As the fintech industry grows around the world, many countries are setting up various support systems to enhance the competitiveness of fintech technology and foster the industry. Several countries in particular introduced the fintech regulatory sandboxes, one of the support systems. The regulatory sandbox is a safe, testing space where participants can test their new business model, innovative products, services, and delivery mechanisms, without immediately incurring all the normal regulatory consequences of engaging in the activity in question [1
]. The reasons for introducing such regulatory sandboxes are as follows. In the financial sector, regulations have been tightened to protect consumers and investors ever since the global financial crisis, making it difficult to determine whether or not to ease off these regulations. Moreover, it is not easy to know the effects of new technologies such as fintech, and whether it would have a positive effect on society or not [2
However, excessive regulation can occasionally negatively impact a company’s ability to innovate and compete in its market. In fact, despite Korea being an IT power nation, the growth of its domestic fintech industry has been sluggish. Pre-regulation by law was the biggest cause. Korean fintech firms hindered by regulations often found it difficult to proceed with their businesses [4
]. Therefore, tests need to be conducted outside of regulations for a certain period of time. After looking at the results of these tests, regulators can decide whether or not to release the new services (or products) on the market and ease off on these regulations [4
] These regulatory sandboxes will benefit both fintech companies and policy making authorities [6
]. The Financial Conduct Authority (FCA) of the United Kingdom stated that the regulatory sandbox is a rich source of case studies to inform our understanding of this technology [6
The regulatory sandboxes are expected to facilitate innovation in the fintech industry. Many experts also believe they will help small firms such as startups and ventures to lead innovation and attract investment. In addition, one of the primary goals of regulatory sandboxes is to attract the attention of investment sources such as banks, private equity, and venture capital funds [8
]. In reality, the United Kingdom, which was the first country to introduce the regulatory sandbox, has many competitive fintech technologies and companies and is also considered to be one of the most active fintech markets at present [9
]. Moreover, most leading countries in fintech have also introduced regulatory sandboxes and consequently, have seen a marked increase in expectations for the effectiveness of regulatory sandboxes. However, it is not clear what kinds of effect could be expected in detail, and therefore it is not easy to determine the success or failure of regulatory sandboxes [5
]. One of the reasons why it is not easy to determine the success or failure of sandboxes seems to be that there is no study of what expected effects might be seen after introducing the regulatory sandboxes. Many articles about fintech tend to focus on the fintech service management and innovation. The research on fintech industry regulations is mostly focused on how to regulate fintech’s activities in the traditional financial markets. This is the most popular topic among fintech regulation researchers because as many fintech companies have entered the market, many problems have appeared. Furthermore, regulation is an important factor in the activation and innovation of fintech [11
]. This study is on fintech regulations which many researchers are interested in and aims to look critically at the effectiveness of regulatory sandboxes through cross-country comparisons. This study will be the first empirical research to verify the effectiveness of regulatory sandboxes.
The purpose of this research is to understand the impact of regulatory sandbox adoption on the scale of investments in fintech through empirical data analysis. The rationale behind this approach is that the activation of venture companies is an essential element and significant indicator of the fintech ecosystem. In order to achieve these goals, we first looked at how the scale of fintech venture investment in the countries that introduced regulatory sandboxes has changed since their introduction. Subsequently, we compared these results with other countries that did not introduce regulatory sandboxes. The first group of countries which introduced regulatory sandboxes, consisted of the United Kingdom, Singapore, Hong Kong, Australia, India, Canada, Malaysia, and Japan. There were two criteria for choosing these countries. First, these countries had introduced regulatory sandboxes for longer than a year, as of July 2018. The second was that these countries had existing fintech venture companies with investments in them, so data needed for this analysis existed. The second, which compared a group of countries that had not introduced regulatory sandboxes was selected from among the top 40 countries in the global competitiveness index of the World Economic Forum (WEF). We selected these countries because it was necessary to select countries with similar environments to the first group to control for variables. The reason why the WEF global competitiveness index was chosen was because it included indicators such as ICT penetration and financial systems, which enabled us to select countries with similar environments to the nine countries of the first analysis group. Moreover, the reasons why we limited the scope of our research to venture firms are as follows: First, venture and startup firms are one of the important elements that make up the fintech ecosystem [14
], and the new fintech wave is also driven by ventures and startups [11
]. Second, the growth of new technology-based ventures and startups is one of the goals of regulatory sandboxes [1
The contributions and differences of our research are as follows: First, it is the first empirical study to identify the expected effects of regulatory sandboxes, especially focusing on the fintech venture investment. Second, it is the first study to compare and analyze the performances of the countries that have introduced regulatory sandboxes. Third, the results of this study can be used as basis for predicting how the regulatory sandboxes will affect the fintech industry. Fourth, the results of this study can be used as a critical frame of reference for regulators and future researchers.
