… What you need to know
Fintech (i.e. financial technology) refers to technology developed to improve and automate financial services. Examples include mobile banking, mobile payment application software, peer-to-peer payment services such as PayPal and Venmo, trading platforms such as Robinhood, and the use and development of cryptocurrencies such as Bitcoin.
As a result of technology, the finance industry continues to see an increase in innovation, and is constantly churning out new ways and opportunities to access and deliver financial services.
While this may be largely beneficial, not all Fintech tools and solutions have been effective and safe for consumers and the market at large. Previously, regulation in the Fintech space was practically non-existent since there were no specific regulatory framework models for them to fall under.
What this meant was that Fintech products were directly experimented with on consumers and the general public, and this posed serious risks and challenges. Several Fintech products have ended up as fronts for underlying scams, and some have had business models that end up deceiving the public. These risks come about as a result of the absence of clear regulatory legal and supervisory frameworks.
With such developments, the regulator (in this case, the Bank of Ghana) had to intervene to deal with these problems. You should be able to understand that generally, and especially within the finance industry, the presence of several rules and regulations might stifle growth and innovation.
However, innovation is necessary in order to keep up with the demands of consumers’ expectations and develop ways to meet them.
Thus, the challenge faced by the regulator is: ‘How do we keep the rapid pace of innovation going; but at the same time, mitigate the associated risks?’
This is where Bank of Ghana Regulatory Sandbox comes into play.
In addition to setting up a Fintech and Innovation department to license and regulate Fintechs, among other regulatory measures, on 25th February, 2021, the Central Bank of Ghana, in partnership with EMTECH Service LLC, launched a regulatory and innovation sandbox pilot.
This aligns with ‘its commitment to evolve an enabling and inclusive regulatory environment that promotes Fintechs and supports innovation.’
This article discusses everything you need to know about the Bank of Ghana Regulatory Sandbox, and provides some insight into how the sandbox actually works in practice.
What is a regulatory sandbox?
A regulatory sandbox is a safe and controlled experimental environment that allows businesses and entrepreneurs to pilot test newly developed financial technology without directly being subject to regulatory and supervisory requirements, thus supporting them to enter the market faster.
Regulatory sandboxes are not a new concept. In fact, they have been around for several years, with the creation of the first regulatory sandbox in 2016 in the UK ‘with the purpose of removing unnecessary barriers for banking and finance businesses looking to innovate’.
Since then, several other jurisdictions have developed regulatory sandboxes and Ghana is no exception.
In order to understand what a regulatory sandbox is, think of the sandbox as a playground of sorts for businesses to test new innovations (products and services), business models and technology before they hit the market. The aim is to allow these businesses to ‘play’ in the sandbox with little or no regulations at all in order to determine whether such new innovative products and services and business models can be developed safely and enter the market.
Within this playground, there is an adult supervisor, i.e. the regulator, which provides room for experimentation while guiding regulation although such innovations are not subjected to full regulatory demands. Within the sandbox, regulation is relaxed in order to create room for innovation.
So, with the use of a regulatory sandbox, businesses and Fintech entities are able to experiment with innovative financial products and services within a well-defined space and duration under the oversight of a regulator before the product is launched on the market.
It is important to know that the regulatory sandbox does not give innovators a permanent license to operate, neither is it a ‘free pass’ to test new innovations on consumers. It is also not a testing ground for businesses to determine the feasibility of an idea or initiative. Lastly, it is not an opportunity for businesses and innovators to attract consumers to their product/service by leveraging the legitimacy of the regulator.
The need for a regulatory sandbox
The purpose of regulatory sandboxes is to learn about the opportunities and risks that a particular innovation carries and to develop the right regulatory framework to apply to it.
Innovation, particularly within the finance industry, benefits consumers and businesses alike.
Although having the best interests of consumers at heart, regulators can discourage innovation by imposing excessive cumbersome regulations. With rapid development within the finance industry, the regulatory sandbox allows the regulator to integrate both compliance and regulations without stifling the rate of innovation and technological development.
The regulatory sandbox allows businesses and entrepreneurs an opportunity to test innovations in the market; however, the presence of appropriate safeguards shields against the consequences of the products failure, and mitigates risks while ensuring the safety of the financial system.
It has also been said that regulatory sandboxes are particularly useful in promoting the innovation necessary to overcome the barriers to financial inclusion. (‘Financial inclusion’ means that individuals and businesses have access to useful and affordable financial products and services that meet their needs, delivered in a responsible and sustainable way)
How does the sandbox work in practice?
The Bank of Ghana Regulatory Sandbox is open to all licensed financial institutions such as banks, Payment Service Providers and Financial Holding Companies, as well as unlicensed Fintech start-ups that have innovative products, services or business models that meet the regulatory sandbox requirements.
The sandbox has time and scope restrictions, meaning it is operated for a limited time and in a limited part of a sector or area. It is important for the scope to be defined to ensure that valuable resources are not wasted on aspects that can be handled outside of the sandbox.
