Regulatory test-bed for financial innovation proves its worth | Wolters Kluwer Financial Services
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  • Regulatory test-bed for financial innovation proves its worth

    By Michael Imeson

    Published May 22, 2017

    The Financial Conduct Authority is playing its part in encouraging innovation in financial services, and fintechs appear to be even more interested in the UK now than they were before the Brexit referendum, as Michael Imeson explains

    The FCA’s Regulatory Sandbox, where businesses test innovative services in a “live” environment, is progressing well. Most of the first cohort, consisting of 24 firms approved last year out of 69 applications, completed their six-month test period at the end of April 2017.

    Meanwhile, the successful applicants for the second cohort, the deadline for which closed in January 2017, were announced in April. Out of the 77 who applied, 31 were successful and will start testing in late May. Joining them will be six firms from the first cohort who were not ready to start their tests earlier.

    The Sandbox is part of the FCA’s Project Innovate, set up in 2014 to encourage innovation by financial services providers. Christopher Woolard, Executive Director of Strategy and Competition, says the project “helps firms tackle regulatory barriers to innovation” by “clarifying regulatory expectations, examining our own rules or enacting policy changes”.

    What is the Sandbox?

    The Sandbox is not a physical location at the FCA’s Canary Wharf offices but a “safe space” in the regulatory framework (safe from the normal regulatory strictures) where businesses can try out new services on real customers, on a commercial basis, without fear of being punished by the regulator if they make an honest mistake. Customers still have regulatory protection, but the firms providing the services operate in a less restrictive environment.

    The Sandbox can be used by unauthorised firms, authorised firms and technology companies providing services to FCA-authorised firms.

    • Unauthorised firms can apply for “restricted authorisation” to use the Sandbox. If they receive restricted authorisation and the services they test in a live commercial environment are successful, they can then apply for a full authorisation. However, restricted authorisation is not available for firms looking for a banking licence.
    • Authorised firms can apply to use the Sandbox to test how an idea would fit into the regulatory framework. It is tested with a limited number of customers in a commercial environment. Once the test has been completed, and the regulations applying to the idea have become clear, the firm can then decide whether to launch it fully. During the testing the FCA can provide guidance to firms on how to interpret the relevant regulation; it can waive or modify UK rules, but not national or international laws, if the test might breach those rules; and it can provide a letter saying there would be no enforcement action against the firm as long as it dealt with the FCA openly, kept to the agreed testing parameters and treated customers fairly.
    • Technology firms providing services to FCA authorised firms can also apply to use the Sandbox, on the same basis as authorised firms as explained above, if they need to test how their services fit in with the relevant regulations.

    Benefits to consumers

    “In supporting innovative firms, products and businesses we’re ultimately looking to satisfy three critical measures of success,” said the FCA’s Christopher Woolard in a speech in April. “Can we see more innovative firms entering the market? Is there greater innovation and competition by and between larger firms? And ultimately are consumers benefiting from that?

     “In the immediate aftermath of the EU referendum there was a concern that we would see the number of innovative firms wanting to operate in the UK fall. Indeed we did see a dip…but the fact is that in the nine months prior to the referendum we received 264 requests for support. But in the nine months after the referendum that figure had increased to 321 requests.

     “We are working more deeply with innovators than this time last year. For example, we received 77 applications for the second cohort of our sandbox, more than applied for cohort 1, and I can announce today that we will be accepting 31 of these applications to progress towards testing.

     “The fact is that through engaging larger firms in innovation through the Sandbox and our Advice Unit, the potential numbers of consumers who could benefit from the services offered by those firms has moved in the space of one year from being counted in the tens of thousands to being counted in millions.”

    Regulators in other countries are copying the FCA and setting up their own sandboxes, but models and standards vary. There is a fear that a “Wild West” situation could develop, with some high-profile failures that could “damage the reputation of and trust in financial innovation”, warned Mr Woolard. That is why the FCA is cooperating with its counterparts in other countries, and with global bodies like the G20 and IOSCO (International Organisation of Securities Commissions), to try to ensure this does not happen.

    Cohort 1: from big banks to start-ups

    Firms in cohort 1 range from large banks, such as HSBC and Lloyds Banking Group, to new or relatively new fintech companies. The innovations they have just finished testing include an e-money service using distributed ledger technology (DLT), an international money transfer service, a personal finance management app and a micro-savings app.

    For example, HSBC has partnered with fintech start-up Pariti Technologies to develop a mobile phone savings app called SmartSave, which has been tested with 2,000 customers. Users set up the app to automatically save “spare change” in a range of spending scenarios. For example, it can be set to “penalise” you every time you buy a luxury item by putting a small amount into your savings account. Another function is that every time you spend, it rounds up the amount to the nearest pound and puts the difference, the “change”, into your savings account. After a while, if the app thinks you should save more, or less, it will automatically notify you.

     “HSBC SmartSave is the result of collaboration between a large international bank and a fintech start-up, enabling the delivery of innovation at a faster speed,” says Raman Bhatia, HSBC’s Head of Digital UK and Europe. “By using customer insights and behavioural science within the FCA’s Regulatory Sandbox, we are pushing the boundaries of what is possible and looking beyond conventional savings to help our customers start or improve their savings habit.”

    Matthew Ford, CEO of Pariti, adds: “The partnership with HSBC is a great example of how fintechs and major banks can collaborate to deliver innovative and intuitive mobile services to banking customers. The collaboration is especially powerful as it leverages Pariti’s algorithmic intelligence whilst integrating deeply with HSBC to allow customers to save almost instantaneously without the effort usually involved.”

    A five-year-old fintech software company called Billon has just finished testing an e-money DLT-based platform that allows consumers to transfer and hold funds using a phone app. Payments are direct between users or between buyers and sellers, with no bank or third party in the middle. This makes it especially attractive for the financially excluded – people without a bank account. Billon is a Polish company which recently moved its HQ to the UK to begin its international expansion. The product is already live in Poland.

    Blink Innovation has trialled flight cancellation insurance. The insurance costs £6.50 per flight and there are no extra fees. If your flight is cancelled, you use an app on your mobile device to choose an alternative flight at no additional cost. Blink is an appointed representative of AFL Insurance Brokers, which is an FCA-authorised firm. The insurance is underwritten by Great Lakes Insurance, a wholly owned subsidiary of Munich Re Group.

    Next steps

    As mentioned earlier, the 31 successful cohort 2 applicants will start their tests in late May. The testing period will last six months, ending in late November. Cohort 3 of the Sandbox will open for applications in June, with a deadline of late July.

    Even if most of these new ideas ultimately fail commercially, some will surely succeed. The digitisation of financial services continues apace.

    About the author: Michael Imeson Chartered MCSI is Contributing Editor of The Banker magazine; Senior Content Editor at Financial Times Live where his role is to organise and/or chair events on financial services; and the owner of editorial services agency Financial & Business Publication. Michael is also a regular contributor to Wolters Kluwer’s Compliance Resource Network.




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