2. Fintech Industry and Fintech Regulatory Sandboxes
Fintech, a combination of two words—finance and technology—revolves around providing traditional financial services in new forms using technology [16
]. The market size of fintech is growing rapidly worldwide [14
]. Different areas of the fintech industry range from payment, billing, lending, wealth management, money transfer, mortgage, and real estate to insurance, personal finance, capital market, blockchain, and crypto currency [12
These fintech industries have been growing and concerns about fintech are growing simultaneously. Since the 2008 financial crisis, governments have been providing rigorous regulations for protecting consumers and maintaining sustainability in the market [5
]. However, the emergence of fintech has posed big challenges to the regulators and regulatory policies [5
]. These rigorous regulations are also stated as being critical hinderances to the growth and innovation of the fintech industry [20
]. After all, many countries have decided to introduce regulatory sandboxes in their fintech industries [5
]. As above-mentioned, a regulatory sandbox is a “safe space” in which businesses can test innovative products, services, business models, and delivery mechanisms, without immediately facing all of the normal regulatory consequences of engaging in the activity in question [1
]. Another definition is a “framework” set up by a financial sector regulators to allow small scale, live testing of innovations by private firms in controlled environments (operating under a special exemption, allowance, or other limited, time-bound exception) under the regulator’s supervision [22
Participants in the regulatory sandboxes may test their services or products over a period of time, beyond the scope of regulations to determine whether their solutions have positive effects on the customers and markets. Regulators may simultaneously look at the impact of new solutions and thus determine whether they are against regulations. Regulators can mitigate regulations relatively quickly, if they need to be relaxed. Therefore, these regulatory sandboxes may eventually solve the problem of delayed market release due to regulatory uncertainty. In addition, it can lead to cost saving and innovation [7
The countries where such regulatory sandboxes have been introduced are the United Kingdom, Australia, Denmark, Singapore, Hong Kong, etc. Moreover, many other countries are considering introducing sandboxes. In addition to these forerunning countries, countries where technological advances are somewhat behind, such as Sierra Leone in Africa, have adopted regulatory sandbox programs to support their fintech industry [24
]. The list of countries introducing and proposing regulatory sandboxes as of April 2019 is set out in Table 1
The contents of forerunning countries’ regulatory sandboxes are as follows. The United Kingdom was the first country to introduce the regulatory sandbox to its fintech industry in 2015. FCA selected companies to participate in the regulatory sandbox by evaluating them according to five criteria: scope, genuine innovation, consumer benefit, need for sandbox, and background research [1
]. Currently, a total of 375 companies have applied to the regulatory sandbox since 2015, and of them, 118 companies have been selected [27
]. The FCA seeks to provide these firms with five advantages: the ability to test products and services in a controlled environment, reduced time-to-market at a potentially lower cost, support in identifying appropriate consumer protection, safeguards to build into new products and services, and better access to finance [1
]. This regulatory sandbox and other actively supportive policies are regarded as critical drivers of the fintech industry’s growth by experts [9
Hong Kong introduced the regulatory sandbox to its financial sector in June 2016. Financial institutions as well as startups working with or without fintech firms were allowed to participate [5
]. In addition, Securities and Futures Commissions (SFC) have the authority to attach accreditation conditions to minimize the risks that investors may incur during the testing period [26
]. They do not clearly specify which regulations can be relaxed or exempted, and the level of deregulations is being set flexibly according to the circumstances of companies [28
]. As of the end of March 2019, 48 new technology products or services have been allowed in the regulatory sandbox and 32 pilot trials have been completed and the products have subsequently been rolled out [29
The Monetary Authority of Singapore (MAS) published its guidelines for the financial regulatory sandbox in June 2016. The companies who participate in it are selected by determining whether the fintech services are innovating, solving major issues of consumers and industries, and providing benefits. The regulatory sandbox of MAS aims to transform Singapore into the center of smart finance industry. MAS seeks to achieve these objectives: increasing efficiency; managing risks more effectively; creating new opportunities; and improving people’s lives through the regulatory sandbox [30
