Regulatory Sandboxes - What Are They?

By JamesIrving | Legal Mongrel | 18 Jul 2020


Photo: Mining Exhange, Ballarat, Australia

There have been a lot of court cases involving coin promoters, especially in the US. What if there were a way to avoid being "busted" for breaching securities laws and other compliance roadblocks to ICOs and STOs? Some jurisdictions are setting up regulatory sandboxes for precisely this purpose. A regulatory sandbox allows a fintech company or coin promoter to work together with the regulator to test their product without attracting a negative reaction. If the product passes the test, the regulator gives the promoter the green light to release the product publicly.

How Do Sandboxes Work?

Regulatory sandboxes are springing up all over the world. The "test before you launch" concept is a good way for governments to encourage innovation and save time and effort on investigations and prosecutions. These sandboxes vary in their features, but they all have the same basic purpose: to support the development of fintech and at the same time assist the regulators to adapt old rules to new products in a non-threatening way. For example, the Saudi Arabian Monetary Authority (SAMA) has launched a sandbox. In its framework document for the sandbox, SAMA says:

"The Sandbox can be described as a regulatory process that acts as a 'safe space' in which [financial services] firms are given facilities to test new digital solutions under a set of conditions and limitations designed to protect customers, but without being immediately required to comply with all the normal regulatory obligations ... "

The framework explicitly states that the KSA sandbox it is open to "innovators proposing non-regulated technology". In other words, if you are testing your product under supervision in a sandbox, and it is unclear what, if any, laws apply to your product, you won't be busted for breaking any laws The regulator wants to find out if and how its laws apply to your product, whether the laws need to evolve and be adjusted, whether what you are doing is safe and transparent for your audience of consumers, and whether new or better regulations need to be developed.

Similar to joining a business accelerator or incubator, regulatory sandboxes have an application process.  The SAMA sandbox, to continue using that example, asks applicants to complete and submit an eleven-page application form, proving information about such things as the stage of development of the product in question, what market research has been carried out to demonstrate that there is a market for the product in Saudi Arabia, and what financial and other resources the applicant has to text the product.

The European Securities and Markets Authority provided the following diagram showing how a regulatory sandbox works in its 2018 report on innovation hubs and regulatory sandboxes in the EU:

Diagram by ESMA

Sandbox Advantages 

The UK's regulator, the FSA (Financial Services Authority) states on its website that participation in its sandbox laboratory may result in "reduced time-to-market at potentially lower cost". Clearly, if a regulator such as FSA becomes concerned about a product pre-launch, or part-way through the launch process - which might run over the course of a year - there is a huge potential for the launch to be interrupted, and for large amounts of the promoter's time and resources to be spent in dealing with the regulator and satisfying its concerns. All of this can be sorted out in the sandbox environment. For product promoters, the most obvious advantage of a sandbox is avoiding prosecution and interruption of their product rollout, but the sandbox may also be an opportunity to improve the product, too. Responsible promoters do care about their users, and do want to ensure that their products comply with consumer protection laws that apply.

The sandbox concept is becoming more popular worldwide. Global Government Forum reported in May 2020 that the government of Spain is developing a sandbox, that Bulgaria is too, and that Lithuania has had a sandbox up and running since 2018. The Netherlands has had a sandbox since 2016. Global law firm Baker & McKenzie lists 18 different countries that have developed some kind of "test before you launch" review regime for fintech products.  This growing popularity shows that governments and product developers are finding the opportunity to test products helpful.

The Digital Financial Services Observatory at Columbia University, New York, has released a report on regulatory sandboxes in developing countries, describing sandboxes as an "innovation-friendly signal to [the] market", a way to "de-risk" product development, and a "test-and-learn" approach by governments. I think sandboxes are a great idea. If the sandboxes are operated effectively and not in an overly bureaucratic way, and help product developers to learn quickly if their product breaks any laws, they will serve a useful purpose.

[Photo credit: Mining Exchange building, Ballarat, Victoria, Australia, by Paul Carmona, a public domain image courtesy of Wikimedia Commons, CC BY-SA 3.0. Diagram by European Markets and Securities Authority, courtesy of the European Union. This post is a basic level, educational and informational discussion of legal concepts. It does not constitute legal advice for any person, nor does it create a lawyer/client relationship with any person. Although care has been taken to ensure that the law is described correctly at the time of publication, no guarantee of accuracy is provided. The author is a lawyer involved in blockchain projects. You can visit his website at ]

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