How Regulatory ‘Sandboxes’ Can Boost U.S. Technological Innovation

States like Louisiana and North Carolina are eager to attract technology companies and promote innovation by temporarily lifting government red tape that stands in the way. But they are running into a big federal problem. States don’t have the power to waive federal financial regulation and licensing requirements even in the interest of allowing a company to experiment. This experimenting space is called “regulatory sandboxes,” and the end result can be innovations that help consumers gain access to innovative services, pay bills or even get legal services.

Sandboxes allow companies to test new innovative products for a limited time under close regulatory supervision.  Already, the Biden administration, Congress, and state lawmakers have role model sandboxes they can emulate and build upon.

The UK’s Financial Conduct Authority launched the world’s first regulatory sandbox in 2016. Since then, many countries, including the United States, have established more than 50 sandbox programs. Currently, the federal Consumer Financial Protection Bureau (CFPB), Arizona, and Utah run sandbox programs, while several states have passed legislation or are currently reviewing legislation to create sandboxes.

In a sandbox program, regulators typically provide exemptions from regulations, waive licensing requirements, or advise firms on regulatory implications of new products and services. Alternately, regulators can issue no-action letters, promising not to pursue legal action against a firm if it abides by agreed-upon terms and conditions. In exchange, the sandbox firms can offer new products and services with legal certainty—often in emerging areas such as biometric payments systems and AI-enabled legal services. 

But states face that hard barrier of un-waivable federal rules. Although Arizona and Utah have been relatively successful in attracting innovative companies, there are limits, since most financial services regulations are federal.

Meanwhile, the CFPB launched a compliance assistance sandbox program in 2016, but regulatory barriers mean have prevented it from being as successful as its international counterparts. The CFPB is not a licensing body, so it cannot waive federal licensing or regulatory requirements for sandbox participants, either. The other problem is that while the CFPB can issue a no-action letter for participating companies, that carries little legal weight. A no-action letter from CFPB is no guarantee that other regulators, like the Securities and Exchange Commission, will not bring lawsuits against the sandbox participant. In other jurisdictions, such as Australia and Britain, a smaller number of regulators makes it easier for those regulators to mutually agree not to bring lawsuits against sandbox participants.

Worse, participating in the CFPB sandbox can result in enhanced scrutiny from federal agencies—further adding to political uncertainty for participants. 

As a result, only two companies have participated in the CFPB compliance program since 2016, and only nine companies have applied for and received a no-action letter from CFPB. In contrast, 118 firms have participated in the UK’s sandbox program since 2016. Furthermore, through the sandbox program and informal regulatory guidance, the UK’s Project Innovate supported 686 firms between 2016 and 2019.

Congress should make the CFPB sandbox more effective by making it easier for the bureau to coordinate with other agencies to grant no-action letters and provide regulatory relief.

Congress should also consider providing a legislative basis for a federal regulatory sandbox program. While state legislation provides the statutory basis for state sandboxes, no specific legislation created the CFPB sandbox. Instead, the CFPB relied on its interpretation of the Dodd-Frank Act to create the sandbox program, which leaves it vulnerable to future legal challenges.

But Congress can be frustratingly slow. Therefore, states still have an essential role to play in making state sandboxes more effective. Several states have introduced but not yet fully launched sandbox programs, but barriers to entry to many of these sandboxes remain high. For example, Nevada imposed a maximum cap of three companies that can participate in the sandbox at a time. By liberalizing the entry conditions and increasing the number of sandbox firms, state lawmakers can improve the sandboxes’ overall benefits.

Read the full article at Real Clear Markets.