Regulatory sandboxing – Work in progress

Regulatory or jurisdictional innovation has always been the hallmark of Malta’s post-Independence economic activity.

Sandboxes provide a safe and transparent setting for innovators to test their innovations and/or clarify regulatory requirements before they seek formal authorization or go on the market

Successive governments have built a successful economy and society based on attractive regulations and legislative frameworks. The speed and the diversity of global financial innovation have accelerated over the past few years, often spurred by technological developments such as Distributed Ledger Technologies, and the rise of FinTech and RegTech together with the emergence of virtual currencies.

Here again, Malta is taking bold steps in this regard with various Bills expected to be tabled soon to establish the socalled “blockchain” island. However, the challenge remains for regulators to seek a balance between regulation and innovation. The ultimate goal is to balance and advance the authorities’ statutory objectives, which may go beyond promoting safety and soundness of financial institutions and financial stability, combating financial crime, promoting financial inclusion, increasing the efficiency of payment systems, promoting competition and protecting financial consumers.

One approach – regulatory sandboxes – has been drawing increased attention by authorities in both advanced economies and in emerging economies. Over 20 authorities have created regulatory sandboxes in the last few years and have acted as catalysts to innovation and to new FinTech companies that have introduced significant innovations and benefits to consumers around the world.

It is therefore a step in the right direction that the Malta Gaming Authority published a consultation document with the aim of establishing a regulatory sandbox. The document, Guidance on the use of Distributed Ledger Technology and the acceptance of Virtual Currencies through the implementation of a sandbox environment, was published at the end of March.

What is a sandbox? The word sandbox originally referred to the small box filled with sand where children played and experimented in a controlled environment. But little by little, the term has acquired a new meaning. In the world of computer science, a sandbox is a closed testing environment designed for experimenting safely with web or software projects. The concept is also being used in the digital economy arena to refer to regulatory sandboxes; testing grounds for new business models that are not protected by current regulation, or supervised by regulatory institutions.

Irrespectively of the variety of their objectives, regulatory sandboxes have one defining characteristic: the establishment, by a financial authority, of a formal and structured mechanism to receive applications by innovators to work with the authority to test innovative products, services or business models, before they are launched commercially. The tests are conducted through small time-bound pilots with actual consumers, implemented by the innovators, while being monitored by the authority. Hence, a regulatory sandbox is “live testing of new products and services in a controlled environment”. With a regulatory sandbox, the authority, in addition to considering innovations presented to them through the normal authorisation process, creates a new channel with standard application and pilot-monitoring procedures and requirements. Sandboxes provide a safe and transparent setting for innovators to test their innovations and/or clarify regulatory requirements before they seek formal authorization or go on the market. At the same time, sandboxes give the authority the chance to learn about innovations in greater depth prior to authorising full rollout and to pinpoint specific regulatory obstacles and risks.

Without going into the merits of the Guidance published by the MGA, the concept of establishing a regulatory sandbox in the gaming sector in view of the disruptive phenomenon we are taking a step in the right direction. This step should be replicated by other regulators such as the MFSA if we really want to develop the FinTech ecosystem. However, regulatory sandboxes should not be viewed as a panacea, and should be considered in the context of a range of steps the authorities can take to promote competition and to enable and encourage innovation.