Intelligence

Explainer: Regulatory sandboxes and fintech incubation

binna

Binna Kim

President

As our CEO Dan Simon reported in his latest segment on Asset TV’s fintech channel, Hong Kong is the latest country to develop a financial technology incubator through its central bank.


The headlines here are obvious. “Hong Kong’s announcement comes at a time when the territory has been seen as struggling to catch up with Singapore on fintech innovation,” the Financial Times reported. The move signals deeper global investments in financial technology are forthcoming.

Arguably more important is the nuance. Media outlets have been deliberate in using the word “sandbox” to describe the approach Hong Kong, and many other jurisdictions, are using with their incubators.

Sandboxing is a widely used technical term in the software sector for the act of separating new code from older code. It’s what security researchers do when they run suspicious code on an isolated computer to make sure it is safe and what software developers do when they sequester experimental code from other programs to preserve existing functionalities.

In the context of the central banks that are promoting financial technology incubators, a sandbox seems to refer to isolated testing that takes place outside of the jurisdiction’s current regulatory regime. But because regulations vary between jurisdictions, the term is imprecise from a technical perspective. So, some examples.

“The regulatory sandbox aims to create a ‘safe space’ in which businesses can test innovative products, services, business models and delivery mechanisms in a live environment without immediately incurring all the normal regulatory consequences of engaging in the activity in question,” wrote a U.K. regulator.

“The regulatory sandbox will enable [financial institutions] or any interested firms to experiment with innovative FinTech solutions in an environment where actual products or services are provided to the customers but within a well-defined space and duration,” a regulator in Singapore disclosed.

In general, sandboxing financial innovation can be looked at as a form of deregulation designed to not only support innovation, but also to give the regulator a preview of real use cases for new technologies while preserving crucial security protocols. While the details seem to vary from country to country, sandboxing could lead to not only better technology, but also better regulatory enforcement.

Making good software is hard, and so is regulating new things. The central banks in question seem to be taking the right approach to incubating these important innovations.

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