Fintech startups are burdened with a fractured and redundant regulatory system.
Not only can it take several months to obtain regulatory approval to operate a fintech startup in just one state, but it can cost a startup thousands of dollars in fees, compliance costs and legal work. Launching a product nationwide is harder still. Entrepreneurs navigating our 50-state licensing regime commonly expect two years of frustration and expenses in the millions.
Such delay and expense is unacceptable in an industry where today’s startup ideas quickly become yesterday’s news and companies have limited capital. Many startups forgo the licensing process altogether and hope they don’t get caught. Others move overseas.
Helping to compensate for this regulatory burden is that American entrepreneurs benefit from unparalleled access to capital through an established venture capital industry. The U.S. captured 54% of the $127 billion in global venture capital invested in 2016. This access to capital has allowed some American fintech startups to succeed despite the regulatory burdens. Yet, the U.S. underperforms in fintech venture capital compared to our share of overall venture capital. In 2016, the U.S. obtained only 33% of the $13.6 billion in worldwide fintech venture capital investment.
This underperformance may have many causes, but our global competitors are certainly exploiting their regulatory advantage to get ahead in fintech. Our global competitors, for instance, often have more streamlined licensing processes for financial services. Sometimes this is a function of a smaller or more centralized country possessing fewer regulators. However, even the European Union has a “passporting” regime that allows money transmitters licensed in one member country to operate across national lines.
In the United States, some propose that states wait for a federal government solution to the regulatory burden placed on startups. To that end, the Office of the Comptroller of the Currency proposed a special purpose national bank charter for fintech companies earlier this year. The Conference of State Banking Supervisors sued the OCC. Then the New York State Department of Financial Services sued the OCC, arguing that the charter exceeded the agency’s authority and unlawfully preempted state law. So far, the OCC has received no applications for its charter, although the agency hasn’t formally begun accepting applications either.
The OCC’s regulatory charter has not yet solved the issues facing fintech. Furthermore, the odds of meaningful federal legislation to ease fintech licensing seem low.
States must look inward and recognize when our patchwork of state regulation stifles innovation and creativity. But given Washington gridlock, states also have an opportunity; we can and we should step up to the plate to maintain our country’s competitiveness in the global marketplace.
While my colleagues and I do strive to protect consumers from deceptive practices, our enforcement actions generally look backward at past harm. We must not forget the potential benefits of innovation for consumers. The best protection for a consumer may be a low-cost product yet to be invented. Therefore, we shouldn’t overburden fintech startups — which face enough challenges raising capital and launching a product — with a fractured and redundant regulatory system.
In other countries, there is a model that appears to be working to foster innovation by easing some of the regulatory burdens: sandboxes. In sandboxes, startups can launch products on a limited scale to real consumers without incurring the regulatory costs that would otherwise be imposed. This environment is important for early-stage entrepreneurs who do not have access to legal counsel to navigate the regulatory process. Furthermore, successfully testing a product facilitates a company’s efforts to raise the capital necessary for an expanded launch of the tested product.
Countries already encouraging fintech investment by instituting sandboxes include the United Kingdom, Singapore and Australia, and the results so far are promising. Case in point: In a little more than a year, the U.K. sandbox attracted more than 40 companies testing products such as mobile payments, savings tools and government benefits distribution in a live environment. Many of these products appear to enjoy initial success. The U.K’s Financial Conduct Authority predicts that most of the companies accepted into the first cohort of the U.K. sandbox will launch the tested product.
The popularity of overseas sandbox programs is evidence that the U.S. needs something similar.
Personally, I am working with Arizona policymakers to introduce a sandbox in Arizona that would reduce entrepreneurs’ barriers to entry without sacrificing core consumer safeguards. This would be the first state sandbox in the United States.
To become a sandbox company in Arizona, an applicant would describe the product, including how it benefits consumers, and propose a reasonable plan to any customer impacts if the product were to fail. Such contingency plans would vary depending on the product, but could include record-keeping for unwinding transactions, for instance. The sandbox term would be 12 months with possible extensions. Companies that successfully test a product or service could remain in the sandbox — and continue to offer the new product or service to consumers — while seeking full licensure. We anticipate this sandbox would reduce the regulatory barriers preventing companies from testing their products in the United States.
Other such sandboxes should be established around the country, accompanied by steps from regulators to relax the burden on sandbox companies. States should ask federal agencies to provide no-action letters or take other appropriate steps to facilitate the sandbox as a one-stop-shop for state and federal regulatory approval.
There are promising signs for cooperation from Washington with several federal financial agencies announcing an initiative to assist fintech. The Consumer Financial Protection Bureau instituted Project Catalyst, which includes offering no-action letters. The Department of Commerce’s version is “Open for Innovation” events, and the Securities and Exchange Commission hosts a fintech working group. Relaxing the federal regulatory burden on state sandbox companies would be an effective means to fulfill the promise of these agency initiatives.
The American way of life is at its best when we encourage people to pursue great ideas and provide opportunities for them to succeed. Launching a fintech sandbox can help promote investment, job growth and innovative products.