]. The Australian Securities and Investments Commission (ASIC) introduced the regulatory sandbox in 2016. ASIC allows both fintech firms and traditional financial companies to participate in it [31
] and target business areas and investment amounts are limited to protect investors [32
The period when participants are allowed to play in the sandboxes is typically limited either by a rule or on a case-by-case basis. United Kingdom and Brunei have allowed a six-month period and Australia, Thailand and Malaysia have twelve months [5
]. Extensions of the period are generally available. As such, although the objectives of each country’s regulatory sandbox guidelines are similar, the details of the guidelines are different country to country. As described above, some countries restrict the type of enterprise and business sectors which are able to participate in the sandboxes. Some researchers insist that these restrictions are counter-productive to the sandbox’s objectives and eventually reduce economies of scale and the value of innovation [5
]. The detailed features of each country’s regulatory sandbox are shown in Table 2
3. Previous Researches and Hypotheses
A related strand of literature addresses that the growth of micro and small companies such as ventures and startups is affected by the regulations [15
]. These studies mention that companies in the countries that have favorable policies to certain industries may have more benefits, such as cost saving, than those in the countries that have strong regulatory policies [35
]. They also argue that the companies in countries that have favorable policies are also easier to innovate because compliance costs prevent innovation [15
]. While rigorous regulations protect investors, they may also lead to high transaction costs and regulatory compliance costs that prevent investors from taking risks, and consequently may discourage investment. Therefore, previous researches say that rigorous regulations could ultimately have negative effects on micro and small firms that need more investment. The more relaxed regulations, the more positive response of the stock market could be, they insist [15
More relaxed regulations can also benefit product innovation, because less regulation to the market could intensify competitions and will lead to lower prices and better qualities [3
]. One study revealed that product and service legislation deter business activities in general, and some laws and compliance hinder competitiveness in particular [3
]. In fact, despite Korea being an IT power nation, the growth of the domestic fintech industry was sluggish. Pre-regulation by law was the biggest cause. Korean fintech firms blocked by regulations were in difficult situations to proceed with their businesses [4
]. For the above reasons, policymakers are trying to limit the negative effects of regulation on innovative industries. The regulations on the innovative industries like the fintech industry need to be systematically checked for potential conflicts and synergies [37
Many experts say that introducing regulatory sandboxes help make proper policies in the same vein and it also will help fintech startups to save time and reduce cost. In fact, FCA expects the sandboxes to reduce the time to market by thirty-three percent and to facilitate the fintech’s access to finance, thereby raising its valuation by fifteen percent. Moreover, the following 30% of companies that graduated from the first UK regulatory sandbox (2016.7–2017.1) succeeded in attracting investment. Furthermore, fintech companies have increased their average investment by 6.6 times after graduating from the regulatory sandbox. Based on these facts, this is one further argument where the regulatory sandbox can contribute to the activation of venture capital in the fintech sector [5
For both reasons, they also expect to enable innovation to reach the market [5
]. Some other previous studies found that the fintech and the regulatory sandboxes contribute to poverty reduction. The study, based on a survey of 3000 people in Ghana and Egypt, found small loans provided by fintech firms were very useful for household finances. The results of the study say that small loans of fintech services have contributed positively to poverty reduction [38
]. In addition to this research, the United Kingdom, Australia, Canada, Hong Kong, Singapore, and others, which are the countries that introduced the sandboxes, are hosts to a predominant number of the top 100 fintech firms [39
]. These countries are also evaluated to have relatively well-equipped policies, including the regulation of sandboxes, infrastructure, and ecosystems, to promote fintech industries [40
]. These examples show that regulations and the growth of the fintech industry are closely related. Nonetheless, there are no discussions on the direct and indirect effects of regulatory sandboxes empirically. Therefore, the effects of fintech regulatory sandboxes need further empirical research.
