John Collins, is an affiliate at the Berkman Klein Center at Harvard University and former head of policy for crypto exchange Coinbase.
I’ve written before about how I believe regulatory “sandboxes” for financial services innovation serve a useful function and, in absence of federal action in the U.S., states should establish them.
Since that time Arizona passed legislation to establish a sandbox, other states are trying, and there are continuing and active discussions in my home state of Delaware around how to support financial services innovation.
During my testimony at a Maryland Financial Consumer Protection Commission hearing on cryptocurrency, I took the opportunity to give a plug for regulatory “sandboxes” because I think crypto and blockchain projects are excellent candidates for such programs.
With that in mind, I read with great interest a recent speech by Maria Vullo, the Superintendent of the New York Department of Financial Services.
She touched on a number of different topics across the financial services landscape (including the state’s BitLicense regulations) and the speech is largely a rebuke of the current administration, its policies, and its overall regulatory worldview. It’s an excellent and provocative speech and I urge everyone to read it.
However, one passage, in particular, caught my attention:
“There are those who argue that the mere utilization of financial technology alone somehow grants them an exemption from the rules that banks and other financial institutions follow to manage risk and protect consumers. I have been highly vocal on myriad fronts in my opposition to this view, which would permit any company that calls itself a fintech to engage in a form of regulatory arbitrage, either with no regulator or in a so-called sandbox.”
She followed with this memorable line:
“A sandbox is where toddlers play. Adults play by rules and if you engage in banking activities, that means you are responsibly regulated in order to protect the customers. Period.”
I don’t disagree with the overall sentiment of Vullo’s statement (and should note than Jan Owen, head of the California Department of Business Oversight made a similar remark a few weeks later): the financial services industry is highly regulated for a reason, and the responsibilities of a financial services company should be higher than that of a photo-sharing app. (I stole this line from Circle co-founder Jeremy Allaire.)
Where I disagree with Vullo is in the representation of so-called “sandboxes” as a no-man’s land of unregulated financial services offerings and the companies who want to discuss new ways of testing financial technologies as “toddlers.”
No one serious is arguing for that type of construct — and if they are, they should stop. And while many of these companies have too many people riding scooters, they aren’t toddlers.
Her description of “sandboxes” sounds more like quicksand. It’s dangerous. In my view, it doesn’t accurately reflect what market participants need or desire — and it doesn’t accurately represent what governments are implementing around the world.
I’ve come to the conclusion that the term “sandboxes” is a bad one. It reinforces the visual that Vullo portrays in her speech and it portends a lack of seriousness that is needed when discussing about financial services.
I have stolen the term “Greenhouse” from Rob Morgan and my former colleagues at the American Bankers Association. I think it more accurately represents what is being attempted. Namely, it’s a place that financial technology solutions can be safely seeded, fed, and controlled.
Those that grow to potential are moved to the real world. Those that fail are filled in with new seeds. And the weeds are cut down.
Fundamentally, these greenhouses aim to relieve the tension between innovation and technology. As technology has (for the most part) finished its disruption of unregulated industries, it has now moved on to the regulated ones.
Testing is inherently necessary for the development of good technology. Disallowing it inhibits innovation, increases the chance of poor technology, and pushes innovators into gray areas that provide little or no transparency for regulators and makes fulfilling their mandate more difficult.
Rather than a “trust but verify” model whereby the regulator accepts an application, allows the business to operate, and checks compliance after operations begin, a greenhouse allows for the solution to be examined in real time.
A few months ago, the UK Financial Conduct Authority published a report detailing its “lessons learned” from experiences over the past several years.
There are certainly problems in the implementation and execution of such programs: Jackson Mueller of the Milken Institute has opined on some of these issues, which include: picking winners and losers, maintaining fairness, finding solutions that actually need such a construct in order to do testing, etc.
Primarily, however, it appears the exercise promotes a two-way conversation between regulators and industry, forces government to make guidance easier to find and understand, and helps companies lower the cost of compliance or quickly pivot away from solutions that might not work, avoiding the waste of time and precious investment dollars.
These are all things we should be promoting. No matter what we call it.
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