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The Joint Committee of the European Supervisory Authorities (the ESAs) issued a report on 7 January 2019 on the status of regulatory sandboxes and innovation hubs following consultations with national regulators across the European Union.

The report compares the innovation hubs and regulatory sandboxes established in 21 EU member states and three EEA states, flagging too that Hungary and Spain are in the process of establishing regulatory sandboxes.

The ongoing and accelerating pace of developments in the realm of cryptoassets in multiple jurisdictions warrants continual review and monitoring. In a report issued earlier this month on the implications of cryptoassets, the international Financial Stability Board (FSB) stated that, while cryptoassets do not currently pose a material risk to global financial stability, vigilant monitoring is needed in light of the speed of market developments. The FSB believes that due to risks such as low liquidity and the use of leverage, market risks from volatility, and operational risks, cryptoassets lack the key attributes of sovereign currencies and do not serve as a stable store of value or a mainstream unit of account. The financial stability implications of these cryptoasset characteristics include an impact on confidence in, and reputational risk to, financial institutions and regulators; risks arising from financial institutions’ exposures to cryptoassets; and risks arising if cryptoassets were to become widely used in payments and settlement. Therefore, regulators are encouraged to “keep an eye on things” as cryptoassets continue to spread throughout the world economy.

As readers of our blog are aware, courts and regulators are playing catch-up when it comes to cryptocurrencies, and to interpreting existing laws and regulations as applied to these new and innovative offerings. One of these many important questions relates to whether virtual currencies are “commodities” within the meaning of the Commodity Exchange Act (CEA) and subject to regulation by the Commodity Futures Trading Commission (CFTC). A recent ruling by a US district court in Massachusetts held that a virtual currency (My Big Coin) is a commodity within the meaning of the CEA and is therefore subject to the anti-fraud authority of the CFTC, even though there currently is no futures contract on My Big Coin. My Big Coin is a Las Vegas-based creator of software that purportedly allows for the anonymous exchange of currency.

The UK Financial Conduct Authority (FCA) issued a press release on August 7 announcing that it has joined 11 other financial regulators from around the world to create the Global Financial Innovation Network (GFIN), building on its proposals earlier in the year to create a “global sandbox.” The network is intended to provide fintech firms a more efficient way to interact with regulators as they test new ideas across different markets and to create a new framework for regulators to cooperate on areas of innovation. This announcement continues a regulatory trend of being more hospitable to fintech innovation, as we have previously discussed.

We write frequently about the SEC’s and the CFTC’s focus on cryptocurrencies, but potential issuers should also be alert to other oversight, including possible enforcement actions, from other regulators as well. Indeed, state Attorneys General are playing a greater role in evaluating whether the mining and use of cryptocurrencies works to the disadvantage of consumers and small businesses. These state enforcement and regulatory officials are becoming ever more powerful. Furthermore, some of them may seek to expand the scope of their authority by pushing the “round peg” of “virtual” financial technology offerings into the “square hole” of outdated “physical only” state statutes and rules.

Meetings of the Conference of Western Attorneys General (CWAG) in New Mexico last week and of the Republican Attorneys General Association (RAGA) (Rule of Law Defense Fund) in California this week included panel discussions of cryptocurrency issues that are now before the Attorneys General and senior staff. Accordingly, fintech companies that intermediate cryptocurrencies should be aware of the increased risk in conducting these activities in particular states.

The UK Financial Conduct Authority (FCA) issued a press release on July 3 announcing the latest cohort of firms accepted into its regulatory sandbox. Twenty-nine firms were accepted, which represents the largest cohort to date. The sandbox, now in its fourth year, allows firms to test their products and services in a controlled environment, prior to use in the open market where they would be subject to the full suite of regulations and associated costs.

The United Kingdom is a leader worldwide in supporting growth and innovation in the world of financial technology. Similar efforts are occurring in the United States, but lag behind UK developments; as we reported just three months ago, Arizona became the first state in the United States to enact a law to create a “Fintech Sandbox.”

Focus of cohort

The focus of this year’s UK Fintech Sandbox cohort appears to be on the capital-raising process, with a large number of applicants seeking to increase the efficiency of the process and improve access to capital, including six firms seeking to automate the issuance of debt or equity. Other notable innovations among the UK cohort include the use of distributed ledger technology (over 40% of the cohort), firms offering automated or “robo” investment advice, and the continued increase of firms seeking to use technology to streamline the AML/KYC process.

Since taking on the role in November 2017, Comptroller of the Currency Joseph Otting has been relatively circumspect regarding his views on the banking industry, bank regulation, and bank regulatory reform. In testimony on June 14 before the Senate Committee on Banking, Housing, and Urban Affairs, Comptroller Otting provided the clearest insight to date about his views on the federal banking system and the role of bank regulation.

In his testimony, Comptroller Otting first discussed risk in the banking system and the OCC’s “supervision by risk” approach, noting the following areas of heightened risk:

  • Elevated credit risk due to eased credit underwriting, increased commercial real estate concentration limits, and policy exceptions that create a higher level of concern
  • Elevated operational risk created by cybersecurity threats and third-party relationships, including risks created by consolidation in the fintech industry, which has led to a limited number of providers servicing large segments of the banking industry
  • Elevated compliance risk due to Bank Secrecy Act (BSA) requirements, the new FinCEN beneficial ownership rules, and new technologies that attempt to increase customer convenience and access to financial products and services, and the need for banks to better manage implementation of regulatory changes in consumer laws

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.

Few topics in the financial news have gotten more attention recently than the rise of cryptocurrency and initial coin offerings (ICOs), which allow startups to raise money from users in exchange for digital currency. In 2017, ICOs raised more than $3 billion in funding, surpassing early-stage venture capital funding for internet companies, and solidifying ICOs as a financing strategy among tech entrepreneurs.

But with surging popularity comes increasing attention and scrutiny from regulators, most notably the US Securities and Exchange Commission (SEC or Commission). Previously, the SEC had adopted a more cautionary approach, advising potential investors to perform due diligence, and issuing trading suspensions for certain issuers that made questionable claims regarding ICO investments. As we have previously reported, however, the SEC has recently taken a more aggressive stance toward ICOs.

Less than a year after the Conference of State Bank Supervisors (CSBS) announced Vision 2020, an initiative to modernize state regulation for non-bank financial companies, the CSBS revealed plans to establish a standardized licensing practice for money services businesses. Seven states have agreed to a compact whereby all participating states accept the findings of one state that has reviewed money transmitter licensing requirements, including IT, cybersecurity, business plan, background check, and compliance with the Bank Secrecy Act. The states that have joined the compact include Georgia, Illinois, Kansas, Massachusetts, Tennessee, Texas, and Washington.