Breathtaking digital technology innovation has been a hallmark of the past 30 years, triggering dramatic, albeit not always beneficial, social change that hardly anyone could have predicted or even imagined. Unlike previous technological or industrial revolutions, digital innovation unfolds endlessly, reaching most corners of the globe at nearly the speed of light. Indeed, no country has mastered avoiding its overwhelming yet virtually invisible and imposing tentacles.
Historically, technological change has usually been far ahead of national policy development. Policymakers thus always find themselves playing catch-up. And when they do, they can comfortably rest on their laurels—at least for a few months. However, such a luxury now seems inaccessible as digital innovation abruptly invades the policy space from all flanks, challenging many existing policies and regulations. It can also propel dramatic institutional change, thus often pulling the rug from under policymakers’ feet.
The complexity of many new technologies, such as AI, can further delay policy responses, as decision-makers are forced to seek external expertise and knowledge to confront almost unrecognizable challenges. Moreover, policymakers are expected to unveil their magic wands to create a neat balance between digital innovation and regulation. That will ensure the benefits of the former increase overall social welfare without triggering unwanted and widespread social harm or systemic risks. Yet, that seemingly grim policy panorama can be overcome by embracing, not rejecting, digitally driven innovation. It is imperative to deploy a new kaleidoscope that sees such innovation as a means rather than just the goal of policymaking. Indeed, once digital technologies become part of overall policy development, policy and regulatory innovations are at hand, facilitating the overall process and potentially expediting policy formulation.
Regulative sandboxes (RSx) are part of the new arsenal of tools readily available to policymakers to decisively confront emerging and recurring challenges. Indeed, RSx are critical regulatory innovations because they can help close the tenacious gap between innovation and policy development faster than otherwise. RSx are indeed part of RegTech.
Software development is one of the core hallmarks of digital innovation. Nowadays, every piece of digital hardware or any digital application can perform its underlying chores thanks to embedded computer code, invisible to end users. Software production has changed dramatically since its birth in the late 1940s, especially in the last few years with the advent of Large Language Models (LLMs) that can produce code semi-autonomously. However, a recurring ingredient is the deployment of test beds or sandboxes where programmers can freely play and interact with the software product still under development to check for bugs or glaring errors that could lead to catastrophic malfunction. Once the testing process is completed, the software is released for public consumption with minimized bugs and failure rates.
A regulatory sandbox has similar functionality but, at the same time, brings in its unique imprint. Indeed, its premier target is to explore if emerging innovations comply with existing regulations before consumers put their eager hands on them. It thus provides an unregulated space where the innovation is tested not for its functionality directly but for its impact on regulatory frameworks. Secondly, RSx are not limited to software. Its scope is much larger and, in principle, includes all products and services that could be subject to regulation — or deregulation.
In that light, RSx can be defined as area-focused and time-limited regulatory experimentation digital platforms deployed for testing emerging innovations for compliance using regulatory leeway to identify potential policy gaps and overall risks. Once identified, if any, regulators are expected to take action and modify existing regulatory frameworks accordingly. Regulators can also demand changes in the product or service under experimentation to ensure compliance with existing or planned regulations. Direct interaction with innovators is thus a critical feature that must be managed and supervised throughout the experimentation process.
Policymakers and regulators should know the differences between RSx and the test beds and sandboxes innovation developers use to design, create and test their new products and services. The two can often operate simultaneously, as the latter is needed to make any product changes regulators might require to ensure compliance and protect consumers.
Furthermore, regulators should be familiar with the global RegTech ecosystem, which offers various technologies to enhance regulatory capacities in both the public and private sectors. One tool they provide to policymakers is sandboxes, while technologies such as AI, Blockchains, and predictive analytics are routinely deployed to support RSx implementation.
Regulators should be cognizant that RSx is not an excuse to avoid regulation. While that is undoubtedly one potential outcome, others, such as ensuring compliance with existing regulations or revising or adding new ones to minimize risk and exposure, are equally possible. Ultimately, it is up to the regulatory entities to decide how to proceed optimally, given the local context and the status of overall policymaking. In any event, RSx should never be an excuse for avoiding regulation altogether.
RSx emerged after the 2008/09 Global Financial Crisis, which exposed the world economy to systemic risks unleashed by a heavily unregulated financial sector led by Fintech. New digital technologies provided fertile ground for accelerated financial innovations that spread globally in the late 1990s. By the time the crisis hit, most financial networks were tightly interconnected, thus exposing them to systemic risks if one node failed.
Not surprisingly, the first regulatory sandbox, officially launched by the UK financial regulator in November 2015, targeted the financial sector. Its relative success led other countries to adopt them promptly. By the end of 2020, over 50 countries were active in this space, while RegTech grew at a similar, if not faster, pace. Moreover, RSx began conquering other policy territories where regulatory challenges emerged. Sectors such as healthcare, energy and renewables, AI, blockchains, and telecommunications, to name a few, were soon rolling out the red carpet to welcome RSx.
From an innovation perspective, RSx can be as disruptive as its digital technology siblings. Thus, embracing them requires policymakers and regulators to do their homework before diving into the disruption pool. Otherwise, critical risks could emerge and have a counterproductive impact.
Thus, policymakers and regulators should be fully aware of the benefits and risks of using (and abusing) RSx and tread carefully to avoid swimming in very heavy quicksands.
Raúl
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