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The future of finance in LatAm & the Caribbean

October 19, 2021

Regulatory sandboxes in LatAm: Fintech test environments take shape

Mar 29, 2021

By Fabiola Seminario
Regulatory sandbox
Regulators in several Latin American jurisdictions are opening regulatory sandboxes to drive innovation - but not all see them as necessary

Regulatory sandboxes are becoming more widespread in Latin America, in a bid to drive innovation in banking and fintech. However, adoption is still early and uneven across countries in the region.

Regulators in Mexico, Colombia and Brazil are leading the way. Others, such as Peru and Chile, have not yet defined their path towards a fintech sandbox.

The goal of a sandbox is to offer a space for novel business models to test out their projects in a controlled environments, with both user numbers and time limited. This allows companies to test the potential of new ideas without needing to fully comply with strict financial services regulations.

For some experts, the long-term idea is to bring all these environments together in a single digital market in Latin America, where companies with a presence in different markets can trial businesses in several jurisdictions at the same time, as Diego Herrera, a representative of the Inter-American Development Bank (IDB), explained to iupana.

In the meantime, each country’s regulations are advancing at their own pace. And a crucial question remains: can ventures succeed outside sandboxes?

With this in mind, here we take a tour of the progress – and challenges – of each sandbox.

Mexico, a work in progress

Mexico is a pioneer in sandbox regulation in Latin America. The country introduced its “novel models” regulation in March 2018, as part of the enactment of its Fintech Law.

The main feature of the Mexican sandbox environment is its flexibility, which allows innovative products and services to be developed with certain regulatory exceptions.

The temporary authorization is for a maximum of two years, with a one-year extension at the discretion of the regulator, the National Banking and Securities Commission (CNBV).

Limiting factor: It’s unclear how new business models will survive outside the controlled environments, particularly because once the trial period is over, they must comply with the regulatory and administrative burdens of the law, which can be very demanding for some startups.

Expert’s opinion:

“It is a ceiling that, unintentionally, ends up discouraging the regulatory sandbox in Mexico,” says Victoria Albanesi, legal advisor to digital economy companies and fintechs, about the post-testing period.

According to the expert, the sandbox period is too short for a new company to reach financial certainty. Additionally, it can be a shock for small startups to process the licenses and permits required by the regulator before moving out of the test environment and into the market.

To date, three years after the Fintech Law was approved, only 6 startups have been selected to participate in the CNBV’s regulatory sandbox. The selection was made through the Sandbox Challenge; a contest organized by the commission and private sector entities, and included a Chilean, a British and four Mexican projects.

“The fact that there is no intensive use of a regulatory resource that, if you hear about it, should be like paradise for fintechs to try, has to do with these limitations,” she states.

Albanesi says that the sector is pushing for changes so that the rules for projects coming out of the sandbox are not so “burdensome” in terms of deadlines and regulations.

“In Mexico there is a great appetite for technology companies, which are arriving, as well as for Mexican entrepreneurship. It is necessary that […] the public sector, together with the private sector, generate the regulatory changes that will effectively cover all these innovative models”, she adds.

See also: Finastra: 5 innovation trends that will transform retail banking in 2021

Brazil’s triple sandbox

Unlike other countries in the region, Brazil has three regulatory sandboxes, separated into industries: financial and payment systems, capital markets and private insurance markets.

The banking sandbox is a testing space that allows institutions authorized and not authorized by the Central Bank of Brazil to test innovative projects.

The regulator is currently analyzing proposals. In “Cycle 1”, the Bank may admit between 10 and 15 projects for 1-year trials, with an option to extend for an additional year.

The Securities and Exchange Commission (CVM) sandbox focuses on stock market platforms. The idea is for the CVM to start the sandbox in May of this year.

The third is the Superintendency of Private Insurance (SUSEP) sandbox, whose task is to regulate the testing of insurance and pension platforms. To date, 11 insurtechs have been selected by the agency to experiment in this area.

Limiting factor: Lack of clarity in the processes for accessing sandboxes and in multidisciplinary projects that include the participation of several regulators.

Expert’s opinion:

“One of the biggest challenges is to properly understand the size of the projects that regulators want, and whether they are open to the most innovative projects or not,” Bruno Balduccini and Giovana Treiger Grupenmacher, partners at Pinheiro Neto Advogados, told iupana in an email.

As this is the first round for each of the sandboxes, the consultants explain that not only the applicants, but also the regulators, did not have straight answers “about the clarity of the processes and the details of how the programs would work.”

“Regulators have certainly been open to innovation and are very accessible and cooperative. This is very important for fostering new ideas,” they stated.

Another obstacle in the Brazilian sandbox is the integration between authorities to analyze multidisciplinary projects involving more than one regulator and, therefore, more than one sandbox.

Despite the lack of precision, the lawyers highlighted the “great advantage” the country has with the largest fintech ecosystem in the region due to its size, population diversity and proclivity for technology.

See also: Cryptocurrencies set for LatAm payments growth

Colombia, testing crypto assets

In Colombia there are two types of isolated systems.

The first is La Arenera, created in 2018 by the Financial Superintendence of Colombia (SFC) as a supervised space. The second is a regulatory sandbox originated last September by the Ministry of Finance through Decree 1234.

The most recent movement of the Arenera was the admission of exchanges to test cash in and cash out operations with cryptocurrencies. The platforms will operate temporarily (1 year) in alliance with financial and payment entities, such as Bancolombia, Banco de Bogotá and Powi, among others.

