The FCA’s regulatory sandbox (sandbox) allows firms to test new products, services and business models in a live market environment whilst maintaining appropriate consumer safeguards. The sandbox was established to support the FCA’s objectives of promoting competition in the interest of consumers. The sandbox opened for applications in June 2016 - of 146 applicants, 50 were accepted and 41 applicants’ propositions were or are currently in the process of being tested.
Fostering sustainable fintech businesses?
The FCA reported that 90% of firms that completed testing in the first round are “continuing toward a wider market launch following their test”, and the "majority" of firms issued with restricted authorisation for testing were granted full authorisation after the tests finished. The FCA's findings also showed that 40% of sandbox participants had secured funding during or after testing. Feedback from sandbox participants suggests that the testing programme (FCA oversight of tests and increased regulatory certainty) provides reassurance to potential investors. The sandbox also gives firms the opportunity to modify business models, where necessary, based on conclusions from live testing ahead of offering the products/services to the wider market.
While the FCA noted it was too early to draw firm conclusions on the impact on competition, a “number of indicators suggest that the sandbox is beginning to have a positive impact in terms of price and quality”.
Distributed ledger technology (DLT)
DLT was the most common technology tested. The majority of sandbox firms using this technology are electronic money or payments institutions.
One test saw DLT being used to enable UK private limited companies to digitally represent and manage their shares and corporate governance processes. Another sandbox firm used the technology to streamline the normal issuance process for a short-term debt instrument.
A number of firms tested the use of digital currencies to facilitate cross-border payments. The sandbox firms’ business models differed significantly from traditional and peer-to-peer money remittance companies. The tests showed reduced transaction times and better exchange rates.
However, tests also highlighted a number of factors - “execution time uncertainty, volatility in the value of digital currencies, liquidity requirements, transaction fees and the availability of exchanges” – would need to be carefully managed by firms if these services were to be provided on a wider scale.
One sandbox firm tested whether an online platform could improve the initial public offering distribution process. The firm aimed to enhance data sharing/collection and investor participation.
Current tests, by another sandbox firm, are aiming to increase small and medium-sized enterprises access to foreign exchange options at a lower volume and cost.
Application programme interfaces (APIs)
One sandbox firm developed a platform that enables consumers to see their current account, credit card, and pensions balance in one place. Consumers can also access a range of financial services products directly via the platform.
A number of sandbox firms tested solutions that used biometric data. One current test uses a DLT platform to enable customers to log-in and pay using biometrics.
Mobile apps to increase access and improve experiences for vulnerable consumers
A number of sandbox firms sought to address issues relating to vulnerable consumers.
Government bodies have supported some sandbox firms to develop mobile apps that allow consumers to have a better overview of their budget - the same app allows them to receive benefits and pay for core services.
Challenging traditional business models
The FCA believes that sandbox testing has shown that variations to existing business models have the potential to better meet consumers’ needs and/or reduce costs.
Tests highlighted data sharing between fintech firms and large firms was mutually beneficial and provided consumer benefits. In one test, a large firm partnered with a sandbox firm to provide a product aimed at increasing customers’ savings. The product involved customers authorising the large firm to share their current account transactional data with the technology provider to help them identify where it might have been both possible and beneficial for them to transfer a certain amount of money to a savings account. The outcome was that consumers testing the product had a significantly higher savings rate over the test period compared with a control group of comparable customers.
A sandbox firm is testing a business model where the consumer pays the premium at the end of the month instead of the start. The consumer would pay a premium that is directly related to the number of claims made in that month, improving transparency around the calculation of the premium, and potentially lowering the price of the policy.
One firm tested a model for home-owners looking to relocate, which guarantees a sale of the customer’s property within 90 days, or failing that provides an interest free loan for 95% of the property’s market value. The test gauged consumer demand and satisfaction for the service, and tested the firm’s ability to sell within their 90-day timeframe. The firm worked closely with the FCA to identify potential risks and implement consumer safeguards. Consumer demand exceeded expectations and the firm used feedback to test pricing structures that deliver better value to consumers.
A number of sandbox firms tested models involving automated advice and guidance – they were supported by the FCA's Advice Unit, which provides regulatory feedback for firms using automated models.
To mitigate risks during the testing period, qualified financial advisers were often used to check the automated advice outputs. Amendments to the underlying algorithm could then be made based on feedback from the financial adviser.
In an ongoing test, one firm is testing the automation of the end-to-end advice process. Consumers automatically receive suitability reports after submitting responses to the online fact-find. To avoid consumers acting on unsuitable advice, consumers are notified that they should not act on the report until they have received a second notification that the advice is suitable.
Limitations of testing
The FCA acknowledges that the sandbox does not fully address all the issues firms face when developing and testing new products and services.
Access to banking services
The FCA has “witnessed the denial of banking services first-hand across a number of firms in the first two cohorts of the sandbox. Difficulties have been particularly pronounced for firms wishing to leverage DLT, become payment institutions, or become electronic money institutions”.
The FCA is also concerned by the apparent blanket refusals for certain kinds of applicant firms. The regulator is aware of the risks this approach has on innovation and competition and intend to “continue their focus on this issue”.
Customer acquisition and governance processes
In some instances sandbox firms have struggled to establish a customer base. Findings showed the success of partnerships between large firms and sandbox firms. Some large firms “stated that the process of setting up their test with a partner often identified ways to improve their own procurement and governance processes for on-boarding start-ups.” The FCA hopes this will lead to further activity beyond the specific propositions tested.
Access to consumer data and integration with APIs
The FCA observed that it was often difficult for sandbox firms to go directly to the financial institution holding consumer data and securely gain the access they require, as formal routes for sharing were unavailable.
The FCA expects this to change in the near-term as industry standards develop alongside the preparations for the forthcoming General Data Protection Regulation and the second Payment Services Directive.
At present, the UK’s Open Banking initiative is working with a number of banks to develop APIs that will enable consumers and small businesses to share their current account information securely with other banks and third parties.
Conditions for authorisation
Applicants for the sandbox must meet a number of conditions before they can be authorised for the activities they wish to carry out. The FCA has found a number of instances where applicants have failed to meet conditions for authorisations – e.g. firms looking to underwrite insurance products or operate multilateral trading facilities.
FCA’s next steps
The FCA is encouraged by what it perceives as the initial successes of the sandbox and it intends to use its findings from the first year of its operation to shape future sandbox developments and the FCA’s broader regulatory work.
 A November 2015 report on the sandbox highlighted the potential benefits: “reducing the time and, potentially, the cost of getting innovative ideas to market; enabling greater access to finance for innovators, by reducing regulatory uncertainty; enabling more products to be tested and, thus, potentially introduced to the market; and allowing the FCA to work with innovators to ensure that appropriate consumer protection safeguards are built into new products and services.”