Inside the UK’s Regulatory Sandbox: How It Fosters FinTech Innovation, Drives Multisector Growth

The U.K. is credited with launching the first regulatory sandbox in 2016, and since then the concept has spread across the world, with an additional 72 FinTech sandboxes implemented in close to 60 jurisdictions, according to World Bank data.

But what exactly is a regulatory sandbox and why are governments around the world increasingly deploying the concept?

The U.K.’s Financial Conduct Authority (FCA) first announced it would be launching a regulatory sandbox in 2015. The first sandbox grew out of the FCA’s Project Innovate, which brought together regulators and industry voices to discuss how to foster a more hospitable environment for innovation, specifically in the financial services sector.

The FCA defines a regulatory sandbox as “a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory consequences of engaging in the activity in question.”

Basic Set Up and Framework

Initially, the first generation of sandboxes were organized into cohorts, with successive rounds of experimentation and discussion that businesses would have to apply to join. Each round typically lasts from six months to a year, with longer periods applied in special circumstances.

As the sandbox concept has evolved, some authorities, the FCA included, have transitioned to a rolling acceptance model. Rather than taking in a fresh batch of firms each year, regulators like the FCA now accept applications to join the sandbox on a rolling basis.

Once accepted into a sandbox, businesses have a direct line of communication with regulators. This alone has huge advantages for innovation — specifically, if the firm in question is an early-stage startup that doesn’t have the resources to hire the necessary consultants and legal teams required to process full regulatory compliance.

Perhaps the biggest advantage of joining a sandbox is that a company is able to propose a specific waiver to an existing rule it would like. It can also ask for permission to pursue an experiment where the law is not clear as to the legal consequences without fear of the regulator imposing fines.

That said, the company is still bound by local laws. It simply gets limited permission within the scope of the sandbox to operate with more freedom than if it weren’t enrolled in the sandbox.

Often, the regulator and the business will collaborate to set up a controlled experiment with a limited number of users and any necessary consumer safeguards in place.

Public-Private Dialogue, Collaboration

While the likes of the FCA state that the primary function of regulatory sandboxes is to stimulate innovation, working with businesses provides regulators with additional insight on where existing policies are hurting business growth, helping to guide future policy changes.

Moreover, by bringing authorities and the people who develop new technologies together, regulatory sandboxes are becoming an increasingly important avenue of dialogue between governments and the private sector.

In a sign of how this public-private engagement is driving change, in the last year, regulators in the U.K. and the European Union have moved beyond sandboxes that open space for experimentation with financial services delivery, to ones that deal with specific technologies and the pressing questions they raise.

For example, PYMNTS reported last month that the U.K. finance ministry will start live testing crypto blockchain technology in financial markets activities — the EU is also in the process of setting up a similar crypto sandbox — as part of the government’s plan to create a friendly and attractive regulatory environment for investors.

Read more: UK Government Pushes for Crypto Sandbox, Stablecoin Regulation

One of the goals of this new sandbox would be to experiment with distributed ledger technology (DLT) projects — the underlying technology used by crypto assets — around activities such as trading, clearing and settlement to accelerate the issuance of bonds or stock, for example.

From FinTech to AI, Healthcare

The regulatory sandbox concept is not limited to financial services technology or FinTech alone. In June this year, the government of Spain and the European Commission announced a pilot of the first regulatory sandbox on artificial intelligence (AI).

The anticipated sandbox is set to focus on the implications of AI for data protection laws and helping firms better understand the legal issues at stake. It will also guide authorities on where laws surrounding the use of data need to be updated to reflect the growing importance of machine learning data processing across industries.

Related: UK Goes for Light Touch AI Regulations; While EU Doubles Down

Overall, the more regulated the sector, the more useful sandboxes can be. For example, healthcare is highly regulated by necessity, but that strict oversight can stifle innovation, often taking years to get a product to market.

Recognizing the need to digitally transform the U.K.’s National Health Service (NHS), the Care Quality Commission (CQC) — the body responsible for regulating the NHS and other healthcare providers — launched its own set of sandboxes in 2019.

And while “at times the sandbox trod a difficult line between supporting experimentation and CQC’s role as the regulator,” the CQC noted in a May 2022 pilot evaluation that they’ve been able to “balance that risk.” Moreover, as they’ve built better relationships with stakeholders who were part of the sandbox, it has “helped to define regulatory boundaries with some other regulators.”

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