Thank you for inviting me to speak at the Innovate Finance Global Summit. Innovate Finance has consistently been a first-class partner and forum for talking about our work as the regulator in this space.
Since the FCA’s Project Innovate was launched, we have had over 400 requests for support and offered direct support to over 200 firms. For us Project Innovate is a vital part of fulfilling our duty to promote competition, but it is also a project that is evolving and adapting as we gain more experience.
By way of example of that evolution, and as this is a global summit, I want to start with a mention of the cooperation agreement we signed in Sydney three weeks ago with the Australian Securities and Investments Commission. For the first time anywhere in the world, two financial regulators have agreed to make it potentially easier for innovative firms to access new markets, by providing information to one another. We hope this will be the first of many such agreements.
However, my focus today is a different world first – the UK’s regulatory sandbox. This is a bold and complex project for any regulator to undertake. As well as significant potential benefits, it comes with risks. In many ways, it won’t just be the firms that are learning in the sandbox, we will be too.
We will open our doors to applications on 9 May. The firms that are successful will be able to test out their innovative ideas without immediately incurring all the normal regulatory consequences.
I want to take this opportunity to explore what this means—the challenges we have faced when developing the sandbox framework, and to unveil some of our latest thinking.
FCA approach to thinking about the sandbox
The key question for us was how does a regulator create a sandbox that gives industry the freedom to break new ground and encourage creative solutions when there is a limited public appetite to accept business failure if things go wrong, particularly in financial services?
To answer this question, we have had to tackle 2 main challenges:
- the first one is how do we deliver a sandbox that lowers barriers to testing within the existing regulatory framework
- the second, how do we ensure that risks from testing novel solutions are not transferred from firms to consumers
Challenge 1
Concerns of unauthorised firms
We are setting up a tailored authorisation process, which means that sandbox firms will first be authorised with restrictions, allowing them to test their ideas.
On lowering barriers, we acknowledge that, to date, firms requiring authorisation have had to incur significant costs before they can meaningfully explore consumer appetite or if there are any significant risks posed to consumers.
For these firms, we looked to the successful process we established for challenger banks through the new bank star-tup unit, jointly run with the PRA.
We are setting up a tailored authorisation process, which means that sandbox firms will first be authorised with restrictions, allowing them to test their ideas but no more. They still need to apply for authorisation and meet threshold conditions, but critically only for the limited purposes of the sandbox test.
So the authorisation tests should be easier to meet and the costs and time to get the test up-and-running reduced.
If, after sandbox testing, the firm wants to launch itself into full activity on the wider market, it can do so if it satisfies the threshold conditions for that wider activity.
We think this strikes the right balance – regulation that starts in proportion to the scale of the concept being tested and can grow with the ambition of the full business model.
Consumers are more likely to have confidence in a new product if it is within the regulatory framework.
We did analyse the feasibility of removing authorisation requirements for sandbox firms altogether. Legally, there are some restrictions that limit our ability to do this. But more importantly, we concluded that sandbox firms undertaking regulated activities should sit within our regulatory perimeter so we can ensure that consumers are protected. Moreover for the firms in the sandbox, our approach also means they should be ready to operate in the regulatory framework after the sandbox. And as we have seen with many markets, consumers are more likely to have confidence in a new product if it is within the regulatory framework.
Concerns about interpretation of rules
Another barrier put to us is concern over interpretation of rules. Finance is an established industry with many rules that pre-date smartphones, let alone blockchain or biometric identifiers. We recognise that there may be regulatory uncertainty if something is not established market practice. We also recognise that firms are interested in dialogue with us to get greater clarity about how we might apply our rules.
To help sandbox firms, we will first look to issue individual guidance, setting out how we interpret relevant rules in the context of the test. This creates a limited safe space for firms because, if they act in accordance with this guidance, the FCA will proceed on the basis that they have complied with the relevant aspects of our rules to which the guidance relates. We have a lot of experience now from Project Innovate which we are confident we can apply in this space.
Another tool in our sandbox framework is our power to waive and modify FCA rules. This is one of our statutory powers and is meant for rules which have become unduly burdensome or are not achieving their objectives. As ever, we would not be able to waive EU law or primary legislation unless we have specific carve outs.
