Israel Finally Readying a Fintech ‘Regulatory Sandbox’

Aim of program is to make it easier for startups to test new financial products and services in the local market

A Bitcoin (virtual currency) coin is seen in an illustration picture taken at La Maison du Bitcoin in Paris, France, June 23, 2017.
A Bitcoin (virtual currency) coin is seen in an illustration picture taken at La Maison du Bitcoin in Paris, France, June 23, 2017. Credit: BENOIT TESSIER/REUTERS

The Arrangements Law that the treasury will soon be presenting to the cabinet will include rules enabling a “regulatory sandbox” that will give Israeli fast-growing financial technology startups an easier environment to experiment with products and services.

A regulatory sandbox creates the conditions for innovative fintech companies to conduct live experiments in a controlled environment under a regulator’s supervision. Israel has been talking for more than two years about establishing one as a way of spurring growth in the local fintech sector.

The program is designed to help startups hone their business model and for the government to see how legislation and regulations need to change to adapt to emerging financial technologies.

The program will provide financial assistance to participating companies. It also aims to encourage Israeli startups to test out their technology in the local market rather than going directly overseas, as most existing startups do today.

Investment in Israeli fintech startups more than doubled last year to a record $1.8 billion, an all-time record, according to a report Start-Up Nation Central issued two weeks ago. It said Israel was home to more than 500 fintech startups in 2019 and drew about 5% global fintech investment, ranking it fifth after China, the United States, Britain and India.

Yair Fonarov, the author of the report, said the coronavirus was making it harder for young fintech startups to raise money, but that it may present business opportunities in the longer-term. “The pandemic will boost the usage and adoption of new technologies,” he said.

The delay in getting the regulatory sandbox approved has handicapped Israeli fintech startups, officials admit. The idea won cabinet approval nearly two years ago and an interministerial committee formed to hammer out the details made its recommendations in February 2019. But finalizing a program was held by demands from multiple regulators as well as Israel’s three back-to-back elections in 2019 and 2020, which froze a lot of government activity.

The regulatory sandbox will be enacted as soon as possible after it has been legislated, Finance Ministry officials said. But other countries, including Japan, Singapore and Australia, have had programs for startups running for a long time.

In Britain, the Financial Conduct Authority has already been through several cycles of its program since it began in 2016. In its most recent one, 29 companies were awarded places in the program from 99 among applicants. The FCA has even proposed a global sandbox that would allow other financial regulators to join.

Despite the size of the Israeli fintech sector, companies prefer to develop products and service for overseas market mainly because the Israeli market is so small, said treasury officials.

However, they added, in many cases it is the onerous Israeli regulations that deter them. For instance, companies are required to hold face-to-face meetings with first-time clients. The rule is designed to meet “know your client” standards and prevent money laundering. But rules like that are a poor fit for internet-based services.

In addition, many startups have encountered problem opening and maintaining bank accounts in Israel. The problem will at least partially be solved by a policy of granting licenses to financial service providers, including fintech startups, which is due to be implemented shortly after delays.

A draft of the law calls for the sandbox, formally called an Experimental Environment, to be operated by a committee comprising officials from the Bank of Israel’s banks supervision division, the Capital Markets, Savings and Insurance Authority, the Israel Securities Authority and the Anti-Money Laundering Authority.

It will have the authority to create a “regulatory playground” of up to two years, with the option of extending it for a second two years. The sandbox will offer two tracks to participating companies – a licensing track for firms that need approvals from one or more regulators and an escort track for all others.

Companies in the licensing track will be able to apply to regulators to awards them adjusted or less stringent regulations for a limited period of time. One example of a less stringent rule would be to drop the requirement for a minimum number of clients.

Firms in the escort track will benefit mainly from easier terms for meeting anti-money laundering rules. Finance Ministry officials said they hope this will lower the risk startups assume vis-a-vis the law and enable the Bank of Israel to ensure they get access to banking services.

Companies will be chosen for the program based on how innovative their technology is and the risk factors they carry. Benefits to consumer will be another criterion.

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