Structured Finance Spectrum - July 2019

6 7 Structured Finance Spectrum | July 2019 Structured Finance Spectrum | July 2019 dividual states have enacted their own regulatory sand- boxes. In March 2018, Arizona created the first regulatory sand- box in the U.S. 1 The 10-year program, which will be over- seen and administered by the state’s attorney general, will allow participants who offer “innovative products or services” 2 to test technologies over a two year period. At the end of the two-year period, the participant must either apply for a license to continue its service or stop offering the specific innovative product or service in Ari- zona, unless it applies and receives a one-year extension. Section 41-5601 of the Arizona Revised Statutes defines “innovative”as“the use or incorporation of new or emerg- ing technology or the re-imagination of uses for existing technology to address a problem, provide a benefit or oth- erwise offer a product, service, business model or delivery mechanism that is not known by the Attorney General to have a comparable widespread offering in this state.” 3 The sandbox limits the amounts transacted and the number of consumers using the innovation. The program will be open to financial services companies that would typical- ly fall under the purview of Arizona’s Department of Fi- nancial Institutions, including lenders, debt management companies, and mortgage brokers. The program also has a reciprocity provision that will allow Arizona participants to operate in other jurisdictions that establish similar pro- 1 https://www.azag.gov/press-release/arizona- becomes-first-state-us-offer-fintech-regulatory-sandbox 2 https://www.azag.gov/fintech 3 ARIZ. REV. STAT. ANN. § 41-5601 (2018). Financial technology is evolving and innovating at a speed that far outpaces legislative adaptation. As a result, many financial technology companies have no choice but to develop and test their products and services with- in existing regulatory frameworks that are often unclear, burdensome, and regressive. This can have the effect of deterring, rather than fostering, innovation. One solution to this problem is the concept of a “regula- tory sandbox.” Introduced by financial sector regulators, a regulatory sandbox is a legislative framework that en- ables financial technology startups and other financial technology innovators and disrupters to test innovations for a limited time within a controlled environment that – although under regulatory supervision and typically limited in the scope of products and services that can be tested, both by quantity and value – is unburdened by traditional licensing and regulatory requirements. Inno- vators can experiment with new technologies and “work out the kinks” without incurring licensing costs and can abandon unsuccessful innovations at early stages. Reg- ulators can learn how to effectively regulate new tech- nologies, without diminishing consumer protection, and both sides can improve communication. Even investors benefit, as regulatory sandboxes highlight and provide insight into new technologies that investors may wish to support or that the market may wish to participate in. The Consumer Financial Protection Bureau (CFPB) proposed a sweeping regulatory sandbox at the federal level that would give FinTech companies immunity from certain state law, but this effort has been resisted by a number of Democratic state attorneys’ general. Nevertheless, in- Play Nice in the Sandbox, Kids: Fostering Innovation in the FinTech Space grams, including internationally. As of May 16, 2019, the program had six participants. 4 Wyoming enacted the Financial Technology Sandbox Act in February 2019, becoming the second state to adopt this approach. The framework is similar to Arizona’s, al- lowing participants a two-year test period with a one year potential extension before falling under formal licensure requirements. The program will be overseen by the Wy- oming Banking Commissioner and Secretary of State and will take effect on January 1, 2020. Utah followed suit in March by creating a similar program run by its De- partment of Commerce and allowing the same two-year testing period but with a potential six-month extension period. States across the nation are recognizing the advantages of utilizing regulatory sandboxes and are joining Arizo- na, Wyoming, and Utah in enacting legislation to insti- tute such programs. Nevada recently proposed a bill that would create the Regulatory Experimentation Program for Product Innovation, a program similar to its state pre- decessors. 5 The District of Columbia Financial Services Regulatory Sandbox and Innovation Council, established by the D.C. mayor earlier this year, is currently studying financial services innovation in the District, including the 4 https://www.azag.gov/fintech/participants 5 https://www.ethnews.com/nevada-senator-wants-to- establish-state-fintech-sandbox feasibility of implementing a regulatory sandbox. 6 And state banking regulators in New England are exploring the creation of the first regional fintech regulatory sand- box that would harmonize the regulatory regime for the sandbox across Maine, New Hampshire, Vermont, Massa- chusetts, Rhode Island, and Connecticut. Success in these jurisdictions could lead to other states making a push to create their own sandboxes. This ap- proach to regulation fosters growth in the financial ser- vices industry concurrently with development in regu- latory oversight, so that innovators can operate more efficiently, and new challengers can overcome barriers to entry. Coordination with the CFPB will also enhance fu- ture efforts to create and expand regulatory sandboxes. n 6 https://disb.dc.gov/release/mayor-establishes-district- columbia-financial-services-regulatory-sandbox-and- innovation