In late 2016, the European Banking Federation called on the European Commission to create a plan for an EU-wide fintech testing environment.
The European Banking Authority (EBA) banking stakeholders group made a similar recommendation last year, adding that the EBA should take the lead in developing guidelines to achieve harmonization in regulatory practices and supervisory criteria on nationally established sandboxes.
Proponents of a pan-European fintech testing platform have been buoyed by the progress of the Financial Conduct Authority’s (FCA) sandbox, which has motivated regulators from various parts of the continent to introduce similar programmes.
The Danish financial supervisory authority was the latest to follow the FCA model, announcing at the end of last year the creation of a platform where selected fintechs are able to test their business model for up to six months before they apply for a full licence.
Benefits and challenges
The CFA Institute has suggested that the European Commission’s legislative proposal for an EU framework on crowd and peer-to-peer finance creates a precedent for exploring the possibility of creating an EU-wide sandbox and investigating the benefits and challenges such a regime.
Stuart Davis, a senior associate at Latham & Watkins (L&W), suggests that there are a number of potential benefits of an EU-wide sandbox, most notably that it would be attractive to firms that want to test their innovation in two or more EU jurisdictions without having to deal with multiple regulatory regimes.
“It could also make available a pool of supervisory expertise to help fintechs shape development of their product,” he adds. “Closer co-operation between regulators on live sandbox projects could also highlight areas where local regimes are inconsistent and promote regulatory harmonization.”
However, concerns from the German regulator about a relaxation of standards is just one obstacle, and the German Federal Financial Services Supervisory Authority (BaFin) might not be the only national regulator sceptical about waiving EU rules for fintechs.
Josh Hogan, partner and head of the financial services regulatory group at McCann FitzGerald, agrees that not everyone is convinced of the overall benefits of the sandbox model and adds that regulators across the EU have taken different views in this regard, giving rise to the possibility of regulatory arbitrage.
Policymakers are also conflicted. A study conducted for the German federal ministry of finance in 2016 suggested that the sandbox approach delays entrance into the ‘proper’ market, potentially placing participants at a competitive disadvantage.
With countries introducing sandbox initiatives at national rather than EU level, some jurisdictions will inevitably emerge as more “innovation friendly” or “light touch”, says Gina Conheady, corporate and M&A partner at A&L Goodbody.
“While this is not necessarily a bad thing of itself, it creates an uncertain business environment for fintech companies operating on a cross-jurisdictional basis in the EU,” she continues. “Implementing a set of baseline safeguards should ultimately reduce the costs and time involved in getting products to market.”
BaFin has reiterated the need for fintechs to get the requisite regulatory licences before releasing a live product, even in a limited testing phase.
However, L&W’s Davis observes that this stance is likely to have been informed by the fact that BaFin does not have the authority to waive the requirements of regulation in the way that the FCA does.
“Not all EU regulators have a positive view of the regulatory sandbox model on the basis that it poses a possible threat to consumer welfare and market stability,” he explains. “According to this view, as the main purposes of financial services regulation include protecting consumers and markets, it makes little sense to remove that protection in the case of untried and untested products that are likely to pose particularly high risks.”
However, McCann FitzGerald’s Hogan also observes that there is flexibility built into existing legislation for regulators to relax authorization standards for certain types of companies.
“For example, the Payment Services Directive permits a regulator to disapply certain requirements to small payment institutions [average monthly payment transactions of €3 million or less],” he adds.
UK fintechs would certainly want access to a pan-European regulatory sandbox post-Brexit. Many of the products and services under development are designed to be scalable to a large customer base and financial technology firms based in the UK would want to retain the benefits of an EU sandbox in promoting access to European markets.
However, whether the EU would permit sandbox access to these firms would depend on the broader negotiated settlement between the UK and the EU, and whether UK firms retain access to the single market and the financial services passport.
“If UK firms lose the financial services passport, access to a pan-European regulatory sandbox may prove to be of limited value given the restrictions on provision of services to EU customers that would entail,” warns Davis.