In this research, we propose a country level comparative methodology to analyze the effectiveness of the introduction of the regulatory sandboxes on the investment scale of fintech venture companies. The rationale behind this methodology is that the main policy effect of the regulatory sandbox is to activate a fintech industry ecosystem. From this perspective, it is highly desirable to analyze the investment scale of fintech venture companies for validation of the impact of regulatory sandboxes because fintech venture companies have initiated most innovations in the area of financial business by their disruptive technologies and creative business models [42
]. In the United Kingdom, where the first fintech regulatory sandbox was introduced, fintech startups and venture companies were most likely to benefit from regulatory sandboxes [30
]. Therefore, in order to determine whether the regulatory sandboxes contribute to the activation of the fintech industry or not, this research needs to be limited to the research of fintech venture companies, which are one of the main constituents of the industry. In the previous studies on the determinants of investment decisions by angel investors and venture capitalists, one of the major investment determinants was found to be the growth potential of companies and their industries [44
]. Moreover, another study argued that ventures and startups are important components of the fintech ecosystem; therefore, the change in the investment size of venture companies can be a key indicator for determining the activation of the industry.
The purpose of this research is to investigate the effect of regulatory sandboxes on the investment scale of investment companies in nine countries that have introduced them. In order to improve the reliability and validity of the results, we compared the results with the countries that did not introduce the regulatory sandboxes. In this research, analysis method was used to analyze the detailed change trend of investment scale. Nine countries were selected including the United Kingdom, Singapore, Hong Kong, Australia, India, Canada, Malaysia, The Netherlands, and Japan. It has been one or two years since they introduced the regulatory sandboxes (as of July 2018). In this paper, we have labeled these nine countries as the “A group”. The fintech areas that are subject to the analysis are all areas of fintech such as financial accounting services, financial data analysis, payment services, financial consulting services, consumer finance, loan services, insure-Tech, robo-advisor, and investment services. As mentioned above, what we tried to understand through this research were the effects that occurred due to the introduction of regulatory sandboxes. The effects of the latter were measured by the change in the investment scale of the fintech venture companies in the countries that introduced the regulatory sandboxes. The hypotheses are as follows.
The total amount of investment in fintech ventures will increase after the introduction of the regulatory sandboxes.
The average amount of investment in fintech ventures will increase after the introduction of the regulatory sandboxes.
The number of investments in fintech ventures will increase after the introduction of regulatory sandboxes.
6. Discussion: The Relation between Regulatory Sandbox and Open Innovation
6.1. Summary of the Research Results
Through the research, the empirical analysis showed that the introduction of regulatory sandboxes had positive effects on venture investment in fintech industry. The nine countries (the United Kingdom, Singapore, Hong Kong, Australia, India, Canada, Malaysia, The Netherlands, and Japan) which introduced the regulatory sandboxes showed a remarkable increase in the size of venture investment (total investment and average investment). Hypothesis 1 predicted that the introduction of a regulatory sandbox would have a positive effect on the increase in the total amount of fintech venture investment. The effect of this variable was statistically significant in analysis 1, 2, and 3, providing overall support for this hypothesis. In detail, the total investment amount increased by 37.7% (p < 0.05) on average. In addition, the total investment increased in eight countries. Hypothesis 2 predicted that the introduction of a regulatory sandbox would have a positive effect on the increase in the average amount of fintech venture investment. The effect of this variable is statistically significant in analysis 1, 2, and 3, providing overall support for this hypothesis. And the average investment amount showed a remarkable growth rate of 86.4% (p < 0.05). The average investment amount increased in nine countries. As a result, it showed that the total investment amount, and the increase of the average investment amount of the country that introduced regulatory sandboxes, was higher than those that did not. However, Hypothesis 3 was not supported by these analyses. The result means that it is difficult to confirm that the number of investments in the introduction countries of the regulatory sandboxes was higher than that of non-introduction countries.
