Regulatory Sandboxes and More

Generally regulators and regulations are viewed as things that stifle creativity. In recent years though, regulators in certain jurisdictions have begun to take a different approach to that creativity in the financial services sector.  Rather than fighting the tide of start-ups and disruptive financial technology, regulators have decided to encourage it. In fact, regulators such as the Australian Securities and Investments Commission (ASIC), the Financial Conduct Authority (FCA) of the UK, the Hong Kong Monetary Authority (HKMA), the Monetary Authority of Singapore (MAS) and the Financial Services Regulatory Authority (FSRA) of Abu Dhabi are either proposing or have put in place regulatory sandboxes. The World Federation of Exchanges has also urged regulators to create additional sandboxes specific to distributed ledger technology to understand its effects on capital markets. These sandboxes are meant to create a safe environment for fintech companies to test their products with customers and receive regulatory feedback. What does a safe environment mean?  It means the ability to test the technology on informed participating clients without fear of disciplinary actions by the regulator. It gives the regulators a seat at the table early on in order to identify and address regulatory issues before the technology is in production.

Regulators aren’t just using regulatory sandboxes to push innovation and increase competition.  For example, the UK’s Competition and Markets Authority (CMA) is trying to level the playing field in the UK retail banking sector through Open Banking requirements. CMA is requiring retail banks to enable customers to share data securely with other banks and third parties, publish trustworthy and objective information on quality of services, and provide updates to customers when branches close or charges increase.  All of this is aimed at allowing customers to have greater access to smaller and newer banks.

Is it working?

When introducing their sandbox, the FCA identified three potential benefits from doing so: reduced time to market for products at a lower cost; increased access to investment in fintech startups; more innovative products reaching the market. There were 427 fintech mergers and acquisitions in 2015, a 14% increase over 2014. In the second quarter of 2016 investment in Fintech globally reached $8.2 billion, an all-time high compared to $6.1 billion in Q2 2015.  In the US, the New York State Department of Financial Services issued the first two BitLicenses to virtual currency firms in late 2015 and early 2016. The UK’s FCA also issued several electronic money licenses over the same time period. Whether you like it or not, changes are coming. In fact, the World Economic Forum released a report last month indicating that blockchain will become the “beating heart” of the financial system by simplifying back end processes.

What does this mean for existing and established banks?

Increased disruptive technology, increased competition, and increased expectations from customers. Drivers for change, that’s what these are.  Take a cue from the regulators, innovate and invest in your own disruptive technologies.  Don’t fight the tide and get left behind.  Partner with fintech startups and/or incubate your own innovations.  Many banks are starting to put in place their own innovation centers to try and stay ahead of the game. For example, Citi has Citi FinTech, State Street has its Emerging Technology Center and Fidelity has Fidelity Labs. The game is changing, you can either adapt or perish.