The New Way to Deregulate


(Bloomberg Businessweek) -- Sandboxes are the hot trend in financial regulation. Or rather, deregulation. China, Singapore, Australia, Canada, and more than 20 other countries have them. U.S. regulatory agencies are starting them. Arizona has one, and other states may follow suit.

Sandbox programs are supposed to be a kind of safe space to allow digital entrepreneurs to test products without regulators breathing down their necks. Governments are willing to stay their regulatory hand because the startups that emerge from such experiments might lead to new jobs and expanded access to financial services. They also provide competition to big banks. There’s even a sandbox for sandboxes: Regulators in 12 countries have agreed to experiment with financial technology across borders.

But as sandbox initiatives proliferate, critics worry that the concept has become a covert effort to neuter consumer protection laws. “Why allow companies that aren’t ready to provide financial services to the public to be permitted to do so?” says Maria Vullo, who on Feb. 1 stepped down as superintendent of New York’s Department of Financial Services, the state’s top financial watchdog. Lauren Saunders, associate director of the National Consumer Law Center, says the movement “has taken a wrong turn in this deregulatory era” under President Trump. In the U.S., she says, sandboxes aren’t “framed as a way to help companies comply with the laws, but to get relief from the laws.”

A proposed Consumer Financial Protection Bureau sandbox is perhaps the most striking such effort. Congress created the CFPB as part of the 2010 Dodd-Frank financial reform act. Its mission is to crack down on deceptive or unfair consumer finance practices. Some of those, such as predatory mortgage lending, helped cause the 2008 financial crisis. The agency was designed to fill what was seen as a gap in existing regulation and enforcement.

But companies approved for the CFPB sandbox would come under a powerful protective umbrella. While a December proposal says applicants would have to show how they plan to control for consumer risks and reimburse customers who might be harmed, approved companies would be partially immune from enforcement actions by any federal or state authority and from lawsuits by private parties. The safe harbor would extend to consumer protection laws that ban discrimination in lending, limit consumers’ liability for unauthorized credit card charges, and require plain-English explanations of real estate transactions. The agency says it plans to invite trade associations to apply for sandbox approval for entire industries.

Paul Watkins, who runs the CFPB’s Office of Innovation and will run the agency’s sandbox if it’s approved, said in a January podcast that “innovation is part of consumer protection—these things are not opposed.” The program, he said, will achieve the bureau’s broader purpose, “which is to ensure competition within markets and ensure consumer access.”

Twenty-two state attorneys general and a coalition of 50 public-interest groups are fighting the idea. People get “starry-eyed when they hear the word ‘innovation,’ ” says Saunders, “but dramatically innovative products require more supervision, not less.” She cites the now-banned practice in which banks automatically gave debit card customers overdraft protection, then charged $40 when an account lacked the funds for a $2 cup of coffee.

The U.S. Office of the Comptroller of the Currency is considering a sandbox program for the national banks it regulates, but it’s already paved the way for fintechs that don’t accept deposits to receive special national bank charters. While the OCC wouldn’t override banking rules, it would tailor them to any newly chartered company’s size, riskiness, and complexity. And the OCC would preempt states, normally the overseers of nondepository financial institutions. “Ten years ago, we went through a crisis because the loosening of regulations permitted institutions to take on risk at the expense of the consumer,” says Vullo, the former New York regulator. “It’s like people have amnesia.”

Bryan Hubbard, an OCC spokesman, says it’s “misleading to suggest consumer protections would suffer” if a fintech company were to receive a federal charter. The OCC, he says, would conduct banklike exams of fintech companies to prevent abuses.

The sandbox movement took off after the U.K.’s Financial Conduct Authority coined the phrase to describe its program, begun in 2016, to encourage innovation and competition. The FCA has since allowed 89 companies to market-test their concepts. A report by Deloitte says perhaps the British initiative’s biggest achievement “has been to break the myth of regulation being a barrier to innovation.”

The Trump administration took away a different lesson: In a July report, the Treasury Department encouraged states to establish sandboxes as a “unified solution” for what it considers postcrisis regulatory overkill. If states don’t do it, the report says, Congress should step in and preempt state laws.

Even without sandboxes, there’s been no shortage of fintech startups. The Treasury report says that more than 3,300 fintech companies started from 2010 to 2018. Funding from investors for such companies has been growing rapidly, reaching $22 billion globally in 2017, a 13-fold increase since 2010. Fintech lending now makes up more than 36 percent of all U.S. personal loans, up from less than 1 percent in 2010. Some digital financial services reach as many as 80 million people, the report says.

Three days after the Treasury report, Arizona’s sandbox opened to fintechs that provide a service to consumers—online loans, mobile payments, cryptocurrency products, robo-advice—not available in the state. Accepted companies can serve as many as 10,000 customers and operate for two years without a license, after which they must obtain approvals or cease operating.

Sweetbridge NFP Ltd., a Scottsdale, Ariz., fintech, is one of three companies that have been approved. It plans to convert the value of vehicle titles into digital tokens that customers can trade, borrow, and lend. The Arizona attorney general office’s website describes the trial as a “blockchain-enabled product designed to purchase financing without a credit check and offer affordable, consumer-friendly vehicle title loans.”

Title loans allow car owners to get access to quick cash by putting up the title to their vehicles as collateral. Since 2010, when the state banned payday lending, auto-title lenders have exploded in Arizona. The state in 2015 had more than 630 title-loan outlets—one for every 8,000 residents—according to a Consumer Federation of America report.

For the sandbox program, Sweetbridge will rely on insurance data and Kelley Blue Book auto values rather than credit checks and other tools of traditional underwriting. It agreed to cap its loans at an annual interest rate of 20 percent—below what most title lenders charge. Sweetbridge’s test, which it says will begin soon, will also limit loans to 20 percent of a vehicle’s value. Scott Nelson, Sweetbridge’s founder and chief executive officer, said in an email that the Arizona sandbox allows startups to quickly test products “in a controlled environment without the cost and time delay that is typical for licensing new financial products.”

If successful, the company plans to offer the title-loan product more widely. A Feb. 6 CFPB announcement could make that easier. The agency said it plans to rescind the part of Obama-era rules that require payday and auto-title lenders to determine the likelihood that a customer can pay back a loan. Sweetbridge says its loans won’t be available in the U.K. and Europe, where such assessments are required.

Jean Ann Fox, the former director for financial services at the Consumer Federation of America, says she’s unsuccessfully tried to find out whether the Arizona sandbox products are actually operating and under what controls, which state laws have been waived, and whether the entities have been asked to post bonds in case they have to reimburse customers. “It’s not so much a sandbox as a black box,” Fox says. Katie Conner, a spokeswoman for the Arizona attorney general’s office, which oversees the program, says it “is the absolute last place where any deceitful players would want to be.” Of the three approved companies, only Grain Technology Inc. has begun offering its product and on a limited basis—personalized savings and credit plans through existing bank accounts. “These companies have been in the sandbox for less than four months—things are just getting started,” she adds.

For now, Arizona’s trials can only be offered to in-state consumers. But the state could extend its reach by seeking admission of its sandbox into the CFPB’s if the agency moves ahead. That may not be difficult: Watkins, who would manage the CFPB’s sandbox, led the effort to design Arizona’s.

To contact the editor responsible for this story: Pat Regnier at

©2019 Bloomberg L.P.

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