Fintech and the city: Sandbox 2.0 policy and regulatory reform proposals

ABSTRACT

Recognising the economic value of London hosting 17 of the world’s top 50 FinTech firms, HM Treasury’s strategy is determined ‘to ensure Britain remains the best place in the world to set up and grow a FinTech business.’ The Financial Conduct Authority’s ‘Sandbox’ regime has attracted FinTech start-ups from around the world to test their technology and business with supervision and regulatory protections, providing an opportunity to grow into major businesses.

The success of the intuitive Sandbox has however led to it being replicated in jurisdictions worldwide, eager to benefit from the growth of FinTech. Competition for high-calibre start-ups means the UK’s post-Brexit Sandbox may need to go further than its existing FinTech Sector Strategy to continuing attracting and developing firms helping the City of London to remain the global centre of finance as perceived in the UK’s Industrial Strategy.

The article examines existing regulations and analyses how the UK can develop an enhanced structure to both further attract and accommodate legitimate high-calibre FinTech entrepreneurs, whilst offering strong client and investor protections to ensure financial stability. It proposes unprecedented legal and policy reforms for the Sandbox structure, including a permissible model to capitalise on funding from amateur private investors worldwide.

KEYWORDS:

• Sandbox
• financial technology
• initial coin offerings

JEL:

• K240
• K220
• G32
• G38
• O32
• O38

Acknowledgments

This publication was made possible by the NPRP award NPRP 11S-1119-170016 from the Qatar National Research Fund (a member of The Qatar Foundation). The statements made herein are solely the responsibility of the author.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

1 ‘“Fintech” is used interchangeably to describe both technology-driven innovation across financial services and to pick out a specific group of firms that combine innovative business models with technology to enable, enhance, and disrupt the financial services sector’ (see HM Treasury 2018, 3).

2 Block.one raised $4 billion in its ICO in 2018 (Rooney 2018).

3 See 2.4 Sandbox 1.0.

4 Incubators were previously proposed as a means of facilitating growth for entrepreneurs (see Aernoudt 2004).

5 See figures compared to European neighbours (Longlands, Round, and Kibasi 2018).

6 Financial services accounted for 6.5% of the UK’s economic output in 2017 (Rhodes 2018).

7 Including artificial intelligence.

8 Hong Kong (9/2016), Malaysia (10/2016), Singapore (11/2016), Abu Dhabi (11/2016), Australia (12/2016), Mauritius (1/2017), Netherlands (1/2017), Indonesia (1+7/2017), Brunei-Darussalam (2/2017), Canada (2/2017), Thailand (3/2017), Bahrain (6/2017), Switzerland (8/2017).

9 Each country’s start-up date is charted in Zetzsche et al. (2017, 27–29).

10 ‘“Startup” refers to a company which is partly or fully owned by an individual or group of individuals who founded it, who are also involved in its day-to-day activities in any capacity. It may also still be at the stage of seeking external investment to develop its products and services.’ (HM Treasury 2018, 3).

In this report, ‘tech’ refers to the digital tech industries and to digital activities in the non-tech industry.

11 Examining the Upcoming Agenda for the Commodity Futures Trading Commission: Hearing before the Committee on Agriculture, U.S. House of Representatives. 25 July 2018 (10:00 AM).

12 Multiple further Sandboxes are being planned around the world in addition to those in existence (see Cambridge Centre for Alternative Finance 2018, 34).

13 The possibilities are explored in Greenfield (2017).

14 The UK’s Fintech Census showed 34% reporting raising equity finance as a key problem (HM Treasury 2018, 11).

15 This would require amendment to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001/544.

16 This would require amendment to the Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business) Order 2001/1177.

17 This issue is considered in Sheridan (2017, 417).

18 This would requirement amendment to the Financial Services and Markets Act 2000 (Exemption) Order 2001/1201.

19 A survey of financial technology founders and investors released last week by Silicon Valley Bank identified regulation as the biggest impediment to growth (Elliott 2015).

20 Established pursuant to the Financial Services Act 2012 (as amended).

21 ‘Novel, uncommon, or irregular devices, whatever they appear to be, are also reached if it be proved as matter of fact that they were widely offered or dealt in under terms or courses of dealing which established their character in commerce as “investment contracts,” or as “any interest or instrument commonly known as a “security””.’ (SEC v. C.M. Joiner Leasing Corp., 320 U.S. 344, 351 (1943)).

22 Securities and Exchange Commission v. W. J. Howey Co. (1946) No. 843 67 S.Ct. 27. [328 U.S. 293, 294].

23 ‘“Smart contracts” involve greater automation of the processes of creating, monitoring and enforcing contracts. This may be intended to increase efficiency and reduce the risk of human error’ (HM Treasury 2015a, 8; see also Fairfield 2014).

24 Regulation (EU) No. 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC Derivatives, Central Counterparties and Trade Repositories. Office Journal of the European Union (OJ. L. 201). 27 July. Available from: http://eur-lex.europa.eu/legalcontent/.