6.2. Regulatory Sandbox and Open Innovation
This research provides important policy implications. First, the introduction of regulatory sandboxes has an effect that promotes the investment of venture capital into the fintech industry. In the high-tech industry, the activation of venture investment is an important factor in the early-stage industrial maturity. This significant increase in the total amount of venture investment can be evidence that the regulatory sandboxes are functioning systematically as a practical deregulation device. Second, the introduction of the regulatory sandboxes provides a policy effect that reduces legal and institutional risks by eliminating uncertainty through the adoption of flexible and inclusive business models in startups of the new industry, fintech. While governments support new industries with platforms and policies, they also play an essential role in the sustainability of innovation by providing business friendly regulations [47
]. The results show a significant increase in the average amount of venture investment in the fintech sector after the introduction of sandboxes compared to the non-introduced countries provide significant implications.
In addition, there are also some hints, which might be interpreted as suggesting the possibility that aggressive adoption of the regulatory sandbox provides positive incentives for venture capital to new industrial fields (artificial intelligence, blockchain, big data, etc.) that require intensive fostering, such as the fintech industry. From the perspective of creative venture companies driving innovation, the role of venture investment in an open innovation ecosystem is indispensable factor. From the perspectives of Schumpeterian entrepreneurial cyclical dynamics of open innovation, cooperative efforts between government and conglomerates are required to foster and sustain market open innovation, which is produced by a new combination, a creative unification of technology and markets including financial system such as VC and M&A [48
]. In addition, the business-friendly regulatory environment strongly promotes open innovation systems by enabling new business models created through intensive collaboration with the private sector. Therefore, it seems reasonable to assume that the regulatory sandbox will act as a catalyst for creating an open innovation ecosystem by promoting the inflow of investment into the innovation ecosystem.
6.3. Regulatory Sandbox and Open Innovation in Fintech
Through this research, we confirmed that that the regulatory sandbox serves as a positive catalyst for investments in the fintech sector. In addition, since the nine countries that adopted the regulatory sandbox had more sophisticated financial systems, we tried to prove the causal relationship using the development of the financial market as a control variable. Nevertheless, there are plenty of possibilities for other factors affecting investment in the fintech sector besides the regulatory sandbox. In addition, the ultimate goal of the adoption of the regulatory sandbox is the commercialization of new and innovative financial services. That is why many fintech startups are testing their business model on a test bed called a regulatory sandbox. It will be difficult for larger incumbent firms to match small creative startup firms at producing value-creating fintech business models and applications. As a result, it would be appropriate for larger firms to outsource, including M&A and JV, their fintech applications, instead of making directly them in-house [49
In this context, the innovative business model of fintech ventures commercialized through the regulatory sandbox can be an attractive investment factor for venture capitalists and corporate venture capitals. In the United Kingdom, the first country to adopt a regulatory sandbox, 30% of venture companies that graduated from the regulatory sandbox received venture investment, and the average investment amount increased 6.6 times. In this context, it is not unreasonable to postulate that the regulatory sandbox has the expected effect of promoting investment in the fintech sector. Consequently, the regulatory sandbox greatly contributes to creating an open innovative ecosystem for fintech business by providing collaborating environments between a government and larger incumbent firms and fintech startups.