Introducing Regulatory Sandbox based on ‘Special Act on Financial Innovation Support’
On December 7, 2018, the bill on ‘Special Act on Financial Innovation Support’ has finally been passed and will be enforced starting first quarter of 2019. Eventually, the legal ground for introducing regulatory sandbox is established, which has been an issue since so-called the era of the ‘4th Industrial Revolution’ emerged.
Regulatory sandbox is defined as a safe space in which businesses can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory and financial consequences of engaging in the activity in question. Considering that South Korea is a IT powerhouse and fast-paced society, it is interesting to note that it has procrastinated in adopting regulatory sandbox and in establishing its legal basis.
In this paper, I would like to discuss further on regulatory sandbox and its significance in this era and introduce features of ‘Special Act on Financial Innovation Support’ of South Korea which is yet to be enacted. Furthermore, I would briefly mention the features of other countries that have already adopted regulatory sandbox for a while and what South Korea can learn from these examples and cases, especially if there are any limitations and sustainability-in-question.
On December 7, 2018, the bill on ‘Special Act on Financial Innovation Support’ has finally been passed and this law is expected to be enforced during first quarter of 2019. The bill was first proposed on March 6. And it was passed rather quickly, within three quarters. Through this law, the legal ground for introducing regulatory sandbox has been established at last, which has been an ongoing issue ever since the so-called ‘4th Industrial Revolution’ or FinTech era emerged.
To define what regulatory sandbox is, imagining a sandbox of one’s childhood playground would make it easy. A sandbox is a sandpit, – a wide, shallow playground construction that holds sand, often made of wood or plastic, where a child can play with sand freely within its boundary. Likewise, regulatory sandbox refers to a framework and process that facilitates the development of the FinTech industry in a calculated way. It is defined as a safe space in which industry players can test innovative products, services, business models and delivery mechanisms without immediately incurring all the normal regulatory and financial consequences of engaging in the activity in question.
Considering that South Korea is a IT powerhouse and fast-paced society, it is noteworthy that the country has procrastinated in adopting regulatory sandbox and in establishing its legal basis. Some of pioneering countries that adopted regulatory sandbox before South Korea include United Kingdom, Australia, Singapore, Hong Kong, etc.
In this paper, I would like to develop further on the concept of regulatory sandbox, and to discuss its significance in this era, and explore the features of ‘Special Act on Financial Innovation Support’ of South Korea which will be enforced. Furthermore, I would briefly talk about features of other countries that have already adopted regulatory sandbox for quite a while, what South Korea can learn from those precedents, especially if there are any limitations and sustainability-in-question, and ways to solve these problems or to improve the Act.
Ⅰ. Regulatory Sandbox and its Significance
As mentioned above, regulatory sandbox is defined as a space where no or little legal sanctions or restrictions exist, and industry players can launch and test their innovative products, services, business models and delivery mechanisms for a given period of time before the actual embarkment. In other words, sandbox can test financial products or services based on new technologies, or new permutations of existing technologies without the burden of heavy regulations and licensing. This mechanism was formulated out of the necessity that derived from the society’s demand to accept new technology and also from a paradigm shift from positive regulation to negative one. Under positive regulation, laws list what are allowed, and products or services not included in the list are not permitted. On the other hand, under negative regulation system, only what are not allowed are stated, thus products or services excluding them are all allowed in principle.
With the help of regulatory sandbox, products or services that have not been permitted due to the absence of relevant law or legal hiatus can be practiced in advance and be tested to ensure customer protection. This is an especially helpful devise in the FinTech sector where a high degree of innovation is pursued and a high degree of restriction deters innovation, therefore requires mitigation of legal control.
Ⅱ. Analyzing features of the appointment system of innovative financial service in ‘Special Act on Financial Innovation Support’: regulatory sandbox
- Significance and Expected Effects
The enforcement of this special act is expected to bring about meaningful changes such as the invigoration of FinTech, promoting healthy competition and innovation in the finance. Also, by appointing new market participators using innovative technology as ‘innovative financial service’ and undergoing a test-bed, determining budget allocation would become easier, alleviating the burden of funds for the selected FinTech companies. Running regulatory sandbox and executing FinTech budget allocation require instant communication in between market participants on a regular basis, hence the interaction among FinTech, financial companies, and experts on constructing FinTech policies and other relevant rules will be propelled.
- Process: Application, Evaluation and Appointment
Before reviewing ‘Special Act on Financial Innovation Support’ articles, I would like to note that, for simplicity, ‘Special Act on Financial Innovation Support’ will be referred to as ‘The Act’ thereinafter.
Article 5 of The Act defines who are eligible for the innovative financial service appointment, and it says FinTech corporates that are defined as ‘merchants’ under the Commercial Act and financial firms can apply for innovative financial service. The authority that has the rights to appoint those innovative financial services is Financial Services Commission in principle, but it will set up a separate yet affiliated commission under its influence to screen the application forms (Article 13 Clause 1). This sub-commission will have a total of 25 members including the head of Financial Services Commission and its public officials, the experts in the fields of technology, finance, law, customer, and etc. The standard for evaluation will be like the followings: ①innovativeness of the service ②increase of consumer benefits ③unavoidable need of this special law ④business competency of service providers ⑤sufficiency of financial consumer protection ⑥the effects to be brought on to financial market and the stability of financial order (Article 13 Clause 4). For a fair screening process, hearings for opinions will be held with invited applicants and third parties if needed (Article 15).
