Financial technology (Fintech) innovations are becoming the mainstay of the global financial sector and user responses to these innovations have been remarkably positive and embraced at an unprecedented scale.
Today, the adoption and usage of fintech innovations particularly those facilitating payments are shown to have surpassed the volumes and values of traditional banking services in many African countries. While everyone is happy with this trend and projecting same as the future of finance, there are valid concerns about the potential use of regulations to create a barrier to the design and deployment of new fintech innovations – due to the associated risks of the emerging innovations such as data protection and privacy, cybersecurity concerns and fraud, among others if left unregulated.
The need to implement strong regulatory oversight requires a balancing act to ensure such new innovations are deployed at the seemingly same rate of development as the underlying emerging technologies. To this end, most central banks are rolling out sandbox programs as a vehicle to pilot and test such new unregulated innovations with strict oversight and to build a better understanding for their future regulations. Therefore, this article will explore how the commercial deployment of emerging fintech innovations can be facilitated through sandbox programs for the ultimate benefits of greater financial inclusions, reduced cost of financial services, financial stability, etc.
FINTECH INNOVATIONS AND FINANCIAL SERVICES
We are not experiencing for the first time innovations in the financial services sector. Global financial services have impressively evolved since the invention of money and the establishment of the first bank in 1474 in the Tuscan city of Siena. From banknotes and coins to traveler’s cheques, bank cards, ATMs, SWIFT transfers, online banking, etc., financial services have been and continue to be delivered on the strict dictates of regulations championed by central banks to regulate, supervise, and manage activities of third-party commercial financial service providers such as banks.
With advances in technologies coupled with their accelerated adoption in recent years due to factors such as the outbreak of Covid-19, traditional means of providing financial services have been transformed at a record pace into almost digital-only financial services today. Technology has been overlaid on financial services, delivered across multiple internet-connected devices, enabling convenience, access, and a relatively reduced cost of performing financial transactions.
Today, the majority of financial services such as payments and transfers are performed by customers with the click of buttons on their connected devices without visiting traditional bank branches. Banks and non-bank institutions have embraced the advantages offered by emerging technologies such as blockchain, machine learning, artificial intelligence (AI), etc., and are designing new ways of digitalizing traditional financial services. The technological processes and outcomes have presented challenges to the regulator’s role to dictate how financial services are provided and compelling central banks to react in an attempt to maintain control and reshape the future of finance using regulations. Whilst some argue that central banks must not intervene in the use of emerging technologies to democratize the issuance, use, and supervision of money and the provision of financial services, that approach may not be in the best interest of users of financial services, interests central banks are primarily set up to promote and protect.
Therefore, in finding a balance, central banks recognizing the speed of development of new technologies and their use cases, are rolling out sandbox programs to provide a launchpad for new financial innovations which do not fall within existing regulated and licensing frameworks. The rollout of these sandbox programs is additional to recent initiatives by central banks to maintain oversight over financial services following the boom in the deployment of fintech innovations such as new legislations (laws), the establishment of licensing regimes, and the setting up of dedicated oversight offices with the requisite technical personnel among others.
THE REGULATORY SANDBOX PROGRAM
Hailed as the regulator’s best response to the current pace of innovations, the regulatory sandbox program is set up as a “regulatory playground” for innovators with new innovations which are unconventional, and not falling within any category of existing licensing regime to on a restricted scale pilot the said innovations under the strict supervision of the central bank. In Ghana, the Bank of Ghana earlier this year launched and admitted the first cohort into its regulatory and innovation sandbox run in partnership with the private sector.
Sandbox programs are considered the best-suited regulatory response to match the pace of innovations due to their ability to facilitate the continuous design of innovations that current regulatory regimes do not permit. This means that innovators do not have to innovate to meet the demands of existing legislative frameworks but rather leverage the full extent of emerging technologies to develop what they consider the new possibilities for financial service offerings for commercial deployment. Under a sandbox program, the regulator will gain insights and a better understanding of admitted innovations, tick the boxes on its supervisory mandates, and design new regulatory guidelines for the full-scale deployment of such innovations post-sandbox test phases.
Sandboxes have become innovators’ windows to test new ideas in a highly regulated financial sector. It has become the only permitted way by which new innovations will be allowed by central banks to be piloted and/or tested because the exposure to the associated risks of unlicensed innovations will be minimized and the regulator’s feedback on piloted innovations can be maximized in its controlled environment. Additionally, sandboxes serve as a regulation and supervision preparedness test for central banks in building their understanding of new innovations and provide the opportunity to institute measures or guidelines on their eventual regulation.
However, because they are designed as regulatory sandboxes, there is the tendency to have regulatory considerations overshadowing the review process – which may include seeking to give green lights to innovations that may provide synergies for existing approved products and services than such innovations being considered for their potential to set out new product or service lines.
