The New York Department for Financial Services is not happy about Fintech sandboxes. In a short and forthright statement, the Superintendent of the NYDFS, Maria T. Vullo, pours cold water all over the idea that a sandbox for fintech companies to test out their products is a good thing.
This is perhaps unsurprising given the NYDFS's approach to the Bitlicense - a licensing regime that basically applies to all virtual currency business that takes place in the state of New York (see final rules webpage and the FAQs). However, it is contrary to the views of many other regulators (see my recent post on the potential global fintech sandbox as well as the US Department of Treasury).
Perhaps it was intentionally controversial, but I cannot say that I agree with the NYDFS here. In my view, the Superintendent's comments do not take into account the ways in which a good sandbox prioritises consumer protection, nor the benefits of sandboxes for new entrants to the financial services market, including from a costs perspective. I've set out below a few thoughts on consumer protection in the FCA's sandbox and on costs and why, despite my initial scepticism when the FCA sandbox was first announced, I see the sandbox as being a positive thing for Fintech.
The Superintendent indicates that sandboxes allow fintech companies to evade their obligations under consumer protection laws. This statement does not really take into account at least the FCA's approach to the sandbox. Consumer protection is at the forefront of the FCA's mind in the sandbox and is one of the FCA's operational objectives.
This is particularly clear when looking at almost any of the FCA's documents or speeches that refer to the sandbox. One of the key things the FCA works on with firms in the sandbox is making sure that there are sufficiently high safeguards for consumer protection. Even in the early stages of the sandbox project, the FCA stated that one thing that they would not compromise on was consumer protection.
The FCA also states that it closely oversees tests using a customised regulatory environment for each test – including safeguards for consumers. In its Lessons Learned report, the FCA explicitly states that "[we] put in place a set of standard safeguards for all sandbox tests, and develop bespoke additional safeguards where these are relevant. For example, we require all firms in the sandbox to develop an exit plan to ensure the test can be closed down at any point whilst minimising the potential detriment to participating consumers." One example where this has worked is in the money remittance space. Where firms were testing the use of digital currencies in money remittance, the FCA required those firms to guarantee funds being transmitted to deliver full refunds in the case of funds being lost.
Many of the firms which carry out testing in the FCA sandbox look to address the needs of more vulnerable consumers who may be particularly at risk of financial exclusion and the FCA sees this as being a particularly beneficial outcome of the sandbox. Testing these sorts of products in an environment with additional, bespoke safeguards for consumers and guidance from the regulators would presumably be better than providing the service without such safeguards.
The ultimate result of the sandbox in the FCA's mind is that there is better choice and variety and therefore this is beneficial to consumers.
Costs of compliance
The NYDFS also seems to have ignored that becoming and being regulated is an expensive business. Having to go through the authorisation and compliance process before knowing whether a particular product or service works at all or is something that clients might want is made even more costly and time-consuming outside of a bespoke process.
The FCA's Lessons Learned report highlights that one of the benefits to firms in participating in its sandbox is reduced time to market and reduced costs. Being part of the sandbox means that firms get help in understanding how the regulatory framework applies to them and also helps to reduce expenditure on external advisers (although perhaps I should be less positive about this as a regulatory lawyer...).
If firms take the view that they cannot afford these initial costs, the outcome will be that either they will not proceed with the service (and thus not provide challenge to incumbent institutions) or they may provide the service without becoming appropriately authorised or knowing which rules to comply with. It is hard to see how this would be beneficial for consumers or lead to appropriate consumer protection.
The New York State Department of Financial Services fiercely opposes the Department of Treasury’s endorsement of regulatory ‘sandboxes’ for financial technology companies. The idea that innovation will flourish only by allowing companies to evade laws that protect consumers, and which also safeguard markets and mitigate risk for the financial services industry, is preposterous. Toddlers play in sandboxes. Adults play by the rules. Companies that truly want to create change and thrive over the long-term appreciate the importance of developing their ideas and protecting their customers within a strong state regulatory framework.