The sandbox is open for fintech entrepreneurs in North Carolina, as startups utilizing a controversial new program may soon be able to bypass regulation entirely to test their products.
Entrepreneurs can now apply for a temporary regulatory exemption through the North Carolina Innovation Council. Called a "regulatory sandbox," it's a program established by the state Legislature last year that allows entrepreneurs to "temporarily test" a product or service in the financial or insurance space with a limited number of consumers without being subject to certain state regulations that some say are holding back innovation.
Dan Quan, an adjunct scholar at the Cato Institute’s Center for Monetary and Financial Alternatives, said the benefit could be two-fold. “It does create a safe space for new companies to try products, and it also gives the regulator more insight, a front row seat if you will, into some of the new things happening,” he said.
But it's controversial – as similar programs in other parts of the nation have come up against harsh criticism from consumer groups and regulators.
"Toddlers play in sandboxes," New York's former head banking regulator, Maria Hullo, once said of the program. "Adults play by the rules."
Jimmie Lenz, director of the Master of Engineering in Fintech at Duke University, said allowing entrepreneurs to "play in the sandbox," makes the state more competitive.
"They are reinforcing the fact that most of the regulation and legislation was built for a different time," he said. "They're basically moving beyond that ... despite this antiquated regulation, we'll get through that, but let's move forward."
He said that instead of waiting for regulation to match fintech, "They're saying regulation needs to catch up."
Lenz sees the program as not just helping homegrown innovators experiment with their ideas but also "incentivizing people to come to North Carolina – both entrepreneurs and new companies."
Sandbox controversy
The idea of a regulatory sandbox is not new. It's an idea that the United Kingdom Financial Conduct Authority – which regulates financial service firms and markets in the U.K. – defined in 2014. Eleven states in the U.S. have now adopted regulatory sandboxes that offer testing grounds in restricted markets, according to Utah-based think tank Libertas Institute.
Quan said the original U.K. program saw some success, companies that were “able to bring products to market in a quicker and safer fashion because they were directly supervised by the agency.”
In the U.S., the programs are so new that it’s hard to broadly judge their effectiveness, he said.
Quan said it typically comes down to the regulator. Just having a sandbox program is “signaling we’re here, we’re open for business.”
But regulators should also be using the program to figure out what bigger policy implications should be, he said. Yes, it’s a sandbox for entrepreneurs to experiment in – but regulators, too, should be playing, he said.
Consumer groups have repeatedly criticized these types of programs. A letter from 80 such organizations in 2019, worried that a federal sandbox proposal "would be an arbitrary and capricious and unlawful measure that could, in effect, give entire industries relief from complying with aspects of consumer protection laws."
Entrepreneurs are optimistic
For the most part, entrepreneurs and investors in the Triangle say they're optimistic that the program could give Triangle innovators an edge.
Lister Delgado, managing partner of Durham venture capital firm Idea Fund Partners, calls a regulatory sandbox a "tool," and said it comes down to implementation.
"It is apparent to me that it is a necessary tool going forward to not be left behind in the race to keep up with innovation in the financial sector," Delgado said. "Like any tool, results will depend on how it is used. How successful a regulatory sandbox is in N.C. will depend on how the process of evaluating new ideas is managed, what ideas get tested and later implemented, what is rejected, and how results are communicated."
Kris Kovacs, founder of credit union-focused fintech Constellation, said, "Well-managed regulatory sandboxes encourage new and existing companies to invest in creating new innovative services."
"Many existing companies are reluctant to support innovative startups solely because they are new and different, and they worry about what their regulator will say about their use of them," Kovacs said. "Often the lack of innovation is a more considerable risk than the innovation itself."