LEVERAGING THE SANDBOX PROGRAMS TO PROMOTE FINTECH INNOVATIONS
While central banks like the Bank of Ghana must be applauded for rolling out regulatory sandboxes, such programs require constant reviews and accommodation of changing market demands to maintain their relevance as the licensing route for new innovations. It will be practically impossible for regulations either to be at par with innovation or stay ahead of same. Therefore, sandbox programs serving the purpose of a bridge between licensed and unlicensed financial products must be implemented in consonance with real-time industry circumstances.
In this light, the following will help enhance sandbox programs and facilitate their uses as catalysts for new fintech innovations:
- A shift from cohort-based programs to rolling admissions
The desire to establish a regime that pilots and permits the commercial deployment of innovations which are at par with technological advances will be defeated if sandbox programs continue to be run on a cohort basis. This is because cohort-based sandbox programs set timeframes, especially for when new innovations can be submitted to the central bank for reviews for piloting. The time gap between cohorts which may be unnecessarily long may limit the potential for new innovations to seek early regulatory approvals and to be deployed in real-time.
Technology has become fluid and any delay in testing and piloting new ideas may result in them becoming obsolete by the next cohort admission time. The best chance to admit and pilot new ideas in real-time is to change the existing cohort models into rolling admissions where innovators can on an “as and when” basis submit their innovations for review and piloting. - Introduction of complementary innovation sandboxes
Innovation sandboxes are not the same as regulatory sandboxes. They are designed usually to test the commercial viability of new ideas than their compliance with regulations or to inform the enactment of new ones. In an innovation sandbox, innovators are given the opportunity to demonstrate product fitness, functionality, and market viability whose objectives may be different from a regulatory sandbox. So, as the first step in assessing the commercial viability of new innovations, innovation sandboxes will help filter innovations which meet the admission criteria for regulatory sandboxes. This will help in reducing the time spent by regulators to review innovations submitted for consideration under regulatory sandboxes as those eligible applicants may have gotten their innovations vetted under innovation sandboxes.
The opportunity to develop and run these innovation sandboxes must be championed by industry stakeholders such as banks, fintech companies, industry associations, etc. as a way of providing innovation pipelines for the central bank’s regulatory sandbox. This can be achieved on either an incubator or accelerator models of innovation sandboxes. - Clarity on the sandbox review process and timelines
The application window for the 1st cohort of Bank of Ghana’s regulatory sandbox ended on 14th March 2023. As of now, submissions are still undergoing review with no definitive piloting timelines. As the first of its kind, such certainty may be difficult to provide and adhere to. However, with time, efforts should be made to provide clear guidelines on the process and timelines for review and piloting of submitted innovations. The suspense and delays may not encourage future participants to submit to the program. Clarity will serve to assist innovators with their planning for piloting and engagement with the regulator on the program. - A simple and streamlined application process
Strongly tied to the issues of clarity on the sandbox process is the need to simplify and streamline the application process. The regulator must be guided by the fact that innovators seeking to enter the sandbox cannot predict with certainty, the regulator’s approval of their innovation. Therefore, the expectation requiring such innovators to have in place some systems, processes, etc. must be assessed carefully. At worse, no compromises should be made on the technical details of the innovation which is really the product or service to be tested during the pilot phase. Other operational demands of personnel, evidence of existing contractual relationships, etc. may be deferred to such time when the regulator is confident of approving the innovation for commercial deployment. - Dedicated resources & partnerships
Technologies underlying new fintech innovations demand the engagement of dedicated staff with the requisite technical know-how to understand how these innovations work. Their ability to interpret how the submitted innovation works may affect which innovations are approved or rejected. Therefore, there is a need for skill upgrades, training, and tools to help such dedicated staff perform their duties effectively.
Also, regulators must seek partnerships and collaborations with 3rd parties service providers and parallel financial sector regulators to build a strong resource base for the sandbox programs.
CONCLUSION
In one way, we are all beneficiaries of new financial sector innovations enabled by technology and expect more. However, regulations hold the key to how quickly new innovations can be deployed. Therefore, it is important that a regulatory response such as the sandbox program which seeks to admit, and test-run new unlicensed innovations before their commercial deployments must be enhanced to ensure we enjoy the real-time benefits of technological advances. And some of the recommendations proposed in this article will be useful.
ABOUT THE AUTHOR
RICHARD NUNEKPEKU is a Fintech Consultant and the Managing Partner of SUSTINERI ATTORNEYS PRUC (www.sustineriattorneys.com) a client-centric law firm specializing in transactions, corporate legal services, dispute resolutions, and tax. He also heads the firm’s Start-ups, Fintech, and Innovations Practice divisions. He welcomes views on this article and is reachable at richard@sustineriattorneys.com.