Finally, we fully expect that with the sandbox we might also encounter propositions we have not seen before. It is possible that in a small number of cases we may not be able to issue individual guidance or waivers. For those rare cases, there may be circumstances in which we could use a ‘no enforcement action’ letter.
These letters aim to give firms comfort that as long as they deal with us openly, keep to the agreed testing parameters and treat customers fairly, we accept that unexpected issues may arise and will not take disciplinary action.
The letters will only apply for the duration of the sandbox test and only to FCA disciplinary action. They cannot limit any liabilities to consumers. We have not used this tool before, so we will carefully consider how we issue such letters in light of the particular circumstances and characteristics of different sandbox tests.
Challenge 2
We will only consider propositions where we are satisfied that there is a prospective direct or indirect consumer benefit.
This brings me to our second challenge: how to ensure that the sandbox’s ‘safe space’ for firms does not transfer risks from firms to consumers.
We see three elements of consumer protection:
First – just as in Project Innovate, we will only consider propositions where we are satisfied that there is a prospective direct or indirect consumer benefit.
Second – we will agree upfront testing parameters and customer safeguards. We want these to be appropriate to the propositions being tested and the types of customer and firm involved. For example, it may be reasonable to ask one firm to guarantee to place ordinary retail consumers fully back in their pre-test state if a test does not perform as expected. Equally, another firm, testing with a smaller group of sophisticated consumers may need to simply have in place very clear disclosures.
As an aside, the concept of ‘informed consent’ has been raised during our development phase. This can mean a lot of different things. In a pharmaceutical context, informed consent sometimes means that a person is knowingly giving up a protection they otherwise would have. We do not believe that this is appropriate for retail consumers in the sandbox. Instead we think retail consumers should keep their existing rights and we should think about whether further protections are needed. For example, there might be sandbox tests where we want firms to disclose that they are only vetted for a limited activity after which the consumer might be transferred to another provider.
That being said, there might be scope for limiting or more likely defining sandbox firms’ liabilities particularly for testing B2B offerings.
The third – and last – element is that we will require every sandbox firm to have a fair exit strategy for consumers. Again, depending on the test, these exit strategies may vary. By way of example, a firm may just call a halt to business, or it may transfer customers to third parties.
Pilot approach
The sandbox is a world-first for financial services regulators. We will be experimenting and learning here. I expect a high degree of bespoke engagement from our staff, so we will only be able to work with a small number of firms at a time.
We will use a cohort approach, not dissimilar to how accelerators operate, and initially run two cohorts a year. This way we can learn what works and what doesn’t, and improve the sandbox for subsequent cohorts.
We will ask firms to submit applications explaining their proposition and how it meets the sandbox eligibility criteria. These will be:
- genuine innovation
- benefit to consumers, either direct or indirect
- the idea is meant for the UK financial services market
- a need for testing in the sandbox alongside the FCA
- readiness to test – in other words, being in a sufficiently advanced stage of preparation to mount a live test
The last criterion is looking for how feasible the tests are. This assessment will also be the final decision maker – we will choose firms with the most doable tests for the first cohorts. Thus, there is a competitive element to motivate firms to submit well-developed testing plans.
Industry recommendations
So that is the FCA’s sandbox.
However, we don't see this as the whole story. In November we floated the idea of options for the industry to foster innovation by working with the regulator rather than schemes wholly being led by us.
I am delighted to announce that Innovate Finance has agreed to lead an industry working group to explore options for industry led sandboxes.
We will be involved in this work and explore what the FCA’s role could be in such projects.
Concluding remarks
To conclude, I just wanted to underline this. We are the first regulator to launch a programme like the sandbox anywhere in the world. It should underline our deep commitment to innovation. We see this as an essential part of promoting competition. It is an experiment for all involved and will need to learn as much as the firms engaged in it. And it will not work if consumers are not given proportionate protection.
But the prize is there. If between us we can get this right, the sandbox can play a hugely important part in helping firms get new and exciting ideas to market more quickly.
I look forward to engaging with many of you on its progress over the coming months.
Thank you.