Arizona has become the first state to create a regulatory “sandbox” for financial innovation—a safe harbor of sorts that allows financial-tech startups to test out new products, services and business models without getting bogged down in costly regulations.
Similar sandboxes have been set up in the UK, Singapore, United Arab Emirates and Australia to encourage innovation. While Congress has proposed one, there is currently no U.S. sandbox, putting fintech startups here at a disadvantage.
Startups pushing new ground in, say, payments or capital-raising, can spend tens of thousands of dollars and many months or years navigating a patchwork of state and federal financial regulations.
Sandboxes do no mean an absence of oversight or consumer protection. Rather, they are intended to encourage responsible and controlled innovation. Businesses that want to use the sandbox must get approval and then must operate within defined parameters.
In Arizona, the Attorney General’s Office will approve applications and oversee the program. Sandbox participants will be required to provide detailed information about their product or service, and will be able to test it for 24 months after their approval date. They AG may also grant an extension of up to one year.
Customers of the product must be Arizona residents. The sandbox will cap the numbers of individuals who may participate in a particular sandbox agreement, as well as the amount of loans that may be issued. Participants must also comply with any statutory limits and caps in Arizona financial law. In addition, the Arizona Consumer Fraud Act applies to all products and services.
Arizona’s sandbox is expected to begin accepting applications by the end of the year.
The bill, House Bill 2434, was sponsored by Representative Jeff Weninger and was signed into law last week by Governor Doug Ducey. “The idea of a regulatory fintech sandbox is not new, and while it’s being discussed at the federal level, Congress is moving at a glacial pace,” said Attorney General Mark Brnovic, the Arizona AG and drafter of the bill.
Laboratories of Democracy
In an op-ed last fall, Brnovich explained the thinking further. “States must look inward and recognize when our patchwork of state regulation stifles innovation and creativity,” he wrote. “But given Washington gridlock, states also have an opportunity; we can and we should step up to the plate to maintain our country’s competitiveness in the global marketplace.”
True to their reputation as the laboratories of democracy, states have often taken the lead in tinkering with financial regulations. Even before the JOBS Act was signed in April 2012, Kansas and Georgia had implemented their own intrastate crowdfunding laws. By the time Regulation Crowdfunding, the centerpiece of the JOBS Act, took effect, more than two-dozen states allowed investment crowdfunding within their borders.
There is still no secondary market for securities issued under the JOBS Act, but Michigan passed a law four years ago allowing the creation of secondary markets to trade shares issued under its Michigan Invests Locale Exemption, or MILE (though no one has yet created such a market).
And, while Congress is still talking about making improvements to the JOBS Act, several states have amended and improved their intrastate crowdfunding laws since passing them.
More recently, some states have rushed to declare themselves open to blockchain and cryptocurrency startups.
A Global Sandbox?
The U.S. is considering the idea of a regulatory sandbox. A bill that included a sandbox at the federal level was introduced by House Rep. Patrick McHenry in 2016 as part of the Financial Services Innovation Act, but it has gone nowhere.
Meanwhile, in Britain, authorities have worked closely with at least 70 companies that have used the two-year old sandbox to test out the validity and demand for their innovations. They have ranged from products that enable people on public assistance to receive and make payments faster, to mortgage innovations and novel blockchain applications. Many of the companies have moved onto a wider launch, according to the Financial Conduct Authority (FCA), Britain’s version of the S.E.C.
The sandbox has been so successful, in fact, the FCA is looking to create a global sandbox in conjunction with other countries that would allow companies to solve global challenges.
Arizona’s sandbox is a start for the U.S.
“Arizona has always been a state for big ideas and this is just one more place where we are trailblazing in entrepreneurship and innovation,” said Brnovich. “I hope to see the sandbox serve as a catalyst for capital investment in Arizona and provide opportunities for Arizona businesses and consumers to thrive.”
It also might serve as a catalyst for other states—or Congress—to act.