Small Enough to Fail: Sizing Up the Global RegLab Movement

Innovation occupies a central role in economic history. From Schumpeter’s concept of industrial evolution to Christensen’s notion of creative destruction, scholars have long endeavored to understand the essential forces that drive commercial progress and economic change. Students of innovation strive to replicate the lightning-in-a-bottle that storied entrepreneurs have found while peering over the horizon. Few succeed.

Innovation is hard. It seems almost odd, then, to speak of regulatory innovation in a single breath. After all, what is regulation if not innovation’s counterpoint?

But regulatory innovation is indeed emerging in financial centers around the world as central bankers, prudential regulators, and market conduct authorities rush to make sense of the proliferation of new financial technologies (FinTech) and their transformative potential not just for individual consumers but for the financial system as a whole. While developing economies have worked diligently over the past fifteen years to implement digital financial services (DFS) infrastructures, much of the recent attention to global FinTech regulation has focused on so-called sandboxes or RegLabs.

Inspired by the United Kingdom Financial Conduct Authority’s Regulatory Sandbox, launched in 2016, RegLabs are regulatory safe zones for conducting small scale, live tests of new FinTech products and delivery models. In a nod to bank regulatory jargon, RegLab experiments are “small enough to fail” – sufficiently developed for regulators to evaluate how new innovations function in the real world but sufficiently narrow in scope to avoid significant consumer or systemic harm.

In theory, RegLabs provide both a pathway for innovators to lower the regulatory uncertainty associated with novel products and an experiential learning venue for regulators to develop insights on the practical effects of FinTech on the financial system. The RegLab format seems increasingly essential as FinTech use cases evolve from digitizing analogue processes to enabling real-time supervision of complex financial institutions.

The FCA’s innovation seems to have struck a chord.  Over the past few months, at least nine additional jurisdictions around the world have signaled their intention to launch formal RegLab initiatives of their own, including Abu Dhabi, Australia, Canada, Hong Kong, Malaysia, Singapore, Switzerland, Thailand, and two each in Canada (OSC’s LaunchPad and the recently announced Canada Securities Administrators Regulatory Sandbox) and Indonesia (Bank Indonesia and OJK’s RegLab-like P2P Lending Regime). More initiatives are seemingly announced every day.

While often described in monochromatic terms, global RegLab initiatives differ greatly depending on their respective mandates and host country legal system characteristics (rules- vs. principles-based), financial system maturity, and economic policy objectives:

• Mandate. The FCA’s Regulatory Sandbox has a competition mandate to promote “disruptive innovation” that generates “new services to customers and challenges existing business models.” Other jurisdictions link their RegLab initiatives to a more specific financial inclusion objective. For example, Indonesia’s P2P lending regime is linked to that country’s National Strategy of Financial Inclusion and other policy efforts to expand financing opportunities for micro, small and medium enterprises.  Still other RegLabs are intended to promote national economic competitiveness – such as Abu Dhabi’s ambition to become a leading international financial center and Singapore’s “smart financial center” initiative. These mandates provide different goals and objectives for their respective RegLabs which should influence their approach to innovation and ecosystem building.
• Structure. The term “sandbox” or “RegLab” is typically associated with the application-based testing program pioneered by the FCA. Initiatives announced in Abu Dhabi, Singapore, Indonesia, and Malaysia are following the same format. Other jurisdictions, however, such as Australia, Indonesia, and Switzerland, do away with the testing structure in favor of a simple statutory exemption for new products with limited customers or risk exposure. Indonesia’s P2P lending regime takes a hybrid approach: allowing lenders to operate under a temporary registration for up to one year while receiving regulatory “coaching” toward full license qualification.
• Participants. Most of the current RegLab initiatives are open to incumbents and FinTechs alike. Some, such as Hong Kong, limit participation to incumbent banking institutions; others, such as Malaysia, make clear that incumbent partnerships are strongly encouraged but not required. Australia limits participation to currently unlicensed entities.

Webs of bilateral agreements and MOUs imperfectly join these initiatives as regulators attempt to promote a broader vision of FinTech collaboration and harmonization.

Despite all of the promise and attention, it’s still too early to assess the impact that RegLabs will have on financial innovation. Most RegLab initiatives are not up and running. To date, only the FCA and Singapore have formally announced companies participating in their RegLabs. Testing protocols – at the FCA and elsewhere – remain opaque.

The next chapter of the RegLab story – moving from signaling to action – will be critical to understanding their true potential. On that score, important questions remain:

• What operational capacities do RegLabs require of regulators?
• Can or should any of these capabilities be outsourced to third-party providers?
• What are methodological best practices for “testing” new technologies? How are testing outcomes linked to policy objectives or regulatory priorities?
• How will test results be reviewed and utilized by regulators?
• How will lessons be shared without undue burden or advantage for RegLab participants?

Amid this promise (and some skepticism), the Aspen Institute’s Financial Security Program is studying the role of adaptive, pragmatic regulatory architectures in facilitating financial inclusion. Among other things, we’re examining the RegLab and innovation hub projects underway around the world to better understand their origin stories, design principles, and implementation strategies that contribute to a regulatory environment that facilitates responsible financial innovation. Our hope is that these learnings will advance the ongoing efforts of financial regulators here in the U.S. to support financial access and inclusion.

This blog comes from the Aspen Financial Security Program.