Late in 2016 The Financial Conduct Authority (FCA) announced the first group participating in its regulatory sandbox. The initiative is the first of its kind globally and has sparked a series of worldwide regulatory bodies to follow suit. The sandbox allows innovative firms to work with the regulator to test their products in a live environment, promoting effective competition and increasing the regulators understanding of innovative companies.

This is the first in a three-part series covering the sandbox experience from the perspective of one of the first participants (Bud). The series will cover the application and test set-up stage, the test stage and finally leaving the sandbox to full authorisations stage.

Despite the potential for growth and market disruption, for "Fintech" firms, regulation can prove cumbersome and a factor in launch delays. A proliferation of organisations adopting a “regulatory arbitrage” approach out of frustration or to obtain market momentum has emerged. Well-known organisations particularly outside of finance (taxis/hotels) have capitalised on this opportunity, which is a worry for all regulators effectively losing regulatory control to compel compliance. This has potential knock-on effects for consumers by the potential increase in unregulated activates. There is, therefore, an undeniable concern as to whether regulators in finance globally can adapt as quickly as Fintech industries grow.

The FCA’s regulatory sandbox is one of the biggest steps by any regulator to combat this disconnect between regulation and technology. Prior to the sandbox those struggling to navigate through regulatory uncertainty had limited options other than to use conventional routes. Traditional routes can be challenging for fintech firms, often resulting in the instruction of regulatory consultancies to handle their application due to a lack of experience dealing with regulation. What can follow are long periods of uncertainty during which the market advantage represented by the product may be lost to competitors in other jurisdictions with a less rigorous regulatory framework. The importance of Financial Services in general and promoting Fintech in particular to a "post-Brexit" UK economy is obvious.

We were a group of friends with an interesting idea. Like many others, we initially had a limited understanding of regulation and found ourselves having early engagements with regulatory consultants. Fortuitously, the sandbox was also open for applications. We took a calculated risk; apply for the sandbox and work in an unknown initiative or proceed down the conventional route with the attendant problems highlighted above. The final decision was based on a problem-solving attitude; the status quo is simply not acceptable, walking down the path to the unknown (but a possible solution to a problem) appealed more than a journey that has proven to be challenging for many.

Our Sandbox application focused on three core areas; the idea; the hypothesis; and “readiness”. Emphasis on the innovation and benefits the company provides the retail market were consistent throughout the application. The hypothesis outlined the problem we are looking to solve, and our KPI’s were used as supporting questions. “Readiness” outlined our timeline to launch the product, and that we were “ready” to begin testing.

We received confirmation of acceptance into the sandbox shortly after the application period closed. Upon acceptance, the first task was to work with the FCA to get up to speed on the regulatory literature, e.g. FCA Handbook and FSMA. This was critical for obvious reasons. It enabled a transition within the business from one that had a limited understanding of regulation, to one that had a firm understanding of regulation in-house when plotting future and current plans.

The sandbox is designed to enable a small-scale initial testing phase then if desired following the test a smooth transition to the wider market. In our case, we needed to make use of the “restricted authorisation” sandbox tool to carry out our test, which meant completing traditional authorisation forms. We were assigned a dedicated sandbox case officer who worked with us throughout this process and provided regular feedback on our submissions. When we came up against issues, our case officer would point us in the right direction rather than prescribe a solution. Information barriers were installed to maintain objectivity and where appropriate the intellectual property in the idea.

The sandbox is not a “golden ticket” to authorisation, nor is it designed to circumvent the regulatory framework, it provides a pragmatic solution to businesses that have been successful in negotiating a rigorous selection process. There were countless all-nighters spent identifying solutions to problems raised throughout the process on top of other issues involved with running a business in this sector. Admittedly there were some transferable skills from my audit and accountancy background when troubleshooting. A consultancy firm could have relieved some strain, however, the same amount of knowledge would not have been accumulated, and it would have cost more principally in communicating the specialist nature of the product. We were also fortunate to have the support of a lawyer who took an interest in what we were doing provided some advice throughout the process.

Following final submission, our restricted authorisation application was reviewed by the FCA and approved in late December 2016. The total time from acceptance to restricted authorisation was four months. What now follows is the test period throughout which regular contact with our FCA case officer will continue.

From the start-up perspective, this approach towards negotiating the first stage of being regulated has proved to be very beneficial. Access to, and an open dialogue with, the FCA has been hugely valuable. It enabled the FCA to gain a rapid and efficient understanding of our ambitions, and for us to have a very valuable and responsive dialogue at a critical time. It has provided a much more cost-effective route to achieving our regulatory goals compared with pursuing the conventional route. Most valuably it has facilitated rapid knowledge growth, which has reduced our organisations burden on third parties for regulatory advice.

Three things no one told us from the start.

1. Study the FCA handbook first. Become aware of areas that relate to your business both now and the future. You may become the most boring pub companion. However, it will provide a great tool to refer to moving forward.
2. Obtain a legal opinion. Should you understand your business and correlate it to the FCA’s regulatory framework you can sit with a good lawyer (as we did) to scope out areas of regulation the business covers.
3. Speak to other businesses. The knowledge sharing possibilities within the industry are largely untapped. A five-minute call with a partner company can 
   save hours of time wasting and point you in the right direction.

Key costs we incurred

1. Application fee (varies depending on the complexity of your application)
2. A legal opinion considering the regulated activities within which your organisation participates.
3. A Penetration (security) test