Utah Becomes Third State to Implement Fintech “Sandbox” but Start-Ups Should be Aware that Regulatory Hurdles Remain
On July 7, 2019, Utah became the third state, along with Arizona and Wyoming, to announce it would be implementing a so-called “regulatory sandbox” aimed at fintech companies. A regulatory sandbox allows start-ups and other industry providers to test products and services on a limited basis without needing to obtain a full licensing and/or regulatory approval. In the fintech space, a states waiving of licensing requirements usually refers to “money transmission” or “money service business” licensing. Money transmission laws are intended to protect consumers using financial services of companies that are not chartered banks. As fintechs and alternative financial services providers like PayPal and Square have grown in prominence, state money transmission laws have risen in importance as the primary regulatory regime governing these services.
A waiver or reduction of these requirements can pay big dividends for start-up companies in the fintech space, as obtaining a license as a money transmitter is a costly endeavor, in terms of both time, money, and other resources. From this perspective, regulatory sandboxes, like the one proposed in Utah and implemented in Arizona and Wyoming, represent a positive step for the continued development of the fintech community, offering start-ups an opportunity to offer and test their products before having to undergo full licensing. However, fintechs looking to these states as a possible answer to their regulatory compliance issues should be aware that participating in a regulatory sandbox is not cure-all and will not insulate a company from other regulatory challenges.
In particular, fintech’s should note that participation in a regulatory sandbox in one state won’t necessarily shield you from an obligation to obtain a money transmission license in other jurisdictions. As noted above, states view their money transmission laws primarily as tools for consumer protection. This means that these laws apply to any person or entity offering services to residents of that state, regardless of where that person or entity itself is located. This, paired with the fact that fintech products are internet based and therefore typically offered across multiple jurisdictions, means that a company that may be exempt from licensing under Utah or Arizona’s regulatory sandbox still faces potential penalties and licensing obligations when that company goes to offer its service in California, Texas, New York and other states. Moreover, fintech companies still need to consider if their activities and services any federal compliance obligations, such as registration with the Financial Crimes Enforcement Network (“FinCEN”) as Money Service Businesses (“MSBs”) and the resulting implementation of Bank Secrecy Act (“BSA”)/Anti-Money Laundering Law (“AML”) policies.
In short, while individual state action to reduce the regulatory burden on fintechs is laudable, without some form of broader relief that reaches across multiple jurisdictions and levels of regulation, it is unlikely to result in the kind of industry wide benefits often touted by the states in question.