The Sandbox Paradox: Balancing the Need to Facilitate Innovation with the Risk of Regulatory Privilege

Abstract

In recent years, “regulatory sandboxes” have gained a great deal of attention from policymakers, regulators, and regulatory scholars. Regulatory sandboxes are closed testing environments in which specific firms are able to experiment with new and innovative business models or products with reduced regulatory burden or expedited regulatory decisions. Sandbox advocates support or defend regulatory sandboxes as a way to promote entrepreneurialism and innovation within the financial sector while still maintaining mechanisms for consumer protection and regulatory oversight. Opponents of sandboxes tend to focus on the potential risk to the consumers who use the services being tested in the sandbox. However, there is a third group affected by regulatory sandboxes: the competitors of firms in the sandbox. By definition, regulatory sandboxes grant certain advantages to specific firms without extending those same privileges to other firms. The goal of this paper is to examine the potential regulatory advantages sandboxes offer, consider the possible risks and costs associated with those advantages—including the potential to distort the market and incentivize cronyism—and propose best practices that policymakers could use to mitigate those costs.

Keywords: regulatory sandbox, financial regulation, financial markets, financial services, public finance, state and local government, regulation and business law, regulatory policy, innovation

JEL Classification: G2, H1, H7, K2, L5, O3