Thus, it would focus mainly on newer niche innovations that do not necessarily fall within the existing regulatory framework. It is when such innovations are admitted into the sandbox that the regulator is able to determine the appropriate regulatory response to these products.
Fintechs that would be granted access to participate in the sandbox must meet the eligibility criteria. Thus, innovations eligible for the sandbox environment must fall within any of the following categories:
1) New digital business models not covered explicitly or implicitly under any current regulation.
2) New and immature digital financial service technology.
3) Innovative and disruptive financial service products that have the potential of addressing a persistent financial inclusion challenge.
On that note, if the product, service or business model does not provide any additional or material value to existing payment and financial services solutions, or is such that an appropriate regulatory response can be developed without the need for live testing in the market, then it is excluded from the sandbox.
The Bank of Ghana has also specified the exact criteria under which innovations would be prioritised. Accordingly, preference would be given to products and services leveraging blockchain technology, remittance products, crowdfunding products and services, e-KYC (electronic know your customer) platforms, RegTech (regulatory technology), SupTech (supervisory technology), digital banking, products and services targetting women financial inclusion.
Live testing experiments of these products are conducted in a controlled environment with the oversight of the regulator. Once proven to be safe, and an appropriate regulatory response is determined, the innovations may then be transported to the live market.
To be granted access to participate in the sandbox, businesses and entrepreneurs would have to apply formally to the Bank of Ghana. The application is done online on the Bank of Ghana website.
The application must provide information on the following areas:
- The company profile (e.g. incorporation documents).
- Details on the governance and ownership structure.
- Details on how the business model/product would benefit and safeguard consumers.
The applicant must also demonstrate a readiness to test the its product, service or business model in the sandbox, and must furnish the Bank of Ghana with both a proposed testing plan and an exit plan.
After applying, the Bank of Ghana takes the application through an evaluation stage before admission into the regulatory sandbox.
After participating in the sandbox, the regulator will determine what regulations need to be followed once the business or innovator transitions out of the sandbox. Thus, upon successful experimentation and on exiting the sandbox, the sandbox entity must fully comply with the relevant legal and regulatory requirements.
Benefits and risks associated with the sandbox
A regulatory sandbox offers several benefits.
One such benefit is that is serves as an evidence base for regulation. With a regulatory sandbox in place, the regulator has access to all the necessary information required to make an informed decision on how to appropriately regulate new services and products infiltrating the finance industry. Regulators are able to base their regulatory response to these products and innovations on the feedback received from the live experiments conducted within the sandbox.
The sandbox also gives innovators an opportunity to pilot test their products and services in a controlled environment while regulating risk, and provides insight as to whether a business model is attractive to consumers. This has the potential of reducing cost of innovation and aids emerging investors to enter the market quicker.
Consumers are also protected against innovations that could potentially be harmful products and services, and the various risks associated with them. Additionally, consumers benefit from the innovative products and services that innovators are able to develop when they are not overly burdened with rules and regulations.
On the other hand, although a regulatory sandbox makes a valuable contribution to the Fintech space, there are some potential risks that come along with it. For example, sandboxes have the potential of ‘muddying’ the market, which makes it difficult for consumers and investors to know exactly which products are safe and reliable.
Additionally, sandboxes have the potential of causing favouritism in the regulatory process or at least, creating a semblance of favouritism. Sandboxes have the potential to strengthen competition, which is good. However, it also has the potential of raising concerns of an uneven playing field between firms and innovators in the sandbox and those outside of it.
This typically happens when clear rules and eligibility criteria for selection are not couched in a transparent manner, and innovators feel they might be competing on an uneven playing field.
Lastly, some economists have noted that despite the good intentions behind the development of a regulatory sandbox, it is possible of being abused, and may even ‘play the role of gatekeeper, slowing down or even halting innovation’.
Despite these risks, sandboxes are a valuable contribution to the finance industry and regulators must endeavour to make sandboxes as fair, transparent and productive as possible.
The Fintech space is widely evolving, and this rate of growth and innovation, if left unchecked, poses serious risk for consumers. Regulators in the Fintech space have had to strike a balance between mitigating these risks and creating room for innovation without suppressing them with several rules and restrictions.
One of such methods is the employment of a regulatory sandbox, where regulators can carefully monitor new innovative digital products, services and business models in a live testing environment, which has the dual advantage of protecting consumers and enabling innovators to bring their products to the market more efficiently, and enabling the regulator to develop the appropriate regulatory response. So the clear aim is to use regulatory sandboxes not only to create areas for testing new products and business models, but also to actively develop the regulatory environment in such a way that it can keep up with the pace of digitalisation.
If properly designed and executed, they can serve as useful tools in advancing innovation in the finance industry, yet at the same time mitigating potential risks involved.
Jojo is a paralegal with the Corporate and Commercial Practice Group, and Emmanuel is a practising lawyer and heads the Real Estate and Infrastructure practice group of M&O Law Consult. He is also a licensed Insolvency Practitioner with the Ghana Association of Restructuring and Insolvency Advisors.