Policymakers around the world are creating “regulatory sandboxes” to foster innovation in the financial sector while keeping alert to emerging risks. One key objective of sandboxes is to facilitate start-ups’ access to capital. The UK Financial Conduct Authority pioneered the world’s first regulatory sandbox in 2015. To date, more than 50 countries have adopted sandboxes, but little evidence exists on whether they actually help innovative fintechs raise funding. And if so, why/how.
A recent working paper from the Bank for International Settlements (BIS) analyzes how entering the UK’s regulatory sandbox affects fintechs’ ability to raise funding. Entry into the sandbox is associated with a higher probability of raising funding and an increase of about 15% in the average amount of funding raised. Evidence suggests that regulatory sandboxes improve access to funding by reducing information asymmetries and regulatory costs for three reasons.
First, the positive effect of sandbox entry on capital raised is particularly pronounced for smaller and younger firms, which are usually subject to more severe informational frictions. Second, sandbox entry is followed by an increase in first-time investors and in the share of investors that are based outside the UK. These investors are likely to face greater information asymmetries due to either geographical distance or a lack of previous relationships. Finally, researchers find that firms with a CEO who has a personal background in financial law benefit less from sandbox entry. This is in line with anecdotal evidence that CEOs without prior experience in financial regulation benefit more from the guidance provided by case officers during the process of obtaining authorization.