Regulatory Sandboxes Give States An Edge Attracting Innovation And Investment

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The latest edition of the Competitive Enterprise Institute’s 10,000 Commandments, an annual report on the federal regulatory burden, estimates the total cost of federal regulations to be $1.9 trillion in 2020. That means the federal regulatory burden faced by Americans is nearly equal in cost to combined federal individual and corporate income tax collections, which came in at $2.076 trillion in 2020. For additional context, the cumulative cost of federal regulations is slightly less than the $2.237 trillion in total 2020 pretax corporate profits. 

Since costly and overburdensome regulations are a challenge not just at the federal level, but also at the state level, many governors and state legislators have been busy proposing reforms and crafting policies that mitigate the cost of state regulatory burdens. Among the newer and more innovative approaches to providing regulatory relief in the states is what’s called a regulatory sandbox. 

The concept of a regulatory sandbox comes from the United Kingdom, which instituted the world’s first in 2016, one specific to the financial technology (fintech) industry. Regulatory sandboxes temporarily relieve businesses of various regulatory burdens and associated costs while they work to bring new services, products, and business models to market. 

“Regulatory sandboxes often reduce the barriers to entry for entrepreneurs and enable them to safely test and iterate on a solution before they invest considerable resources to scale their offerings,” explains a National Law Review article published by Richard Levin, Brandon Neuman, and Jeffrey Kelly on October 19. “In exchange, regulators can gather empirical data about new business models and use an evidence-based approach for future policy decisions. This approach can validate or dispel regulatory concerns about an innovation’s impact and assist regulators and businesses in delivering beneficial services to the marketplace.”

“As the name suggests, a sandbox is a defined environment where innovative companies may safely experiment under the watch and guidance of regulatory agencies,” writes Andrea O’Sullivan, director of the James Madison Institute’s Center for Technology and Innovation. “Firms that successfully complete a sandbox program will grow enough to become a full-fledged business that is regulated similar to every other incumbent…By lowering the initial regulatory costs for market upstarts, these firms may have the chance to grow into competitors that can capably shoulder normal compliance costs, at which point they ‘graduate’ from the sandbox.”

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In 2018 Arizona became the first state in the U.S. to create a regulatory sandbox, one specific to fintech companies like in the U.K. That reform was proposed by Arizona Attorney General Mark Brnovich (R), who first made the case for stateside regulatory sandboxes in a 2017 op-ed in the American Banker: 

“Fintech startups are burdened with a fractured and redundant regulatory system,” Brnovich wrote. “Not only can it take several months to obtain regulatory approval to operate a fintech startup in just one state, but it can cost a startup thousands of dollars in fees, compliance costs and legal work. Launching a product nationwide is harder still. Entrepreneurs navigating our 50-state licensing regime commonly expect two years of frustration and expenses in the millions.”

Attorney General Brnovich worked with Arizona Representative Jeff Weninger (R) to introduce regulatory sandbox legislation. That bill was ultimately signed into law by Governor Doug Ducey (R) on March 22, 2018, making Arizona the first state in the U.S. with a regulatory sandbox. Arizona’s regulatory sandbox, which is administered by Attorney General Brnovich’s office, allows participants to avoid typical regulations for two years, with an option for a one year extension. 

“Our wonderful federal system allows states to try some experiments that may not yet be embraced at the national level,” the Federalist Society wrote about a regulatory sandbox in Arizona when it was proposed by Brnovich. Attorney General Brnovich acknowledges that regulatory sandboxes have been discussed by federal officials, but makes a case for why state officials elsewhere should take action like he did and not wait for help from Washington. 

“The idea of a regulatory fintech sandbox is not new, and while it’s being discussed at the federal level, Congress is moving at a glacial pace,” said Brnovich. “Arizona has always been a state for big ideas and this is just one more place where we are trailblazing in entrepreneurship and innovation. I hope to see the sandbox serve as a catalyst for capital investment in Arizona and provide opportunities for Arizona businesses and consumers to thrive.”

Arizona As A Hub For Policy Innovation

Arizona, as much if not more so than any other state, has been a proving ground in recent years for novel and innovative reforms that have subsequently swept the nation. There is reason to expect this will also be the case with regulatory sandboxes. 

As was the case with the implementation of a regulatory sandbox, Arizona was also the first state to enact occupational licensing reform often referred to as universal license recognition (ULR), in which new Arizona residents who have an occupational license from their previous state, and it is still in good standing, can get to work right away in that licensed field in Arizona. Since Governor Ducey made Arizona the first state with a ULR law, nine other states have enacted broad ULR legislation and eight other states have passed more narrow ULR laws. 

Arizona was also the first state to create Education Savings Accounts (ESAs), enacted in 2011, that help parents and children have more education options and the resources to access them. With its leadership in enacting ESAs, ULR legislation, and other reforms like Right To Try, which was ultimately adopted nationwide, Arizona has established itself as a national leader in policy innovation. As with these other policy initiatives, other states continue to follow Arizona’s lead by enacting regularly sandbox legislation. 

This year members of the North Carolina General Assembly, which is run by Republicans, enacted regulatory sandbox legislation that was signed into law by Governor Roy Cooper (D) on October 15, 2021 after passing with bipartisan support. As it has with Arizona, North Carolina’s new regulatory sandbox is expected to make the Tar Heel State a more attractive place to launch and invest in new companies, technologies, and services. 

“A regulatory sandbox is a creative initiative to keep North Carolina competitive and encourage more businesses to come to the state,” said Jordan Roberts, government affairs director at the John Locke Foundation, a Raleigh-based think tank. “It recognizes that government moves much slower than innovators.”

North Carolina was the 10th state to offer a regulatory sandbox. In addition to Arizona and North Carolina, regulatory sandboxes have also been created in Florida, Hawaii, Kentucky, Nevada, Utah, Vermont, West Virginia, and Wyoming. The expansion of regulatory sandboxes has also continued abroad. As of November 2020, there were 73 FinTech-centric regulatory sandboxes in 57 jurisdictions worldwide, according to the World Bank’s 2020 Report of Regulatory Sandboxes. “The vast majority of these sandboxes,” notes the aforementioned National Law Review article, “focus on promoting innovation in the delivery of digital financial services, and several sandboxes included specific goals of encouraging blockchain, InsurTech, and RegTech solutions.” 

Prior to 2021, all of the regulatory sandboxes created in the U.S. had been industry-specific like the recently-passed North Carolina law that applies to the fintech and insurance industry. The nation’s first general purpose regulatory sandbox, was enacted this year in Utah with the passage of House Bill 217. That bill was signed into law by Governor Spencer Cox (R) on March 22, 2021, which was the three year anniversary of the day that Governor Ducey approved the nation’s first regulatory sandbox. 

Lawmakers in Tennessee and elsewhere have expressed an interest in pursuing regulatory sandbox legislation in 2022. Don’t be surprised if more states follow in Arizona’s footsteps by creating a regulatory sandbox in 2022 that could make any state a more attractive destination to launch and operate a new company.