Fintech Regulatory Sandboxes: Update on Arizona’s Sandbox and Other Developments

Perkins Coie
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Arizona’s financial technology (“fintech”) sandbox (“Sandbox”), the first of its kind in the United States, has been open for several months and has accepted three participants.  A month after the program’s launch, Arizona’s Attorney General announced his approval of the first participant, payment platform Omni Mobile, Inc.[1]  Two other companies providing consumer lending services, Sweetbridge NFP, Ltd. and Grain Technology, Inc., joined Omni as Sandbox participants shortly thereafter.[2]  Arizona’s Sandbox may serve as a helpful illustration of what entrepreneurs can expect in Arizona (should they also wish to participate in the Sandbox) as well as in other states that decide to implement similar programs.[3]  To that end, this client update provides an overview of regulatory sandboxes generally, Arizona’s Sandbox, and potential future developments.

Due to their novelty, it is often difficult to determine whether and to what extent innovative products or services will be desired by customers before they are deployed in the market.  At the same time, financial services activities typically require licensing and are often accompanied by high (or unknown) compliance costs and regulatory responsibilities.  This is particularly true for financial products or services based on new technologies such as virtual currencies or blockchain.  Regulatory sandboxes aim to mitigate the deterrent effect that fintech businesses face as they weigh these high upfront costs against the uncertain benefits, while still ensuring that the public interest is adequately protected.  They do so by providing fintech businesses with the ability to test a product’s market viability on a small scale before deciding whether to incur the costs of licensing and compliance.  In addition, regulatory sandboxes can provide a fintech business with valuable market insights while maintaining compliance, as well as greater knowledge of the laws surrounding its product or service and the opportunity to begin building a relationship with a regulator.

Consistent with those key characteristics, Arizona’s Sandbox allows participants to temporarily test-drive their products, engaging in certain financial services activities under regulatory supervision without undertaking the costly process of securing traditional licenses prior to operation.[4]  As Evan Daniels, Fintech Sandbox Counsel at the Office of the Arizona Attorney General, has further explained:

The Arizona sandbox is designed to allow innovative ideas to get to market more quickly by reducing “one-size-fits-all” regulatory requirements in exchange for more active involvement by the Attorney General’s Office. It’s not a license for participants to do whatever they want, but it is meant to provide a dynamic arrangement where the regulator and participant can observe what’s happening in the market and make adjustments as needed regarding monitoring and regulatory compliance at the state level.

To be approved, a participant must offer an “innovative” financial product or service.[5]  Broadly speaking, this means that the product or service offered is based on either an “emerging technology” or the “reimagination of uses for existing technology.”[6]  The financial services permitted within the sandbox include those of sales finance, consumer lending, investment management, and money transmission.[7]  The Attorney General’s Office receives and approves applications in consultation with other state agencies as appropriate and oversees the operation of the program.[8]

Once approved, a participant is free to offer its products or services to the public, subject to certain activity- and consumer protection-based limitations.  Among other limitations, these include:

  • A participant may test its approved product or service for only two years. After two years, a participant must either apply for a license to continue its service or stop providing the service in Arizona.[9]  In limited situations, a participant may apply for an extension of up to one year after the first two-year period has run.[10]
  • The Sandbox limits the number of consumers, transactions, and amounts transacted—with specific limitations linked to the particular service or product that the participant provides.[11] For example, a participant engaging in money transmission may provide its service to no more than 10,000 customers, with the aggregate amount of each customer’s transactions limited to $25,000.
  • A participant must provide specified disclosures to its customers and keep sufficient records for purposes of consumer protection enforcement.[12]
  • The Sandbox applies exclusively to the laws of Arizona. Consequently, participants should ensure that their activities do not implicate federal law or the jurisdiction of other states.

Inevitably, a successful company will need to expand its offerings beyond the framework of the Sandbox in order to grow, at which point standard regulatory requirements will be enforced.  For this reason, it will be important for Sandbox participants to keep potential laws and regulations that may apply to their product in mind throughout testing and development.  This will better prepare them for their eventual exit from the Sandbox.

Arizona is also making efforts to establish reciprocity among regulatory sandboxes internationally.[13]  Arizona has signed an agreement with Taiwan that establishes a “cooperation structure” between the two governments.[14]  For now, the agreement is limited to the sharing of information, but it is hoped that it will one day lead to participants in either program having the ability to test their products in each jurisdiction simultaneously.  Efforts to create a similar reciprocity structure in the United Kingdom, which has its own fintech regulatory sandbox, are also underway.  These agreements may provide participants with the ability to enter markets that were previously unavailable, thereby increasing a company’s ability to scale.

