Regulatory Sandboxes—a Bridge Between Regulators and Business Innovation

As the world becomes more digitized, regulators worldwide try their best to stay on top of the latest technologies in business. Regulatory sandboxes have therefore emerged as a way for both regulators and businesses to experiment with technological innovations in the business world under supervision.

Regulatory sandboxes are gaining popularity, too. Just recently the Italian Ministry of Economy announced a second series of projects for the Italian Fintech Sandbox. Admitted companies will be allowed to test innovative products and services with significant regulatory exemptions in place.

While regulatory sandboxes do offer a lot of benefits for regulators and businesses, there are concerns that they may be misused or abused. So let’s dive into what these sandboxes are all about, which countries have them, as well as their pros and cons.

What are regulatory sandboxes?

Regulatory sandboxes allow businesses to experiment with new products, services, or business models with real customers under the supervision of a regulator for a limited period of time. Businesses can therefore test and develop innovative products without immediately having to comply with the full range of regulatory requirements.

Regulatory sandboxes: 

• Help businesses develop by enabling them to test innovations with real customers.
• Encourage regulatory learning or, in other words, experimentation with legal regimes to support business innovation ideas.
• Promote collaboration between businesses and regulators, fostering mutual understanding and knowledge sharing.
• Ensure consumer protection and the prevention of systemic risks, sinc there is close supervision by regulatory authorities. 

While overseen by regulators, the sandbox environment is designed to be less restrictive than the standard regulatory framework. This allows businesses to experiment with a reduced compliance regime. At the same time, regulators are involved in the process to ensure that consumer protection and systemic risks are adequately managed.

The exact level of regulatory involvement in a given sandbox may vary depending on the type of business and the tools available. In some cases, regulators may conduct site visits or request demonstrations to better understand the product under development. Many aspects of this supervision, such as reporting and monitoring, are done remotely.

Getting accepted into a regulatory sandbox involves submitting an application and going through an evaluation process. The exact steps and requirements vary depending on the jurisdiction and the regulatory authority overseeing the sandbox.

Innovation hubs vs. regulatory sandboxes

Innovation hubs allow companies to engage with regulators, allowing them to raise questions about regulatory frameworks, licensing or registration requirements, and supervisory expectations. These hubs play an important role in facilitating communication and collaboration between regulators, businesses, stakeholders, and other participants within the regulatory ecosystem.

Regulatory sandboxes, meanwhile, emphasize innovation, experimentation, and the development of new technologies and solutions under regulatory supervision.

“The main difference between them lies in the nature of the facilitation they aim to provide: while innovation hubs provide a platform to exchange knowledge and informal guidance, a regulatory sandbox usually implies some lenience or supervisory discretion about the way in which the regulatory framework applies to innovative products or services.” (STUDY Requested by the ECON committee)

What types of regulatory sandboxes are there?

Regulatory sandboxes vary from country to country, and are usually run by local regulators. Specific features, eligibility criteria, and duration of participation can differ depending on the sandbox’s objectives and the regulatory landscape in a particular jurisdiction. Here are the most common types:

Financial technology (fintech) sandboxes. This is the most widespread type of regulatory sandbox, focusing on encouraging innovation in the fintech sector. These allow fintech startups and financial businesses to experiment with new products and services in a controlled-risk environment with relaxed regulations. Fintech sandboxes often cover areas like payments, insurance, blockchain-based solutions, and more. They are present in the UK, UAE, Hong Kong, Singapore, and a number of other jurisdictions.

Technology sandboxes. These sandboxes can cover a wide range of industries and use cases, allowing businesses to experiment with new technologies, such as artificial intelligence (AI) and machine learning (ML), Internet of Things (IoT), blockchain, and other developing and emerging high-tech areas. Technology sandboxes are present in Norway and the UK. 

Cybersecurity sandboxes and innovation hubs. These sandboxes allow businesses involved in cybersecurity to simulate cyberattacks and test security solutions in a controlled-risk environment to identify vulnerabilities. 

Transportation sandboxes.These sandboxes support the development of autonomous vehicles (cars or drones), smart transport systems, and other innovative transportation solutions. The UK provides a regulatory sandbox for emerging transport technologies, while Canada offers a Remotely Piloted Aircraft Systems regulatory sandbox.

Healthcare sandboxes. These sandboxes deal with the healthcare and pharmaceutical sectors. They enable businesses to develop innovative medical devices, services, and pharmaceutical products (i.e. for early prediction of diseases) under regulatory supervision. One example is the Sandbox for Telemedicine and Mobile Medicine by the Singapore Ministry of Health.

What are the pros and cons of regulatory sandboxes?

Regulatory sandboxes have advantages and disadvantages.

