Arizona has become the first state in the United States to enact a law to create a “Fintech Sandbox” – a safe zone for fintech startups to test new applications and financial services otherwise subject to state money transmitter, banking, and similar licensing requirements without having to obtain a state license. Although other countries, such as the United Kingdom, Singapore, and Australia, have created similar fintech sandboxes, similar legislation or regulations thus far have not been adopted in the United States at the federal or state level.
The Fintech Sandbox idea was promoted by the Arizona attorney general and will be administered by the Arizona Office of the Attorney General (AZ OAG). However, the Fintech Sandbox does not mean that fintech companies will be unregulated in Arizona. There will be a substantive application and oversight process.
Any applications for the Fintech Sandbox will be required to “contain sufficient information to demonstrate that an [applicant] has an adequate understanding of the innovation and a sufficient plan to test, monitor and assess the innovation while ensuring consumers are protected from a test’s failure.” Further, there are limits on the products that will be approved for the Fintech Sandbox, including
the product may only be offered to Arizona residents;
the product may be only offered to a limited number of consumers, depending on the type of product and the capitalization of the applicant; and
the product will be subject to a number of Arizona laws, including Arizona’s Consumer Fraud Act and all statutory limits and caps related to financial transactions (e.g., usury laws).
The form of application and the associated fees have not yet been determined by the AZ OAG, although under the new law the application will likely include
a requirement to identify key personnel and disclosure of past criminal convictions;
detail regarding the product being tested, including benefits and risks to consumers; and
the proposed testing plan and timing for pursuing any necessary licensing.
The timing for a fully developed application and fee schedule has not been determined but is expected to occur late in 2018.
In considering Fintech Sandbox applications, the AZ OAG is required to consult with the regulatory agency that would otherwise regulate the proposed product or activity. Further, approval of an application is at the discretion of the AZ OAG and will not be considered an appealable agency action. Under the new law, the Fintech Sandbox program is scheduled to end on July 1, 2028.
Given the patchwork of complex state laws that apply to a number of fintech products in the marketplace and that are being developed, the Fintech Sandbox presents an opportunity to test products without incurring the full cost and burden of state licensing in a popular consumer market, and for that reason it may spur innovation. However, while it may enable established companies and/or startups to “incubate” new products at lower cost, the Fintech Sandbox only applies to activities conducted with or for Arizona’s seven million residents. Therefore, in order to scale their activities nationally, participants in the Fintech Sandbox would ultimately have to pursue a national licensing strategy.
Some in the industry hope that state laws such as Arizona’s will spur federal regulators or other states to launch similar fintech safe harbors. However, any federal action raises the question of federal preemption of state consumer laws, a hot-button topic for both state and federal regulators, as well as whether and how the Consumer Financial Protection Bureau would be prepared to accommodate the sandbox concept from a consumer protection standpoint.
Given this uncertainty at the federal level, and the general lack of similar activity at the state level, fintech companies with products that are subject to state licensing will continue to face substantial legal and compliance costs in connection with state laws and licensing. Fintech company opportunities may nevertheless increase if other states follow Arizona’s lead.