In the age of Web3 and the metaverse, the term “sandbox” has suddenly taken on a new meaning. No long just a fun place for kids play in, but a series of public policy programs to encourage innovation by entrepreneurs. Now foreign governments and several U.S. states are competing to build the better sandbox to attract the benefits of innovation to their respective jurisdictions.
Sandbox programs can help attract high-potential startups and technology companies by providing an experimenting space for launching innovative financial products. However, for the programs to become successful, state lawmakers and regulators must make it easier for new startups to apply and join. Fortunately, there are examples they can follow.
Arizona became the first U.S. state to launch a sandbox program in March 2018, which has attracted 10 companies since to date. Hawaii’s Digital Currency Sandbox, which began accepting applications in March 2020, currently includes 15 companies. At the federal level, the Consumer Financial Protection Bureau (CFPB) has admitted several participants to its Compliance Assistance Sandbox and Trial Disclosure Sandbox. As of January 2022, at least 11 states have announced the creation of sandbox programs, and several states, such as Louisiana and Ohio, are considering legislation to establish similar programs.
Yet, with a few exceptions, most U.S. sandbox programs have been unsuccessful in attracting participants. For example, Wyoming’s two financial technology (FinTech) sandbox programs began accepting applications in January 2020, but the program had no participants as of November 2021. West Virginia’s FinTech sandbox has only admitted one participant even though the state’s legislature passed the sandbox legislation in March 2020. Likewise, according to publicly available information and correspondence with state regulators, FinTech and insurance-focused sandboxes in Kentucky, Nevada, and Utah have yet to accept any participants — even though these states established their sandbox programs in 2020 or earlier.
While there are many reasons for this lack of participation, overly strict entry criteria are a common problem affecting these programs. For instance, the FinTech sandbox programs in West Virginia and Wyoming require potential applicants to demonstrate physical presence in the state. And while Utah appears to have removed this requirement for its FinTech sandbox, the Utah Commerce Department notes that potential applicants must still “have an established physical location in Utah.”
Such mandatory physical presence requirements pose an additional barrier for non-resident companies — especially as the COVID-19 pandemic increases the prevalence of remote work. Expanding the eligibility criteria for non-resident firms can help state-level sandboxes attract potential applicants that might not have the resources or market incentives to relocate to a different state.
In contrast, Hawaii’s digital currency sandbox, which has the highest number of companies in the U.S., allows entry to non-Hawaii businesses. This flexibility has allowed Hawaii to attract FinTech and money service businesses headquartered across the country. Arizona’s FinTech sandbox also allows non-resident companies to participate. And, of course, the CFPB’s federal sandbox programs have no state-specific physical presence requirements. Removing such requirements for applicants can help states like North Carolina and Florida, which recently created their own sandbox programs, to attract more companies.
Regulators can also take several steps to raise the profile of their respective states’ sandbox programs. State legislation typically gives regulators the authority to sign reciprocal agreements with domestic and foreign counterparts. For example, Arizona’s House Bill 2434, which established the state’s FinTech sandbox, gives the Arizona attorney general the authority to enter into reciprocal sandbox agreements with “state, federal or foreign regulators.” Under such agreements, firms accepted to one sandbox can expand their client base by offering products through another.
State regulators should also consider negotiating reciprocal arrangements with regulators in Australia, Great Britain, Hong Kong, and South Korea, which operate successful sandbox programs. This would be especially worthwhile for large states like Florida, North Carolina, and Ohio, whose sizeable economies can help attract innovative foreign tech companies. For smaller states, designing flexible sandbox programs with liberal entry criteria and residency requirements can improve their sandbox programs’ attractiveness to non-resident foreign companies.
The growing number of sandbox legislation is a step in the right direction, but state governments should not become complacent. Ultimately, for sandbox programs to become successful, state lawmakers and regulators need to open them up for non-resident and foreign companies. Designed properly, sandbox programs can be a valuable tool to help entrepreneurs create new financial products, expand access to financial services, and bolster America’s global economic competitiveness.
Ryan Nabil is a Research Fellow at the Competitive Enterprise Institute (CEI) in Washington, D.C. Ryan is the author of an upcoming CEI report that compares major sandbox programs in the United States and select foreign jurisdictions and provides recommendations for American lawmakers and regulators on designing more effective sandbox programs.
