The UK’s Regulatory Sandbox promotes innovation

The UK is credited with launching the first regulatory sandbox in 2016, and since then the concept has spread worldwide, with a further 72 FinTech sandboxes implemented in close to 60 jurisdictions, according to World Bank data.

But what exactly is a regulatory sandbox, and why are governments around the world increasingly implementing the concept?

The UK’s Financial Conduct Authority (FCA) first announced that it would launch a regulatory sandbox in 2015. The first sandbox grew out of the FCA’s Project Innovate, which brought together regulators and industry voices to discuss how to foster a more hospitable environment for innovation, particularly in the financial sector.

The FCA defines a regulatory sandbox as “a ‘safe space’ where businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of engaging in that activity.”

Basic setup and framework

Initially, the first generation of sandboxes were organized into cohorts, with subsequent rounds of experimentation and discussion requiring companies to apply to join. Each round usually lasts from six months to a year, with longer periods used in special circumstances.

As the sandbox concept has evolved, some authorities, including the FCA, have moved to a rolling acceptance model. Instead of admitting a new batch of firms each year, regulators such as the FCA now accept applications to join the sandbox on a rolling basis.

Once accepted into a sandbox, companies have a direct line of communication with regulators. This alone has huge benefits for innovation – especially if the firm in question is an early-stage startup that doesn’t have the resources to hire the necessary consultants and legal teams required to handle full regulatory compliance.

Perhaps the biggest advantage of joining a sandbox is that a company is able to propose a specific exemption to an existing rule that it wants. It can also ask for permission to carry out an experiment where the law is not clear about the legal consequences without fear of the regulator imposing fines.

That said, the company is still bound by local laws. It is simply given limited permission within the framework of the sandbox to operate with greater freedom than if it were not registered in the sandbox.

Often the regulator and the business will work together to set up a controlled experiment with a limited number of users and any necessary consumer safeguards in place.

Public-private dialogue, cooperation

While the likes of the FCA state that the primary function of regulatory sandboxes is to stimulate innovation, working with businesses gives regulators additional insight into where existing policies are harming business growth, and helps guide future policy changes.

By bringing governments and the people developing new technologies together, regulatory sandboxes are becoming an increasingly important avenue for dialogue between governments and the private sector.

In a sign of how this public-private engagement is driving change, over the past year UK and EU regulators have moved beyond sandboxes that open up space for experimentation in the delivery of financial services to those that deal with specific technologies and the pressing issues they raise .

For example, PYMNTS reported last month that the UK Treasury will begin live testing of crypto blockchain technology in financial market activities – the EU is also in the process of setting up a similar crypto sandbox – as part of the government’s plan to create a friendly and attractive regulatory environment for investors.

Read more: UK Government Pushes for Crypto Sandbox, Stablecoin Regulation

One of the goals of this new sandbox would be to experiment with distributed ledger technology (DLT) projects – the underlying technology used by cryptoassets – around activities such as trading, clearing and settlement to speed up the issuance of bonds or shares, for example.

From FinTech to AI, healthcare

The regulatory sandbox concept is not limited to financial services technology or FinTech alone. In June this year, the government of Spain and the European Commission announced a pilot for the first regulatory sandbox for artificial intelligence (AI).

The anticipated sandbox is set to focus on the implications of AI for data protection laws and help firms better understand the legal issues at stake. It will also guide governments on where laws around the use of data need to be updated to reflect the growing importance of machine learning data processing across industries.

Related: UK Goes for Light Touch AI Regulations; While the EU doubles down

Overall, the more regulated the sector, the more useful sandboxes can be. For example, healthcare is highly regulated out of necessity, but the strict oversight can stifle innovation, which often takes years to get a product to market.

The Care Quality Commission (CQC) – the body responsible for regulating the NHS and other healthcare providers – launched its own set of sandboxes in 2019, recognizing the need for digital transformation of the UK’s National Health Service (NHS).

And while “at times the sandbox walked a difficult line between supporting experimentation and the CQC’s role as a regulator,” the CQC noted in a May 2022 pilot evaluation that it has been able to “balance this risk.” Also, as they have built better relationships with stakeholders who were part of the sandbox, it has “helped define regulatory boundaries with some other regulators.”

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