CBE Pilots its Fintech Regulatory S

This month witnesses the launching by the Central Bank of Egypt (“CBE”) of a pilot program in the field of financial technology (“fintech”) to evaluate the Regulatory Sandbox for Innovative Fintech Apps (the “CBE Regulatory Sandbox”) that was recently set up by the regulator.[1] Fintech start-ups and technology companies specializing in Electronic Know Your Customer (“e-KYC”) solutions can apply to this round of pilot cohort although generally speaking, registered fintech service providers and licensed financial institutions (including banks) are eligible to apply to the CBE Regulatory Sandbox provided they meet the requirements and criteria related to the products/services they will test as set forth in the CBE’s Framework for the CBE Regulatory Sandbox (the “CBE Framework”). Published last month on the CBE’s website as a “guide for different stakeholders in the fintech system in Egypt”, the CBE Framework defines the contours of the CBE Regulatory Sandbox, with particular emphasis given to outlining the different stages that applicants go through in the Sandbox, their timeframes, and the reporting and procedural requirements and prerequisites. Notably and commendably, CBE highlights throughout the Framework’s pages the lack of proper fintech legislation in Egypt and the Sandbox’s potential role in filling this regulatory gap, while simultaneously maintaining that the Framework itself will be regularly updated, at least biennially, to reflect changes in the market.

Background

In the fintech ecosystem, a “regulatory sandbox” refers to a closed, controlled environment supervised by a regulatory institution and made available to both start-ups and established companies as a testing ground for new fintech products and/or services while partially or totally exempting these start-ups/companies from some rules that would normally be enforced provided they meet certain pre-determined requirements. The rationale behind such a setup is to offer a safe space for both fintech start-ups/companies and consumers as it lowers the regulatory obstacles and costs on the former for experimenting with and developing innovative technologies while safeguarding consumers and other stakeholders from possible repercussions and increasing their access to new products/services in a controlled environment with minimized risks. It could also allow for a more proactive dialogue between regulators and fintech practitioners, thus enabling the former to develop evidence-based legislation to promote inclusive and stable fintech. In this sense, the United Nations Secretary-General’s Special Advocate for Inclusive Finance for Development (“UNSGSA”) discerned two main models for regulatory sandboxes that have been operating to date – product testing sandboxes and policy testing ones – although it maintained that such models often overlapped on the ground and have not been rigidly separated.[2] Historically, the credit for the first regulatory sandbox goes to the United Kingdom, where it was launched in 2015 as a response to the incompatibility of legal rules with financial and technological realities, particularly the slow pace and sometimes even outright absence (if not resistance) of regulatory interventions in dealing with fast, dynamic, and sometimes even disruptive technology-enabled innovation in financial services.[3] Since then a plethora of other countries have implemented a form of this setup and there are regulatory sandboxes now operating or planned in over 50 jurisdictions, including Japan, Singapore, Switzerland, the United States, and several Arab countries like Bahrain, Jordan, Saudi Arabia, and the United Arab Emirates.[4]

The CBE Regulatory Sandbox and its Framework

In keeping with global trends, the CBE’s regulatory initiative offers a formal, free-of-charge way to test new fintech products/services and business models with actual consumers while maintaining certain safeguards and oversight through live, time-bound, limited-scale testing cycles (which CBE terms ‘cohorts’).

• The Sandbox’s Purposes

CBE highlights five interrelated purposes for its Regulatory Sandbox, which all stem from the overall goal of product testing as stated in the CBE Framework. In this sense, it seems that the model undertaken by CBE for its regulatory sandbox is mainly leaning towards product testing (while maintaining some policy testing, or policy development to be more accurate, in the process). As new products and/or services are tested, the following five purposes are to be achieved:

1. Encouraging New Fintech Solutions

The CBE Regulatory Sandbox is designed to encourage the adoption and deployment of innovative fintech solutions in Egypt’s financial and banking sectors.

2. Streamlined Deployment Procedures

Relatedly, the CBE Regulatory Sandbox should help streamline the deployment of innovative fintech solutions in the Egyptian market by making such a process faster and cheaper.

3. Policy Testing/Review

CBE maintains in its Framework that there is a lack of regulatory structures for many innovative fintech activities in Egypt. In this sense, the CBE Regulatory Sandbox is devised to help CBE identify regulatory challenges and obstacles facing innovative fintech in Egypt – whether in terms of existing legislation or the lack thereof – and address them through an experimental, risk management methodology.

4. Promoting Investments in Fintech

Connected to the previous point, the CBE Regulatory Sandbox works towards bolstering investments in fintech by introducing better fintech regulation and thus simultaneously reducing the fears of investors and encouraging more innovation in the field.

5. Raising Institutional Fintech Literacy

Finally, the CBE Regulatory Sandbox works towards contributing to CBE’s literacy on innovative fintech, which would in turn help in more effective and sound policy legislation.

• The Sandbox Lifecycle and its Regulations

CBE identifies five consecutive stages in the Sandbox lifecycle or journey:

1. Application

A 6-month cohort system is followed in the CBE Regulatory Sandbox, wherein CBE announces its opening of the application process and the deadline for each new cohort on the CBE’s official website, the FinTech Egypt Hub, and social media outlets. The cohort size (i.e., the number of applicants to be admitted to the Sandbox) varies depending on the Sandbox’s capabilities and so does the theme of each cohort. Thus, for example, for the ongoing pilot cohort, CBE has specifically invited fintech start-ups and technology companies specializing in e-KYC solutions to apply. General eligibility criteria are set for both applicants and products/services as follows: It is worth noting that CBE calls attention to the flexibility of the eligibility criteria for products/services, noting that they could be amended depending on the context and demands of the market (which are constantly developing).