Here, the participating watchdogs may request a temporary operation certificate from the Superintendency that, in no case, should exceed 2 years.

The specific difference between the Arenera and the regulatory sandbox is that in the former, the projects do not require a license to operate. What the supervisor gives are adjustments and guidelines so that the product policies are adjusted, so that they do not generate risks. Here can be monitored and unguarded entities.

The regulatory sandbox, for its part, seeks to deliver a temporary license to a supervised entity when it wants to release a product that is not specific to its license. Only watched entities are supported here.

Limiting: Lack of clarity regarding the benefits of the regulatory sandbox.

Expert voice:

“In the regulatory sandbox it is not yet clear the benefits of applying for a temporary license. Still those interested in establishing a supervised entity do not know how it will work, what type of pantries they may apply, etc. ” explains Lina Lineros, director of the banking and finance area of ​​Posse Herrera Ruiz, a Colombian law firm.

In this context, the lawyer suggests that a way forward would be for startups to go through the Superintendency’s hub first, so that they can decide where to turn, if the supervisor’s sandbox, or the temporary license sandbox.

The bub, or also called the innovation office, is the orientation space for fintech entities and ventures that validate whether the startup’s activity complies with the requirements of current regulations, request information to establish a supervised financial entity, express interest in participate in the test spaces, etc.

Another limitation that the lawyer adds is the lack of flexibility in opening to non-supervised companies; that is, those that wish to operate independently, without the protection or alliance with a supervised entity.

“The regulatory sandbox gives you an exception, they let you operate temporarily, but once the time provided for in the regulation is over, you have to demonstrate compliance with the applicable regulation to obtain an indefinite license or, otherwise, dismount. So, the limitation is that it does not open up the possibility of modifying the regulatory framework or achieving a permanent exception. ”

Similarly, the lawyer warns that since technology is a “super changing” issue, if the standard does not become more flexible and adapt to innovation, “it will be a constraint from time to time”.

And although the government does not have a clear position on cryptocurrencies, its admission of these projects to the sandbox has set an important precedent for exploration, says Lineros.

“From the supervisory sandbox, I highlight the new project of alliances between crypto-asset platforms and financial entities, it seems to me that it is the boom because it will allow access to the Colombian market of said platforms that until now was limited because its first barrier was at the time of requesting a bank account ”, she maintains.

Banks were reluctant to participate in this business because they felt they were in a regulatory “limbo”, putting them at risk of being associated with little-understood areas; however, this obstacle is slowly being overcome.

“The supervisory sandbox and the new Regulatory sandbox demonstrate the regulator’s ambition to support innovative projects that boost services and products in the financial, insurance and capital markets, which may be gray regulatory areas, creating controlled test environments,” she says.

See also: 4 Key Trends that will Define LatAm Payments in 2021

Peruvian sandboxes: TBD

In January, the Peruvian government issued a decree to promote the financing of ventures and startups, in addition to regulating crowdfunding.

The document also opened the way for the development of a regulatory sandbox in the country. The decree authorizes the securities market regulator (SMV) and the banking and insurance supervisor (SBS) to approve the temporary performance of any operation or activity through innovative models, allowing them to issue regulatory exceptions for those who enter the sandboxes.

However, regulators have not developed further guidelines – or actions – regarding this issue, raising doubts about the future of local sandboxes.

Limiting factor: Peru does not yet have a sandbox regulation, nor has it given clear clues as to what one might look like in future.

Expert’s opinion:

“I am not very optimistic about the sandbox regulation for this year,” says Alvaro Castro, director of Sumara Hub Legal, a Peruvian law firm specializing in startups, fintech and insurtech, in reference to the regulatory vacuum.

The regulatory stagnation reflects priorities by regulators, who maintain their focus on the traditional system, says Castro.

“Given that the resources and time behind a regulatory initiative are significant, they decide to put the focus where they think there is the most impact. I think regulators feel that fintechs are not yet a priority because of the low impact they have.”

According to Castro, although fintechs represent “very little” value in operational terms, compared to the stock market or the financial system, what is important in this industry is their potential.

“Countries that have more pro-innovation and pro-entrepreneurship regulations have an important advantage. The fact that our regulators, focused on the investment and credit industry, are not convinced of the benefits of the sandbox, gives an advantage to other countries,” he says.

See also: Bank-fintech interoperability hits the agenda for Peru

Chile: Sandboxes ruled out

The Chilean government argues that there are no limitations to innovation or the emergence of new financial services in the country.

Consequently, according to the Financial Market Commission (CMF), a regulatory sandbox wouldn’t deliver advantages for its ecosystem, and instead, they are betting that innovation will emerge without the need for a law to motivate it, nor the supervision of the regulator.

Limiting factor: Chile does not consider the creation of a sandbox necessary at this time.

Expert’s opinion:

“In the industry, the view is similar, the sandbox seems to be more of a special form of regulation that ultimately inhibits innovation,” suggests Ignacio Pera, Fintech and Venture Capital practice leader at Dentons, a multinational law firm.

Just a few weeks ago, the CMF published the bill on fintech in the areas of the securities market which also does not contemplate a sandbox regulation .

“Everything suggests that Chile will not implement a sandbox,” says Pera.

See also: Exclusive: IDB proposes pan-LatAm fintech sandbox amid innovation boom

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