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The FCA’s sandbox or why the UK is leading on fintech regulation

Telephone box and Big Ben in London

Law is often reactive and follows social and economic changes.  However, when regulators have a forward-looking attitude, are not averse to changes, and are able to think outside the box, projects as the Financial Conduct Authority (FCA)’s Regulatory Sandbox may happen. This initiative is not only great news for the fintech industry, but an example for other EU countries’ regulators, as well as for the the rest of the World.

What is the FCA and Project Innovate?

The Financial Conduct Authority (FCA) is the UK’s regulator for financial firms whose main activity is not credit intermediation (including fintech). Such firms would fall under the Bank of England’s Prudential Regulation Authority (PRA)’s umbrella. Besides, the sandbox initiative is framed within the FCA’s Project Innovate, which “encourages innovation in the interests of consumers and promote competition through disruptive innovation”.

What is the regulatory sandbox?

Successful applicants to the sandbox will be provided with an ad hoc regulatory framework for testing their new products, services and business models in a safe way, without having to incur all the regulation that the activity would require under normal circumstances.

In the words of Christopher Woolard, FCA Director of Strategy and Competition, the sandbox aims at lowering “barriers to testing within the existing regulatory framework, ensuring that risks from testing novel solutions are not transferred from firms to consumers”.

Is this initiative meant for firms pursuing a banking license?

Those firms aiming to perform the activity of taking deposits need a banking license. Therefore, they need to be prudentially regulated by the PRA, which is not the target of the FCA’s sandbox. However, both the PRA and the FCA have recently designed the New Bank Start-up Unit in order to support those institutions thinking of becoming a new bank in the UK.

Is the sandbox only for new firms entering the market?

The initiative targets both, incumbent and challengers. New and unauthorised successful entrants will have a tailored authorisation process, starting with a restricted authorisation for them to test their ideas. This will help firms to meet FCA’s requirements and to get the test up and running. However, incumbents (i.e. authorised firms) that need to have a more clear view of the current regulatory framework before testing ideas that do not easily fit into it, are also invited to participate. Besides, technology businesses providing services to firms already authorised by the FCA may also apply for the sandbox.

How does “testing products without immediately incurring all the normal regulatory consequences” crystallize for successful applicants?

Since the sandbox’ first application process just started (applications are opened from 9 May until 8 July 2016) and due to the experimental and self-learning approach of the project, there are not examples of real cases yet. However, for authorised firms, the FCA has remarked that it will support firms in different ways, from individual guidance and waivers or modifications to FCA’ rules, to no enforcement action letters.

Do we find similar initiatives in Europe?

Unfortunately, the rest of the EU countries fall behind UK’s regulators in terms of fintech support. The regulation applicable to these technological financial firms in the Eurozone is applied by the national authorities (regulators or central banks) and not by the European Central Bank (which mainly supervises “significant” banks in the Eurozone).

Not surprisingly, more than half of last year’s investment in European fintech was made in the UK. Obviously, to a great extent this is due to the role of the City as a global financial center. However, UK regulators seem to have understood the importance and the disruption power of these new actors, showing their will to engage with them in order to boost innovation while reducing risks for consumers.