2. Evaluation of Applications

The CBE Regulatory Sandbox evaluates all completed applications against the eligibility criteria within 21 working days before making its decision regarding which applicants are to be admitted into the announced cohort. Within this period, the Sandbox’s management could request from applicants further details or explanations of their to-be-tested products/services and applicants could revise their applications based on their discussions with the Sandbox’s management.

3. Preparation for Testing

This 21-working-day stage involves the CBE Regulatory Sandbox ensuring, among other things, that the necessary procedures have been undertaken by admitted applicants to inform volunteer consumers of their participation in the testing and to obtain their informed formal consent. It is worth noting that admitted applicants are responsible for getting the volunteer consumers, who must include a sample of the actual targeted consumers post-deployment in the market. Volunteer consumers could either be individuals, retail clients, or corporations. The Sandbox and admitted applicants must also reach an agreement regarding all aspects of the testing stage before the former issues an official acceptance letter for the applicant to proceed to testing.

4. Testing

The actual testing of the products and/or services occurs in this stage, which usually spans half a year, but which could be extended to no more than 12 months as the case requires and after approval from the CBE Regulatory Sandbox’s management. Throughout this stage, periodic evaluations and monthly reports are undertaken and prepared to ensure that the initial targets of the applicants are feasible and achievable. At the end, admitted applicants must submit a detailed final report (that includes, among other things, operational performance measures as well as the risks and operational and technical accidents that occurred) to the Sandbox management within 15 days from the date of end of testing, and the Sandbox then reaches its final evaluation of the applicants within 21 working days.

5. Exit

There are two exit options for admitted applicants from the CBE Regulatory Sandbox: (1) a “natural graduation” with either the success or failure of the testing, or (2) an “early exit” with the termination of the testing. In case of a successful natural graduation, the applicant must prepare for its product’s/service’s partial or full deployment in the market (after obtaining any necessary licenses and meeting the regulatory requirements). In case of a failed natural graduation, the applicant must clarify the reasons for the failure of testing and possible lessons learnt for the future; applicants who have failed could re-apply to ensuing cohorts. As for applicants opting for an early exit, they must notify the Sandbox management by at least a month before the termination of the testing and they must settle any dues to consumers. The Sandbox could also terminate at any time the testing stage of any applicant for not complying with the agreed-upon testing plan and parameters or for other reasons deemed appropriate by the Sandbox management.

Conclusion

Despite the potential for significant growth, economic development, and financial inclusion through the burgeoning fintech scene in Egypt – with an internet penetration of 48% in 2018-2019 and a mobile penetration rate of 101% in February 2019 as per statistics published by the Ministry of Communications and Information Technology – there still remains several challenges facing all stakeholders and the CBE’s initiative in this regard is but a step that needs more refinement.[5] To begin with, the provisions of the CBE Framework related to laws, regulations, and supervision requires more development and clarity. For instance, CBE maintains in its Framework that one of the CBE Regulatory Sandbox’s roles is to “provide sufficient guidance and supervision for all Sandbox admitted participants” including the “provision of regulatory and supervisory support.” It also maintains that the Sandbox is not to be used for circumventing existing laws and regulations, thus requiring the compliance of applicants with “relevant laws and regulations” that cannot be exempted or suspended during the testing stage. These two points, in addition to the requirement that applicants to the Sandbox be registered or licensed, could potentially be problematic when read in parallel with the CBE’s insistence on the absence of regulation for innovative fintech in Egypt and when juxtaposed with a foundational rationale behind regulatory sandboxes, which is the partial or total exemption from obstructing regulation. Accordingly, a first step in the revision of the CBE Framework would be to clarify which regulations or requirements could be relaxed or waived (and in which contexts) and which could not – for example, possible exemption of board composition, governance requirements, and the requirement of being a licensed or registered applicant (and issuing instead Sandbox licenses for non-licensed innovators to enter the Sandbox as has been done in other countries), and the required compliance with consumer protection and confidentiality among other things. In addition, strengthening the policy testing component of the CBE Regulatory Sandbox could prove beneficial to strike a balance between product and policy testing, making the latter more than just a hoped-for collateral outcome, and promoting the Sandbox’s potential in becoming conducive to regulatory structures that are clearer, more accessible, and nurturing to innovation within the fintech ecosystem. Finally, other factors outside of the CBE Regulatory Sandbox’s scope – such as infrastructural problems, the lack of fintech literacy among consumers and other relevant players like SMEs and public entities, the lack of financial literacy generally, and the persisting reliance on and preference for cash – must be simultaneously addressed.[6]   [1] The Central Bank of Egypt, Financial Technology, available through this link. [2] UNSGSA FinTech Working Group and CCAF, (2019), “Early Lessons on Regulatory Innovations to Enable Inclusive FinTech: Innovation Offices, Regulatory Sandboxes, and RegTech”, available through this link. [3] Fenwick, Mark D., Kaal, Wulf A., and Vermeulen, Erik P.M., "Regulation Tomorrow: What Happens When Technology Is Faster than the Law?", American University Business Law Review, Vol. 6, No. 3 (561-594), available through this link. [4] Oxford Business Group, “Innovative tech solutions driving evolution in the global financial services landscape”, available through this link. [5] Ministry of Communications and Information Technology, “ICT Indicators in Brief”, March 2019 – Monthly Issue, available through this link. [6] Nabil, Y. (2019, May 19), “Banking for the unbanked: The growth of fintech in Egypt”, Wamda, available through this link.