Several other states and agencies have proposed or are currently developing programs similar to Arizona’s.  Accordingly, Arizona may not be the only state to offer this type of program for long.  In fact, a proposed bill in Illinois made its way through the state legislature at the same time as Arizona was adopting its Sandbox, mirroring Arizona’s program in many ways.[15]

Federal agencies have also discussed the potential for similar programs at the federal level, and several have made some efforts to implement them.[16]  For example, the Consumer Financial Protection Bureau (“CFPB”) announced plans to develop and implement sandbox-type programs.[17]  The CFPB’s Office of Innovation—the body charged with administering the CFPB sandbox—has stated that it would like to pursue some form of regulatory sandbox.  Notably, Paul Watkins, a key contributor to Arizona’s Sandbox while leading the civil litigation division of the Arizona Attorney General’s Office, is currently serving as the head of the Office of Innovation.[18]  Additionally, the U.S. Treasury Department referenced the potential for fintech sandboxes as part of a broader financial policy position.[19]  Although individual federal regulators (such as the CFPB) may choose to implement sandboxes covering their domain of regulated activity, there is unlikely to be a holistic federal fintech sandbox in the foreseeable future, given the fragmented nature of federal financial regulation.  As a result, participants would need to confirm that their licensable activity is regulated solely by the federal regulator(s) administering the sandbox they are in before conducting such activity without a license.  Notwithstanding such limitations, these developments are notable because they highlight a growing willingness of the federal government to adopt and pursue sandbox-style regulatory tools.

Fintech businesses should closely consider these developments because they allow for a new means of testing and deploying innovative technologies that may be beneficial for them.  If a company or entrepreneur wishes to apply to the Arizona Sandbox, or other similar programs, that applicant should consult with legal counsel to ensure compliance with the sandbox’s requirements and other regulations that may apply to the product or service offered.

[1] Arizona Attorney General, Arizona Accepts First Participant into FinTech Sandbox (Oct. 2018), https://www.azag.gov/press-release/arizona-accepts-first-participant-Fintech-sandbox.

[2] Arizona Attorney General, Two More Participants Join Arizona’s FinTech Sandbox First Arizona-based company enters program (Nov. 2018), https://www.azag.gov/press-release/two-more-participants-join-arizonas-fintech-sandbox-first-arizona-based-company.

[3] See, for example, Wyoming’s proposed fintech sandbox bill.  H.B. 0057, 65th Leg. (Wyo. 2019), https://wyoleg.gov/Legislation/2019/HB0057.

[4] Ariz. Rev. Stat. Ann. § 41-5602.

[5] Ariz. Rev. Stat. Ann. § 41-5603.

[6] Ariz. Rev. Stat. Ann. § 41-5601(4)-(5) (setting forth these and additional criteria in defining “innovative” financial products and services).

[7] Ariz. Rev. Stat. Ann. § 41-5605.

[8] Ariz. Rev. Stat. Ann. §§ 41-5604-05; see also Arizona Attorney General, Arizona Becomes First State in U.S. to Offer Fintech Regulatory Sandbox (Mar. 2018), https://www.azag.gov/press-release/arizona-becomes-first-state-us-offer-Fintech-regulatory-sandbox.

[9] Ariz. Rev. Stat. Ann. § 41-5607.

[10] Ariz. Rev. Stat. Ann. § 41-5608.

[11] Ariz. Rev. Stat. Ann. § 41-5605.

[12] Ariz. Rev. Stat. Ann. § 41-5606.

[13] JD Alois, First of its Kind Arizona Fintech Sandbox Looks to Partner with Fintech Leaders in United Kingdom, Crowdfund Insider (Sept. 5, 2018), https://www.crowdfundinsider.com/2018/09/138658-first-of-its-kind-arizona-Fintech-sandbox-looks-to-partner-with-Fintech-leaders-in-united-kingdom/.

[14] Arizona Attorney General, supra note 1.

[15] Sara Merken, States Embrace Fintech Sandbox Concept as Federal Action Stalls, Bloomberg News (Sept. 21, 2017), https://www.bna.com/states-embrace-Fintech-n73014464317/.

[16] Other programs have been adopted by federal agencies that encourage a relationship between regulators and innovators.  For example, the Commodity Futures Trading Commission’s “LabCFTC” provides entrepreneurs with a communication gateway so that entrepreneurs may work with the regulator in all stages of product development.  LabCFTC Overview, U.S. Commodity Futures Trading Commission (last visited Nov. 19, 2018), https://www.cftc.gov/LabCFTC/Overview/index.htm.

[17] Bureau of Consumer Financial Protection, BCFP Office of Innovation proposes “disclosure sandbox” for Fintech companies to test new ways to inform consumers (Sept. 13, 2018), https://www.consumerfinance.gov/about-us/blog/bcfp-office-innovation-proposes-disclosure-sandbox-fintech-companies-test-new-ways-inform-consumers/.

[18] Bureau of Consumer Financial Protection, BCFP Announces Director for the Office of Innovation (July 18, 2018), https://www.consumerfinance.gov/about-us/newsroom/bureau-consumer-financial-protection-announces-director-office-innovation/.

[19] U.S. Department of the Treasury, A Financial System That Creates Economic Opportunities: Nonbank Financials, Fintech, and Innovation (July 2018), https://home.treasury.gov/sites/default/files/2018-08/A-Financial-System-that-Creates-Economic-Opportunities—Nonbank-Financials-Fintech-and-Innovation_0.pdf.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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