruptive. That’s why it is important that we have the expertise to keep a sharp eye on potential pitfalls and that we are careful about how we set our policies from the start, especially after what we have been through with the regulation and supervision of the Global Business Companies.
There have also been concerns about unscrupulous firms exploiting the regime to sell consumers harmful products. They have noted the fact that “start-ups think they’re being seen as more legit after they’ve been through the sandbox means they probably are being seen as more legit”.
This perception of a kind of stamp approval – of endorsement – by the sandbox regulatory authorities could put consumers at risk of rogue operators in the finance sector, in particular in the Initial Coin Offering market. To protect the consumer, we have to make sure that we have in place the required legislation.
Indeed, Fintechs will have to adhere to robust consumer protections and disclosure requirements, including responsible lending obligations, best interests duty, and adequate compensation and dispute resolution arrangements. Some consumer organisations have warned that “instead of conducting limited, carefully drawn trials of model disclosures that could improve consumer understanding, (we are)… allowing firms to obfuscate or eliminate important information in the name of “financial innovation,” a label that was often applied to defend practices in mortgage lending that led to the 2008 crisis.”
Moreover this kind of stamp approval, some say, has created an uneven playing field. A number of companies have benefited from being vetted by the regulator, which large financial institutions say they require before they can work with them. But others say they have been excluded by the process, or tangled up in bureaucracy, costing them time and resources and leaving them effectively frozen out of the marketplace. That’s why some don’t necessarily agree that a sandbox is a good way to go. If they have one, they believe it should be open to all, with little restriction. The regulators shouldn’t be interfering with market selection. They are only making a sandbox because they recognize that their existing regulations are excessive for new entrants.
Another issue is the regulatory sandbox to enable Fintech companies to test ideas and products in a safe space is like a regulatory incubator where regulators are more concerned with start-ups which are too small to succeed. The regulator working with these start-ups in a specific environment of a limited amount of customers and model do not necessarily allow them to become familiar with new business models of the real world, of the system as a whole or that they can really develop more appropriate regulatory policies through greater visibility into these new innovations exhibited on a limited scale. Thus the arguments that new and barely-tested Fintech programs may pose any kind of risks to the stability of the system as a whole and even contribute to structural economic instability as well may be valid.
The whole idea of the far-reaching regulatory incubators allowing Fintech firms to experiment with new business models and products without falling foul of financial rules in a conditioned environment may not be of much use because once the innovation or technology moves to higher scale in the real world, the risks are likely to be different.
These regulatory issues will continue to be a hot topic within the industry, but we have to remain alert to the latest developments while we put in place the right framework that will aim at a healthy balance between maintaining stability in the market and protecting customers while providing enough room for companies to develop and implement the latest innovations.
* Published in print edition on 21 December 2018