Financial sector regulatory sandboxes: Let’s go to the beach

Provided by Dommisse Attorneys Inc.

By Christiaan Harmse

Topics Banking & Finance Law | Competition & Antitrust Law | Consumer Protection

18 Nov 2020

Under the more relaxed lockdown restrictions, and with a change of season in the air, lots of South Africans may be heading to the country’s beautiful coastlines en masse to enjoy the first hints of summer and feel the cool sea breeze against their face and hot sand beneath their feet. It’s much better than that backyard sandbox-and-garden-hose substitute, amiright?

Sandboxes weren’t always so unappealing. During our formative years we built empires and excavated treasures in them! With an unencumbered imagination, our sandboxes were our canvas. And they can be again.

Regulatory sandboxes

The concept of a regulatory sandbox should instill a sense of childlike wonder in the observer.

Financial product innovation doesn’t necessarily occur in a legislator’s office. Active market participants who have spent years developing new products in accordance with existing regulations as their market’s needs develop can discover a massive gap in the market for which clear legislative guidance is not available. Market participants are in excellent positions to assess what current market needs are; what regulatory policies are being pursued and what the underlying rationale for past legislative changes were. Combine this with field experience and entrepreneurship and it’s easy to see how services providers can get a bit ahead of regulations!

Enter the sandbox. Essentially a financial services hall pass, it allows for experimenting with new and unfamiliar products, under strict guidance. It has been used internationally, and South Africa isn’t going to miss out on the fun.

The Intergovernmental Fintech Working Group (IFWG) (including the likes of the National Treasury, SARB, SARS, FSCA, FIC, NCR, the Competition Commission – all financial regulatory powerhouses) has rolled out a regulatory sandbox for local use. The Innovation Hub was launched earlier this year, making a range of exciting tools for innovators in the financial services sector available. Instead of a top-down instruction of action and consequential enforcement by the regulator on the regulated, the Innovation Hub is aimed at establishing a dialogue between market participants and regulators.

Tools such as regulatory sandboxing allow services providers to ask, suggest, collaborate and show regulators that new doesn’t necessarily mean wrong. Regulators are always looking out for the best interests of consumers, so their erring on the side of caution is an understandable default approach. Even where the intention of the service provider is also to protect consumer interests, wires might get crossed somewhere and, without an open dialogue, the parties view themselves as adversaries rather than being on the same page.

Waiting on the World to Change

It can be difficult (or sometimes even impossible) to determine the extent to which the financial world is changing. Firstly, you’d need a point of comparison to assess deviations – but what year should be used as a timestamp to observe current change? Should modern financial product structuring be viewed in light of changes since the integration of the internet into modern business; prior to the internet’s invention; or, say, before the commercial domestication of electricity? And what about the parameters to be drawn for such a comparison? Will you only be looking at ease of communication or will you be looking at sector interactions, the development of collaborative platforms and globalisation as well? Clearly, there’s a potential problem of information overload.

As change is a comparative moving target, it would be wise to focus on the context. It’s not the technological advancements that facilitate product structuring, or changes in perception as to what constitutes acceptable remuneration, or an increase in the average consumer’s access to a wide array of financial products within seconds that drives change, it’s all of these and more. There’s a potentially bottomless pit of factors, so the natural response would be to focus on what seems relevant and disregard the rest. In identifying what’s truly relevant, having the financial regulators as your sounding board can be especially helpful.

So in this sense, change becomes cyclical. Change initiated by financial services providers through sandboxing products may lead to a change in regulations after regulatory refinement, and such regulatory changes may in turn lead to a further pushing of boundaries.

The dialogue function of regulatory sandboxing underpins this continuous change as it allows entrepreneurs to test new sandcastle building techniques whilst the regulators are assured that sand won’t go flying into anyone’s eyes. Mechanisms are in place to address unacceptably risky architectural designs, but also provide an opportunity for contractors to explain why it is, in fact, structurally sound. Before you dismiss this symbiosis as overly optimistic, consider the developments being made in the realm of crypto assets. The , created under the watchful eye of the IFWG and whose members are represented on CAR WG, brought out a consultation paper on – you guessed it – crypto assets. The IFWG’s April 2020 position paper on crypto assets cites this collaboration:

The consultation paper offered an opportunity for industry participants and stakeholders to provide input to formulating a revised policy position on crypto assets. The regulatory authorities considered these comments carefully in drafting the position paper.

So perhaps instead of being subjected to a changing world or waiting for regulatory changes to match your business visions, it might be worth initiating a change yourself through the use of tools like regulatory sandboxes. Or, at the very least, find ways to make your voice heard by regulators during a consultation process. Even if such consultancy does not lead to the introduction of a new financial product or even sandboxing, it may help to identify other relevant considerations which were previously disregarded as irrelevant.