Thinking Out of the (Regulatory Sand) Box

The financial services industry is international in nature and so are innovations in financial technology, or fintech. Hong Kong’s annual FinTech Week provides local regulators with the perfect chance to underscore the importance of international collaboration – while also positioning Hong Kong as an innovative and leading financial center.

Last year, Australia hosted its inaugural fintech week, while Hong Kong and Singapore built on their inaugural experiences in 2016 to create larger scale and more successful fintech weeks last year.

In Hong Kong, during the second Hong Kong Fintech Week, held from October 23-27, 2017 at the Hong Kong Convention and Exhibition Centre, the Hong Kong Monetary Authority (HKMA) announced fintech collaborations with the Monetary Authority of Singapore (MAS) and Shenzhen’s Office of Financial Development Service (OFDS).

The HKMA and MAS signed a co-operation agreement covering referrals of innovative businesses, joint innovation projects, sharing of information and exchange of expertise. The first collaborative initiative will be a joint project on trade finance.

Meanwhile, the HKMA-OFDS collaboration will focus on a fintech competition to encourage cross-border collaboration, a mutual referral program to facilitate entering into each other’s market, and a talent development program to provide internships to broaden and deepen the talent pool.

The other two key financial regulators in Hong Kong have not stood still. The Securities and Futures Commission (SFC) last year announced it had opened its regulatory sandbox – established to provide a confined environment – for existing licensed corporations and start-up firms to test their internal controls and delivery of the financial services through fintech, whereas the newly established (since 26 June) Insurance Authority announced its own “insurtech” sandbox and a fast track pilot scheme for insurers using purely digital channels.  

Interestingly, the initiatives taken by the local financial services regulators address two key areas – the regulatory environment and access to talent - Hong Kong has been perceived as less supportive in a European Chamber of Commerce paper comparing Hong Kong with six other markets against the criteria of: 1) access to capital, 2) access to talent, 3) infrastructure, 4) regulation, 5) demand for fintech start-ups, and 6) supply of fintech start-ups. The paper – co-written by the author of this article – has been shared with the European Commission. 

Local Regulatory Sandboxes in Asia – Australia, Hong Kong, Singapore and the UK

Let’s take a closer look at the sandboxes provided by Australia (part of the Australian Securities and Investments Commission’s Innovation Hub), Hong Kong, Singapore and the United Kingdom (part of the Financial Conduct Authority’s Project Innovate).

In all these cases, sandboxes help reduce time and cost of getting innovative ideas to market for financial institutions and fintech firms, facilitate greater access to financing for innovators, and enable products to be tested in terms of commercial viability, consumer reception to pricing strategies and the actual technology.

Moreover, they also help regulators “think out of the box” in formulating their approaches toward regulating emerging technologies that provide products and services.

Applicant Scope – Focus on Incumbent Financial Institutions of Innovative New Entrants

In essence, local regulators regulate financial institutions and fintech companies when they engage in regulated activities. It is not always 100% clear whether their activities are regulated activities, which in the early days of fintech were (and still is, albeit to a lesser degree) cause for debate between regulators, fintech companies and their advisers.

Where it comes to the focus and scope of companies for local regulatory sandboxes, regulators have chosen slightly different approaches.

Australia’s regulatory sandbox focuses primarily on fintech firms, as does Singapore’s where financial institutions are already free to launch new products without explicit regulatory approval or the need for a regulator sandbox.

Hong Kong which has separate regulators for banking (HKMA) and securities (SFC) focuses on both incumbent financial institutions and innovative new entrants to apply for their regulatory sandboxes, whereas the insurance regulator requires a fintech firm to be sponsored and collaborate with an incumbent insurer in order to qualify for entry into their regulatory sandbox.

The UK FCA’s regulatory sandbox is probably one of the most comprehensive in terms of scope of companies, i.e. financial institutions (authorized), fintech companies (unauthorized), and technology companies supporting financial institutions.

Principles, Mission and Vision

The core mission of financial services regulators is to protect consumers, investors and maintain fair and orderly markets through market oversight.

Any regulator – especially of an international financial center should ask itself how it wants to balance its core mission of market oversight against the vision of market development to facilitate their home jurisdiction to become a vibrant fintech hub of innovation.

Australia, Hong Kong, Singapore and the United Kingdom rely on existing statutory exemptions or flexibility in the law to justify the use of regulatory tools to support firms in their regulatory sandboxes.

It is worthwhile to note that Australia introduced the concept of a fintech licensing exemption and waiver system for the testing of specific products and services in their sandbox where a notification to the regulator suffices to start testing. Products and services not eligible for licensing exemption can apply for individual relief.

Active Regulator Involvement

In principle, all regulators have opted to take an active role in the review and selection of the companies wishing to test their products and services in their sandbox.

For products and services eligible for a licensing exemption in Australia, the regulator does not review the proposed testing approach, etc.

Regulatory Tools

Regulators have a number of tools at hand in its engagement of firms engaged in fintech, irrespective whether they are incumbent financial institutions or new entrants.

Customer Safeguards (Non-exhaustive)

Effective and efficient customer safeguards are key to strike the right balance between the regulator’s roles of market oversight (including customer and investor protection) and market development.

Timing and Duration

With the exception of the UK FCA, which has a specific timeline for selection and acceptance of applications for their regulatory sandbox (twice a year), most regulators in Australia, Hong Kong, and Singapore do not have a specific period for application to their sandboxes.

The period during which a regulator allows firms to test their product and services has a maximum, with Australia for example stating a period of 12 months.

Progress So Far

Australia has four active fintech firms using its licensing exemption to test products and services, whereas Singapore had three active sandbox experiments as of the first quarter of 2018.

In Hong Kong, as of the end of 2017, the HKMA had tested 28 products and services, where banks collaborated with fintech firms in 16 trial cases. The SFC and the Insurance Authority have not published any statistics on the number of firms in the regulatory sandbox.

The UK enjoys a headstart because it has successfully tested products and services from 18 firms (from 69 applications) in the first cohort, 24 firms (from 77 applications) in the second cohort, and accepted 18 firms (from 61 applications) in the third cohort and is starting applications for the fourth cohort.

Concluding Remarks and the Emergence of a Global Sandbox

Currently, domestic sandboxes are local in nature as they only allow firms to conduct tests in one jurisdiction. The UK FCA is contemplating the idea of taking its fintech bridges (i.e., formal agreements with international regulators) to the next level and creating global sandboxes, where products and services can be tested in more than one jurisdiction. A question is which regulator will be the primary regulator (and thus have the most project control).

The local legal and regulatory structure, maturity of the financial services industry and fintech eco-system, and the government’s overarching objectives, will ultimately drive the final shape and form of the different regulatory sandboxes, where success requires collaboration and understanding between the regulator, financial institutions, fintech firms, and supporting organizations, both locally and globally.

The article is based on the author’s interpretation of publicly available information and sources. If legal advice or other expert assistance is required, the services of a competent professional should be sought.

"This article was first publishing in the Spring 2018 edition of Momentum, the official publication of The Chamber of Hong Kong Listed Companies, published by Ninehills Media."

Author

Lapman Lee
Partner
Deloitte China Risk Advisory
Tel: +852 22387700
Email: lapmanlee@deloitte.com.hk