Ronald Zvendiya economist
A REGULATORY sandbox is a framework set up by a regulator that allows innovators to conduct live experiments in a controlled environment under a regulator’s supervision. The sandbox approach allows regulators to base their regulatory response to innovations on the results of live experiments and make informed decisions on how to appropriately regulate or supervise new products reaching the marketplace.
The Insurance and Pensions Commission (IPEC) has a fundamental role to play as an Insurance sector regulator to ensure that designed or conceived products and concepts do not go directly to the market before being subjected to an innovation testbed or sandbox environment.
The debacle surrounding the June 2011 tripartite partnership between Econet, First Mutual Life, and Trustco (a Namibian-based technical service provider), the “EcoLife” product, remains a stark reminder of the uncertainty and prejudice that policyholders can be exposed to if the regulator does not adequately appreciate a product. Had the regulator been making use of regulatory sandboxes, the “Ecolife” saga could have been averted.
Over the past few years, the insurance sector in Zimbabwe has witnessed a growing number of companies that are keen to offer innovative products and services. These institutions require the regulator’s support in the form of an enabling regulatory environment. However, regulators are faced with a key challenge; how best to protect consumers, ensure fair markets and enforce regulation while allowing these new technologies to flourish.
One of the options available to the regulator is the implementation of the sandbox approach which is underpinned by the test-and-learn principle providing market players and the Insurance and Pensions Commission with a learning opportunity that can, over time, feed into changes in regulatory design.
This would enable the regulator to stay abreast of innovations while promoting products that are safe, reliable, and efficient without compromising on the delivery of its mandate.
The sandbox approach can be implemented using a temporary bespoke regulatory treatment that entails a reduction in regulatory requirements specifically for innovators, in the interest of testing and learning. The types of bespoke regulatory treatment tools most commonly observed include:
Restricted authorisation or reduced licensing requirements — under this tool firms are only permitted to test the ideas that they have agreed on beforehand with the regulator. The main benefit of restricted authorisation is that its requirements are easier for innovators to meet and few resources are invested
Waivers and exemptions — these allow firms to engage in activities that would otherwise constitute an infringement of the rules. They are applied to rules that are considered to be “burdensome” to meet for firms that intend to test an innovation. One of the main advantages is that it enhances regulators’ flexibility to respond to innovative developments. However, regulators may not have the authority or statutory powers required to implement these tools. In some cases, national or international law or codes of practice may impose hard limits on the feasibility of the application of waivers and exemptions.
No-enforcement-action letters (NALs) or letters of no objection — NALs or letters of no objection constitute a commitment by the regulator not to initiate disciplinary proceedings against a firm for engaging in an activity that does not fall within the current regulatory framework, subject to specific restrictions outlined within the letter. These tools may make it possible for regulators to deal with innovative developments that they have never encountered while providing individual firms with more clarity regarding a regulator’s expectations and reducing the regulatory uncertainty that individual firms face. Although regulatory uncertainty may decline for an individual firm when a regulator applies these tools, overall regulatory transparency in the market may decrease. Moreover, the likelihood of an unlevel playing field being created is also heightened. NALs or letters of no objection may also be resource-intensive and complex for a regulator to issue.
The adoption and implementation of the sandbox approach in the insurance sector may bring at least five benefits.
First, a sandbox offers a standardized and publicized framework for dealing with innovations that promote open and transparent communication between the regulator and the sandbox entities to facilitate learning from each other.
Second, the introduction of sandboxes is a clear signal to the market and among the regulatory and supervisory staff that innovation is on the regulator’s agenda.
Third, sandboxes offer a safe space where live experiments can be conducted in a controlled manner and with safeguards in place to contain and compensate for any potential harm to customers and the financial system as a whole.
Fourth, there is potential for a reduced time-to-market cycle by streamlining the authorisation process and reducing uncertainty for market players.
Fifth, sandboxes are expected to improve the insurance penetration ratio is at a low of 3 percent, according to the Insurance and Pensions Commission.
However, the insurance supervisor may face the following challenges in the future:
The supervisor needs to understand how innovations work and are applied to ensure adequate assessment of new products and business models.
The regulator will also need to balance the risks of innovations against the benefits for policyholders and the insurance sector as a whole.
The supervisor will need to evaluate and, where appropriate, adjust their regulatory framework from a prudential and conduct of business perspective to adequately address changed risks and business models.
The regulator also needs to arrange proper technical resources, knowledge, and skills to be able to deal with financial technology in the future. Thus, collaboration with other stakeholders needs to be stepped up to build up and maintain an adequate understanding of innovations.
The sandbox approach is associated with reputational risk. Failed sandbox insurance products may be attributed to the regulator because of its deep involvement. Liability issues in case of failed testing that resulted in harm to customers or other market participants may threaten the reputation of the regulator. In addition, there are also concerns around those affected during the test process since they will not be compensated.
The Insurance products are normally tested for a certain period, which is normally 24 months. On the completion of the testing period, the innovator will exit the sandbox guided by the exit plan which shall guarantee an orderly exit without disruption to the insurance value chain and prejudice to customers.
Thereafter, the entity is allowed to do a full-scale deployment of a successfully tested product or service. However, it is imperative to note that sometimes a product deemed to be successful after an assessment may come with the risks of errors, and the permitted conduct may prove harmful to clients or the service may turn out to have broader effects in the insurance market than previously assumed by regulators.
In conclusion, a sandbox approach is an overarching approach to innovation. It allows innovators to enter the market safely, reduces regulatory uncertainty, and enables regulators to learn how to regulate innovations. However, the multitude of avenues for innovation means that a regulatory sandbox is not a one-size-fits-all solution. It is one instrument among other options, including a test-and-learn approach. For instance, some incremental innovations cannot be tested within a limited period and at a small scale as required by the regulatory sandbox approach.
Zvendiya is an independent economist. These weekly New Perspectives articles, published in the Zimbabwe Independent, are coordinated by Lovemore Kadenge, an independent consultant, past president of the Zimbabwe Economics So-ciety and past president of the Chartered Governance & Accountancy Institute in Zimbabwe (CGI Zimbabwe). — kadenge,email@example.com or mobile: +263 772 382 852.