EN/TXT/?uri=celex%3A32012R0648, Recital 13 and arts. 4(1)(a)(i) to (iii) and art. 4(1)(a)(v).

25 468 F.2d 1326 (2d Cir. 1972).

26 The Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business) Order 2001 (SI 2001/1177).

27 ‘ … a public record of firms, individuals and other bodies that are, or have been, regulated by the PRA and/or FCA’ (see https://www.fca.org.uk/firms/financial-services-register). This is required by the Financial Services & Markets Act 2000, Payment Services Regulations 2009, Electronic Money Regulations 2011 and Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017.

28 Engaging in a controlled or specified ‘investment activity’ is as defined in the FSMA, s.21.

29 Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC.

30 The order explains the compliance with EU law: The definition of ‘personal recommendation’ in article 53(1A) follows that in Article 9 of Commission Delegated Regulation of 25 April 2016 supplementing Directive 2014/65/EU of the European Parliament and of the Council as regards organisational requirements and operating conditions for investment firms and defined terms for the purposes of that Directive(c).

31 The amendment was recommended by HM Treasury (2017a).

32 See FCA definition of ‘personal recommendation’ at https://www.handbook.fca.org.uk/handbook/glossary/G877.html?starts-with=P.

33 Financial Conduct Authority, Consumer warning about the risks of Initial Coin Offerings (‘ICOs’) https://www.fca.org.uk/news/statements/initial-coin-offerings.

34 Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC OJ L 168, 30 June 2017, p. 12–82.

35 Directive 2010/73/EU of the European Parliament and of the Council of 24 November 2010 amending Directives 2003/71/EC on the prospectus to be published when securities are offered to the public or admitted to trading and 2004/109/EC on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market Text with EEA relevance.

36 Commission Delegated Regulation (EU) No 862/2012 of 4 June 2012 amending Regulation (EC) No 809/2004 as regards information on the consent to use of the prospectus, information on underlying indexes and the requirement for a report prepared by independent accountants or auditors Text with EEA relevance.

37 Coffee (1984) advocates the need for disclosure requirements.

38 Regulation (EU) 2017/1129 of the European Parliament and of the Council of 14 June 2017 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/ECText with EEA relevance. OJ L 168, 30 June 2017, p. 12–82.

39 See also Financial Services and Markets Act 2000 (Financial Promotion) Order 2005; The Financial Services and Markets Act 2000 (Financial Promotion) (Amendment No. 2) Order 2007 No. 2615.

40 Directive (EU) 2015/849 of the European Parliament and of the Council of 20 May 2015 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing, amending Regulation (EU) No 648/2012 of the European Parliament and of the Council, and repealing Directive 2005/60/EC of the European Parliament and of the Council and Commission Directive 2006/70/EC OJ L 141, 5 June 2015, p. 73–117.

41 Section 18 of The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 2017 No. 692.

42 Section 19–21 of The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 2017 No. 692.

43 Section 33-35.

44 The Money Laundering Regulations 2007 (SI 2007 No. 2157).

45 Section 40.

46 Section 24.

47 Sections 5 and 6 of the regulations define what are beneficial owners for these purposes: The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 2017 No. 692.

48 The Proceeds of Crime Act 2002 (as amended by the Crime and Courts Act 2013 and the Serious Crime Act 2015).

49 Part 9 of the Section 19–21 of The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 2017 No. 692. Rules are also applicable from The Terrorism Act 2000 (as amended by the Anti-Terrorism, Crime and Security Act 2001, the Terrorism Act 2006 and the Terrorism Act 2000 and Proceeds of Crime Act 2002 (Amendment) Regulations 2007).

50 Financial crime task force eyeing binding crypto exchange rules: Japan official, Reuters June 12, 2018, https://uk.reuters.com/article/us-cryptocurrency-regulations-fatf/financial-crime-task-force-eyeing-binding-crypto-exchange-rules-japan-official-idUKKBN1J80UZ.

51 Electronic Money Regulations 2011, SI No. 99, and Directive 2009/110/EC of the European Parliament and of the Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions amending Directives 2005/60/EC and 2006/48/EC and repealing Directive 2000/46/EC OJ L 267, 10 October 2009, p. 7–17.

52 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU.

53 Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012.

54 Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU Text with EEA relevance, OJ L 173, 12 June 2014, p. 349–496.

55 Pursuant to Article 4(1)(15).

56 Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010, OJ L 174, 1 July 2011, p. 1–73.

57 Puckett v. Rufenacht, Bromagen & Hertz, Inc., 587 So. 2d 273, 278 (Miss. 1991).

58 Finance Act 2016 (as amended).

59 Finance Act 2012 (as amended).

60 Finance Act 1994 (as amended).

61 Finance Act 1995 (as amended).

62 Finance Act 2008 (as amended).

Additional information

Funding

This work was supported by Qatar National Research Fund [grant number NPRP 11S-1119-170016].