Participation in the regulatory sandbox helps fintechs attract investment, says FCA

Out-Law News | 24 Oct 2017 | 10:24 am | 3 min. read

Participation in the UK Financial Conduct Authority's (FCA's) regulatory sandbox is helping firms to attract investment for their innovations, the regulator has said.

The FCA said that at least 40% of firms that had completed testing in the first round of sandbox testing had "received investment during or following their sandbox tests".

The regulator confirmed the investment levels in a new report outlining the lessons learned from operating its regulatory sandbox scheme (21-page / 325KB PDF).

"Feedback from sandbox firms indicates that taking part in the sandbox programme provides a degree of reassurance to investors through the oversight the FCA has of the firms’ tests and the increased regulatory certainty participation provides," the FCA said in its report. "For example, one firm stated that continuous dialogue with us during the sandbox process has enabled them to develop more rigorous policies and processes than they otherwise would have."

"Obtaining authorisation helps firms access funding. For firms that are not yet authorised, the sandbox can offer a quicker route to authorisation, enabling them to provide more certainty to prospective partners and investors. Given the rapid pace of growth that many early stage firms experience, this can be especially beneficial in reducing constraints to growth and funding. Feedback received indicates that investors can be reluctant to work with fintech companies that are not yet authorised," it said.

The FCA's sandbox scheme allows businesses to "test new ideas without incurring all of the normal regulatory consequences", the regulator has said previously. Testing under the scheme can involve real world experimentation of innovative products, services, business models and mechanisms of delivery under a light-touch regulatory framework and tightly controlled conditions.

To-date, 41 firms have engaged in sandbox testing across two rounds of trials that the FCA has overseen since the sandbox initiative opened for applications last year.

Around 90% of the firms that participated in its first round of sandbox testing "are continuing toward a wider market launch following their test", the FCA said. Most of the firms that were granted a restricted authorisation for their test have subsequently successfully gained full authorisation, it said.

The FCA said that approximately a third of the firms that took part in the first round of sandbox testing had "used the learnings to significantly pivot their business model ahead of launch in the wider market".

The regulator said that while it was "too early to draw robust conclusions on the sandbox’s overall impact on competition", it believes the testing has shown that the scheme "is making progress towards promoting competition in the market".

It highlighted examples of the emergence of new technologies tested in the sandbox environment, such as distributed ledger technology (DLT), online platforms, application programme interfaces (APIs) and biometrics, in "delivering innovative products and services that can improve on those currently available".

Yvonne Dunn, an expert in financial services and technology law at Pinsent Masons, the law firm behind Out-Law.com, said that it was great to see that the firms participating in the FCA sandbox process are "deriving benefit from it and building sustainable businesses".

"Although it is early days, the range of technologies being developed through the sandbox is encouraging at a time when it is important for the UK to maintain and grow its competitive position in fintech," Dunn said.

In its report, however, the FCA said it was concerned that some banks appeared to have been "withdrawing or failing to offer banking services" to fintech start-ups.

"The drivers behind these practices are many and complex," the FCA said. "This is, at least in part, driven by banks’ perception of greater money laundering and terrorist financing risks posed by certain types of customers, but also appears to come from other factors including strategic business decisions, the profitability of certain relationships, credit risk assessments, and overall compliance costs. Research has found that some banks are closing accounts for certain companies (for example money transmission services), and that de-risking seems to affect small businesses more than large ones."

"We have 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. We are concerned by what appear to be blanket refusals for certain kinds of applicant firms. There are also apparent inconsistencies within individual banks regarding how they apply their assessment criteria in approving access to banking services," it said.

The FCA said it intends to continue its focus on the potential impact these practices have on competition and innovation.

The Financial Times reported that some of the fintech businesses that have struggled to open bank accounts in the UK are those that handle cryptocurrencies.

Dunn said: "The comments in the FCA report around difficulties in setting up bank accounts for certain fintech start-ups are consistent with recent commentary around ICOs and cryptocurrency businesses: there is currently a 'fear factor' around them. While it is correct to be circumspect, these businesses offer interesting disruptive potential and it is important that they are considered on their merits rather than being the subject of blanket rejection."