Sandboxes aren’t just play areas for toddlers. Increasingly, state and national governments around the world are creating so-called regulatory sandboxes: programs that allow software companies to skirt regulations in order to test a new product or service.
The most common U.S. sandbox programs serve companies that make financial technology, such as digital payment apps or software for assessing credit risk. Governors in six states have in recent years signed laws creating such programs. The federal Consumer Financial Protection Bureau runs two on the national level.
And the idea is spreading. Lawmakers in 11 states and Washington, D.C., this year proposed bills that would create financial technology sandboxes, according to the Libertas Institute, a libertarian-leaning think tank based in Lehi, Utah, that promotes the sandbox concept nationally.
Sandbox laws allow companies to test prototypes without getting a state license. While proposed and enacted laws vary, they drop requirements such as net worth amounts, collateral deposit amounts and interest rate limits. Several laws say that in a sandbox, none of the state’s financial services laws apply, and it’s up to regulators to decide if any laws or regulations should apply to protect consumers or licensed banks from a certain product test.
States also have created sandboxes for companies developing insurance, legal, real estate and other new products and services.
Supporters say legal wiggle room can help banking and lending startups grow and create jobs. But consumer advocates say loosening licensing rules could expose customers to unfair or abusive products, such as loans with high interest rates.
They like to quote New York’s former head banking regulator, Maria Vullo, who once said, “Toddlers play in sandboxes. Adults play by the rules.”
“Just because there’s a claim of innovation, or that technology is involved, doesn’t mean it’s automatically good,” said Lisa Stifler, director for state policy at the Center for Responsible Lending, a Washington, D.C.-based nonprofit that fights predatory lending.
State financial technology sandboxes also have struggled to attract businesses. In the four states accepting applications this year—Arizona, Florida, Utah and Wyoming—no companies are currently enrolled.
In Arizona, only 10 companies have participated. “Those companies may or may not have gotten through their actual test,” said Assistant Attorney General Sam Fox, who oversees the state program.
Financial technology sandboxes are best understood as “signaling mechanisms,” attempts by lawmakers to show their state is forward-thinking, said Lee Reiners, executive director of the Global Financial Markets Center at Duke University School of Law. “They’re not going to help that many firms,” he said.
Playing in the Sandbox
Arizona Gov. Doug Ducey, a Republican, signed a law creating the first U.S. financial services sandbox in 2018. Backed by business groups and blockchain enthusiasts, the law has since become a template for other states.
Companies can participate in the Arizona program without having an office or employees in the state. Once admitted, they can offer products and services—mostly loans, money transmission services and investment advice—backed by new technology to up to 10,000 state residents for two years without getting a state license.
State regulators monitor participating companies. Participants can handle only a limited amount of money—money transmitters can offer transactions of up to $2,500 at one time or $25,000 per consumer, for instance—and they must comply with the state Consumer Fraud Act. Arizona’s 36% annual interest rate limit for small consumer loans still applies.
So far, participants have included a cryptocurrency payments company that serves marijuana businesses; a company that gives consumers cash in exchange for a percentage of their future earnings; and a company that’s developed an algorithm for evaluating renewable energy projects.
BrightFi Services, a company whose software lowers the cost of administering bank accounts, used the sandbox in 2019 to test an iPhone banking app aimed at people who lack accounts. It chose a small group of test users, including some of its own employees, and asked them to share feedback on the app’s features.
Supporters say sandbox programs help regulators learn about new financial products and services, which in turn can inform better laws. “Let’s make sure that the regulations that we have in place are the absolute best possible form of regulations we can have,” said James Czerniawski, a policy analyst at the Libertas Institute.
Many sandbox backers also want to show that their state welcomes high-tech companies.
But opponents say that because of the loosened regulations, the programs could harbor abusive or misleading products.
“We’re really concerned about predatory lending to low-income families and low-income individuals,” said Jackson Voss, economic opportunity policy analyst at the Louisiana Budget Project, a left-leaning public policy nonprofit. The nonprofit opposed a financial technology sandbox bill proposed by Louisiana GOP state Rep. Mark Wright this year.
Companies that use sandboxes are “really experimenting on the people of whatever state adopts the sandbox,” Voss said. “And that seems problematic.”
Even some conservative lawmakers are skeptical. “I have a problem just saying, ‘If you come up with a product, you can ask the regulators to waive all the laws that we put in place, presumably for good reason,’” said Louisiana Republican state Sen. Jay Morris during a Commerce Committee hearing on Wright’s bill.
Arizona officials say their program has consumer protections in place and note that it’s overseen by a consumer protection lawyer. But neither the companies admitted to the program nor the attorney general’s office have published information about tests conducted in the sandbox, so it’s hard to know whether customers have been helped or harmed.
Consumer advocates have filed public records requests seeking more information but haven’t received satisfying answers, said Kelly Griffith, executive director of the Southwest Center for Economic Integrity, a Tucson-based consumer advocacy group. “That lack of transparency, for us, raises a big red flag.”
State leaders don’t have to bend the rules to help regulators learn about new financial products and services, said Stifler of the Center for Responsible Lending. She pointed to California, where lawmakers last year created an innovation office to study novel financial services and cryptocurrency companies.
Playing by the Rules
In most states with a financial services sandbox, and some states where they’ve been proposed, the banking industry is regulated with a relatively light touch. That may limit how many businesses benefit from the programs.
During the Louisiana committee hearing, Wright struggled to identify products and services the sandbox would bring to the state. His only answer was a vague reference to cryptocurrency companies, which didn’t satisfy Morris.
“You can purchase cryptocurrency now,” Morris said, holding up his phone for emphasis. “You can get on Coinbase, buy all you want ... we don’t need this bill to buy crypto, because it’s allowed already.”
Wright’s bill failed in committee.
Other sandboxes allow an industry to operate, period. For instance, before Hawaii’s cryptocurrency sandbox launched last year, the state’s strict licensing rules made it too expensive for cryptocurrency trading platforms to do business there.
“Without the sandbox program, we probably wouldn’t have been able to operate in Hawaii, frankly,” said Alexandra Gaiser, director of regulatory affairs at River Financial, a bitcoin trading app and one of 11 companies in the state’s program.
River Financial legally operates in 35 states, including Arizona, Florida, Utah and Wyoming. It has a money transmitter license in 14 states. In the others, Gaiser said, the company either doesn’t need a license or has an agreement with state regulators that allows it to serve customers without one. It’s not participating in other sandboxes.
Financial technology companies generally aspire to operate in all 50 states, so a one-state program may not be compelling. Although some sandbox laws include reciprocity agreements, companies still need to apply to every state program they’d like to use.
“I think for them to be really useful, they would need to string together a number of states—so they create bigger markets—and create some firmer understanding with the feds,” said Andrew Lorentz, a lawyer for Davis Wright Tremaine who co-chairs the national law firm’s financial technology practice.
Startups also have another way around costly banking rules and regulations: Rather than serving consumers directly, they can sell their software to established banks and credit unions and avoid licensing hassles altogether.
At BrightFi, company leaders jettisoned plans to create an affordable bank not long after testing their app. Now the company is selling its technology to traditional financial institutions. “For smaller fintechs [financial technology companies], sometimes it’s easier to partner up with a bank that already has a license,” Lehman said.
The Arizona sandbox helped convince BrightFi to move to Phoenix in 2019. But the firm had other reasons too, and it eventually found that making connections, not lighter regulation, was the program’s main benefit.
“I don’t think we would be where we are right now had we not been introduced to some of the people—banks, regulators, even nonprofits that we were introduced to,” said Crystal Lehman, BrightFi’s chief technology officer. “It was immeasurable.”