Pub. 9 2019 Issue 3

13 ISSUE 3. 2019 Continued on page 14 “Many statutes and regulations addressing the financial sector date back decades. As a result, the financial regulatory frame - work is not always optimally suited to address new business models and products that continue to evolve in financial ser - vices. This has the potential negative consequence of limiting innovation that might benefit consumers and small businesses. Financial regulation should be modernized to more appropri - ately address the evolving characteristics of financial services of today and in the future.” 7 It is not simply an issue of quality, but quantity, when it comes to U.S. financial regulations. Fintech innovators must adhere to more than 50 jurisdictions – federal, state, and territorial – with overlapping, redundant, and, worse, contradictory laws and regulations. And it is not simply an issue of complying with 50-plus jurisdictions, but with multiple regulators within each jurisdiction. As the Treasury Department report noted, “… many stakeholders expressed frustration with the sheer number of agencies at the federal and state levels that need to be consulted when bringing a new product or service to market. Frequently, firms find that it is not even clear which agencies – or which units within those agencies – need to be engaged. The result is that innovators, particularly smaller firms, face significant and unnecessary burdens in terms of time, money, and opportunity costs.” 8 A 2016 report by the Government Accountability Office 9 identified a dozen federal regulators, in addition to state regulators, with varying degrees of jurisdiction over the financial sector. Describing the U.S. financial regulatory structure as complex and fragmented, the report noted there are multiple agencies with overlapping au- thorities, potentially placing financial entities under the regulatory authority of multiple regulators. 10 Compliance with this web of regulations is cumbersome and resource-intensive. Fintech innovators must engage legal and com- pliance experts to first determine the applicable laws and regula - tions and resolve uncertainties of federal vs. state jurisdiction and preemption, 11 an assessment that can takes months and not yield definitive answers. Beyond that are application fees, fingerprinting and background check requirements, physical presence and agency rules, and financial and other disclosures. Companies estimate a process of two years and costs typically ranging from $200,000 to several million. 12 The Treasury Depart - ment report indicates that financial licensing costs can range from $1 million to $30 million. 13 Even the low end of this estimate can be cost prohibitive for a startup’s entry into the U.S. market. In many instances, this compliance must be completed before a fintech product or service can be offered in the marketplace, even to test the technology or assess market adoption and viability. These untenable licensing regimes present a Hobson’s choice for fintech businesses, particularly startups – expend precious time and resources complying with numerous licensing regimes or don’t. As a result, some forego compliance and hope they don’t get caught, while others leave the U.S. for friendlier regimes. Neither of these choices is good and places the U.S. at a significant competitive disadvantage. In 2018, the United States captured only roughly a third of the $39.6 billion in worldwide fintech venture capital investment. 14 The Growing Trend of Regulatory Sandboxes While novel in the U.S., regulatory sandboxes have been implement - ed by a number of other countries, including the United Kingdom, Australia, Canada, the United Arab Emirates, Taiwan, Mexico, Hong Kong, Singapore, South Korea, and even China. In 2018, a dozen international regulators – including the Consumer Financial Protec - tion Bureau (CFPB) – joined together to form the Global Financial Innovation Network to explore the creation of a global sandbox. 15 Despite these efforts, U.S. regulators have been slow to embrace regulatory sandboxes or other proposals to address the financial reg - ulatory quagmire. But momentum appears to be growing. Following Arizona’s enactment of HB 2434, regulatory sandbox proposals were introduced or enacted in 11 states, 16 the CFPB launched a sandbox for businesses subject to its regulations, 17 and the Dis- trict of Columbia Mayor Muriel Bowser established the Financial Services Regulatory Sandbox and Innovation Council in January 2019. 18 The Council is expected to study and issue a report within six months on the feasibility of implementing a financial services regulatory sandbox. 19 Notably, the Treasury Department report touts a regulatory sandbox as a means to enhance and promote innovation. It has recommended that “federal and state financial regulators establish a unified solu - tion that coordinates and expedites regulatory relief under applicable laws and regulations to permit meaningful experimentation for innovative products, services, and processes.” 20 Arizona’s Fintech Regulatory Sandbox The Arizona Regulatory Sandbox Program 21 enables businesses to test innovative financial products and services for two years 22 on (in most circumstances) up to 10,000 Arizona consumers. 23 Under limited circumstances, applicants can seek permission to test the product or service with up to 17,500 Arizona consumers or seek an increase in individual and aggregate transaction caps if testing as a money transmitter. 24 At the end of the testing period, participants must wind down the test and either exit the market or seek the appropriate state license. Businesses seeking to test an innovation must apply and be admitted to the program by the Attorney General’s Office. 25 Applicants must provide a detailed description of the financial product or service, explain how such product or service is “innovative” under the statu - tory definition, and describe how such innovation would be subject to Title 6 or the relevant portions of Title 44 of Arizona law were it offered to Arizona consumers outside the sandbox.