After going through this screening process, if a specific service is appointed as ‘innovative financial service’ of The Act, it will be exempted from relevant financial regulations (Article 17 Clause 1) as long as it does not trigger irreparable consumer damages (Article 17 Clause 2).
- Supervision and Customer Protection
After a service is appointed as ‘innovative financial service’, its provider must operate their services within the legal test-environment where the special rules are applied. If the test is run beyond the boundary of appointed test-environment, one can be punished or sanctioned by law (Article 33, 34, 35). Even after the appointment, the state of service provision state will be closely monitored and if there appears to be a worrying situation that would cause damages to consumers or disorder to the financial market, actions will be taken to correct or improve the situation. Furthermore, under the emergency such as an actual occurrence of damages to consumers, measures to change situations can be taken or suspension order can be issued (Article 11).
The service providers must prepare for risk management plans and must submit them in a written form when applying for the appointment of innovative financial service. Only when these plans are deemed feasible and substantial, a test-bed is allowed (Article 13, 19).
To strengthen consumers’ rights, when consumers ask for compensation and bring the cases to courts, the burden of proof is alleviated, that is to say, the service providers need to prove that damages did not occur due to their intention or negligence, which is also known as the transition of burden of proof. (This is called transition because in general cases, according to Civil Procedure Act, plaintiff asking for compensation need to prove their damages, whereas in this case defendant needs to prove non-existence of their bad faith or negligence of their duty) Also, in the case of the service providers’ insolvency, devices to execute obligation are to be contrived (Article 27). It can be executed in a way of making it a legal duty for service providers to buy the insurance.
- Follow-up Measures after the Test
The test period is to last for up to two years (specific duration to be decided when appointing a service as innovative financial one). After this period, general regulations will be applied, and thus the service provider would no longer enjoy the privilege of exemption (Article 9). If needed, the period can be extended once, also up to two years (Article 10). Once, a service is under the test period, it can go through an approval process (Article 21 Clause 2), and if improvements regarding relevant rules or system are needed before the actual market launch, the Commission can advise that legislative measures be taken (Article 13 Clause 5). In other words, the public officials are aiding such service providers’ stable docking in the fast changing and dynamic financial market. Even more, such appointed service providers can demand for their exclusive rights for up to two years. That is to say, their license is to be protected whereas similar or the same services cannot be launched for two years (Article 23).
Ⅲ. Comparing with Cases of other countries
So far, I have introduced characteristics of ‘Special Act on Financial Innovation Support’ which will enable regulatory sandbox to be practiced in South Korea beginning March 2019. Other countries that had been the pioneers in the FinTech market have already amended or legislated the regulations to adopt regulatory sandbox. Taking a closer look at the features of other pioneering countries can be a guide to resolving concerning issues. Among them, United Kingdom and Australia are most frequently mentioned examples when it comes to regulatory sandbox and FinTech-relevant regulations.
- United Kingdom
United Kingdom does not run regulatory sandbox on the basis of one separate law that matches like that of South Korea’s special act word for word. Instead, the supervisory authority has a comprehensive legal power such as approving individual financial corporations, deciding whether an exemption or a suspension of applying regulations should be made and many others. Also, the supervisory authority is taking a rather flexible stance; when applying regulations, it considers each service provider’s features and situations, and then chooses the one that suits the specific firm, on a one on one basis.
Unlike the majority of nations, Australia did not adopt prior approval process to that could decide whether specific service providers can participate in regulatory sandbox or not. Instead, the service providers can notify the government authority that they are willing to participate and start the test in regulatory sandbox. However, this does not mean that the government is lowering the entry barrier. In fact, by limiting the service providers only to FinTech corporations, and strictly applying the rules of using regulatory sandbox such as requiring an official permission to be a financial corporation before actually participating in regulatory sandbox, the entry barrier is already functioning in the first step. Australian government deems corporations exempted from basic regulations can cause customers’ risks, and thus prioritizing customer protection.
Ⅳ. Conclusion: Limitation and Sustainability
This special act that speeds up financial service providers’ market participation while promoting competition aims for consumer surplus. In this process, the government cannot take internal risks of new services, hence testing in advance using regulatory sandbox is an essential task to be done before approving the actual market launching.
On the one hand, empowering Financial Services Commission to exercise a comprehensive right to decide and select firms as innovative financial services just like that of the United Kingdom is deemed suitable as various financial services emerge and one cannot be just defined to be financial under specific categories. However, if not based on the statutable authority, the abuse of the authority, or even ‘poaching of the authorizing organization’ by FinTech firms might occur, which has already been a nuisance in the United Kingdom.
On the other hand, there is a worrying voice that not enough consumer protection is guaranteed and we should learn from Australia’s example but excessive protection might lower down the speed of market participation while impeding competition, and can even make the efforts of establishing this special law in vain.
The establishment of ‘Special Act on Financial Innovation Support’ with the introduction of regulatory sandbox in the financial sector itself is already marked as significance. After the actual enforcement of this law, South Korea’s own problems might occur and can be addressed and revised accordingly in the future while taking cases of other nations into consideration.
Financial Services Commission, The Press Release on the Review of the National Assembly plenary session on ‘Special Act on Financial Innovation Support’, released and accessed on 8 December 2018.
Jung, Soon-seob, Technology Development and Financial Regulation, ‘so-called Korean way of introducing Regulatory Sandbox and possibility’, The Institute of Financial Law, Vol. 85 (September 2017)
Ahn, Soo-hyun, Regulatory sandbox and Legislative Tasks: Based on the Draft on Special Act on Financial Innovation Support, Commercial Cases Review Vol. 31, No. 3 (30 September 2018)