Here are the advantages:

• Inspiring innovation. Regulatory sandboxes foster innovation by providing a risk-free environment for companies to experiment with new technologies. This leads to the development of high-tech solutions that do good both for consumers and industries.
• Reduced regulatory burden. Startups and existing businesses participating in a regulatory sandbox enjoy temporary relief from strict regulatory requirements, allowing them to focus on experimentation and innovation.
• Real-world scenarios. Companies can validate their ideas with real customers within a sandbox environment, gaining necessary insights before launching a product or service. At the same time, consumers stay protected, because regulators monitor sandbox activity to ensure customer interests and privacy are safeguarded.
• Collaboration between regulators and business. Sandboxes facilitate collaboration between businesses, regulators, and other parties,  fostering mutual understanding of business needs and technological adoption..
• Quick regulatory approval. The “fast-track” regulatory approval of sandboxes allows companies to bring their products to market faster, accelerating the pace of innovation.

Disadvantages:

• Limited scope and duration. Usually, regulatory sandboxes operate within a specific scope and timeframe. This limitation may prevent some companies or technologies from fully realizing their potential within the sandbox environment. Although some sandboxes, like the one belonging to the UK’s Financial Conduct Authority, are open to applications year round, most work on a cohort basis. This means that firms can only apply during a specific application window.
• Potential for regulatory arbitrage. In some cases, participants might use sandboxes to exploit regulatory loopholes or completely avoid regulations.
• Potential data privacy issues. Data privacy breaches may occur in a  regulatory sandbox environment due to  reduced regulatory scrutiny, new and unproven technologies, or a lack of experience in dealing with cybersecurity or data privacy practices. 

Real-world example of a regulatory sandbox

One of the oldest and most well-known regulatory sandboxes in the world belongs to the  UK Financial Conduct Authority. It has been up and running since 2016.

The FCA’s sandbox was designed to provide a safe space for fintech startups and other innovative financial services companies to test their products, services, and business models without immediately facing the full burden of regulations. 

In 2021, the UK sandbox moved to an ‘always open’ model, allowing firms to submit their applications throughout the year. Here’s what it says on the FCA website: “Firms can now access our testing services at any point throughout the year, at the right point in their development lifecycle, at a time that works best for them.”

The process of joining the FCA sandbox is similar to sandboxes in other countries:

• Apply online
• Application assessment
• Panel review
• Sandbox tool issuing (e.g. informal steer, individual guidance, restricted authorization, waivers, no enforcement action letters, etc.)
• Testing
• Sandbox exit.

The success of the FCA’s sandbox has inspired many other countries to establish their own regulatory sandboxes in various industries.

Which countries have regulatory sandboxes?

Apart from the UK, the following countries also offer sandboxes for high-tech startups and established firms:

• Singapore. The Monetary Authority of Singapore (MAS) has established its fintech regulatory sandbox to support innovation in the financial sector.
• Australia. The Australian Securities and Investments Commission (ASIC) launched its Innovation Hub as well as a regulatory sandbox for fintech companies.
• United States. Several states in the US, such as Arizona, Wyoming, and Utah, have set up sandboxes to promote fintech innovation.
• United Arab Emirates. The Dubai Financial Services Authority (DFSA) has its own fintech regulatory sandbox. Also, the Abu Dhabi Global Market offers a Regulatory Laboratory (RegLab) sandbox program for fintechs.
• Malaysia. Malaysia’s Bank Negara launched a regulatory sandbox to facilitate the testing of innovative fintech solutions.
• Bahrain. The Central Bank of Bahrain launched its regulatory sandbox to support fintech startups.
• Hong Kong. The Hong Kong Monetary Authority (HKMA) also launched the Fintech Supervisory Sandbox for banks and tech firms.
• Canada. The Canadian Securities Administrators (CSA) has launched a regulatory sandbox for fintech and other innovative companies.
• India. The Reserve Bank of India (RBI) has set up regulatory sandboxes for fintechs.
• Japan. The Government of Japan launched a regulatory sandbox for cutting-edge technologies in any sector.
• European Union. The European Commission has been exploring sandbox initiatives in several industries. The following countries have regulatory sandboxes: Austria, Denmark, Hungary, Latvia, Lithuania, Malta, the Netherlands, and Spain.
• Saudi Arabia. The Saudi Arabian Monetary Authority (SAMA) launched its fintech regulatory sandbox several years ago.

Regulatory sandboxes are powerful tools for fostering innovation in a number of industries. However, striking a balance between innovation and regulatory oversight is important to ensure the long-term success and sustainability of the sandbox approach. 

FAQ

• Does the US have a regulatory sandbox?

  There is no centralized regulatory sandbox in the US. At the moment, regulatory sandboxes operate only at the state level.

• What is a fintech regulatory sandbox?

  A fintech regulatory sandbox allows fintech startups and financial businesses to experiment and test new products and services in a controlled-risk environment, with relaxed regulations.

• What is the RBI regulatory sandbox?

  The RBI regulatory sandbox is the Royal Bank of India sandbox.

• What is the FCA regulatory sandbox?

  The FCA regulatory sandbox is the Financial Conduct Authority in the UK.