Arizona creates nation's first testing ground for fintech

Arizona on Thursday became the first state in the nation to grant financial companies a carve-out from certain regulatory requirements so that they can test innovative products with consumers.

Legislation signed by Republican Gov. Doug Ducey establishes a so-called regulatory sandbox modeled after a similar initiative in the United Kingdom. The Arizona measure has drawn support from business organizations but opposition from consumer groups — a dynamic that is likely to be replayed in other states.

Companies that get accepted into the Arizona program will be allowed to forgo state licensing requirements. In most instances, they will be able to offer their products to as many as 10,000 consumers over a two-year period.

The bill’s supporters hope that the measure will attract more financial technology companies, including digital currency firms, to the desert. The Phoenix area has emerged as a hotbed for banking jobs, but fintech startups remain concentrated on the coasts.

“Are we going to be on the forefront, or are we going to suffer the consequences of being behind the curve?” state Rep. Jeff Weninger, who sponsored the legislation, said at a hearing in February.

Consumer advocates have problems with several aspects of the new law. They argue that it does not provide adequate protections for customers of money transmitters, including digital currency users.

They also take issue with the decision to assign the program to the Arizona Attorney General’s office, which they argue does not have the necessary resources or expertise to monitor participating companies, instead of the state’s financial regulatory agency.

Finally, consumer groups oppose the decision to allow auto title lenders to participate in the new program. Auto title lenders are major providers of high-cost consumer credit in the Grand Canyon State, which banned payday loans in 2010.

“Auto title lenders suck so much money out of our communities,” said Zaida Dedolph, director of public policy at the Arizona Community Action Association.

The bill’s supporters note that the new law does not make any changes to, or exempt lenders from, Arizona’s interest rate rules.

Arizona Attorney General Mark Brnovich, a Republican who championed the legislation, dismissed the argument that the law will enable predatory behavior by financial companies.

“I think our track record speaks to the fact that we want to help Arizona consumers, and no Arizona consumers are going to be harmed by this,” he said Thursday in an interview.

Brnovich said he hopes that Arizona will reap economic benefit from being the first state to establish a regulatory sandbox for financial companies. The goal is to attract more of the venture-capital dollars that today go to states like California and New York.

Weninger, a Republican from suburban Phoenix, compared the effort to lure fintech firms to Arizona with steps the Grand Canyon State has taken to become a leader in the testing of autonomous cars. (The latter experiment has drawn scrutiny in recent days, following the death of a pedestrian in Tempe who was hit by one of Uber’s autonomous vehicles.)

“I think we can do the same thing with fintech. I think we can do the same thing with blockchain and digital currencies,” Weninger said in an interview Thursday.

Arizona officials drew inspiration from the U.K., where the government hails its own regulatory sandbox as a success. In a report last fall, the U.K.’s Financial Conduct Authority found that its year-old experiment had reduced the time and cost of getting new ideas into the market and helped facilitate access to capital for innovators.

Following a six-month testing period, around 90% of participating firms continued toward a wider launch of their products, the U.K. report stated.

At an industry conference last October, Christopher Woolard, director of strategy and competition at the Financial Conduct Authority, said that firms that participate in the regulatory sandbox must still abide by consumer protection rules.

“There is no point in having sandboxes where there’s a sort of race to the bottom,” he said.

Many in the U.S. fintech industry lament the absence of a similarly bold initiative by financial regulators in Washington. The Consumer Financial Protection Bureau’s Project Catalyst, an effort to encourage consumer-friendly innovation, has failed to gain much traction.

Arizona is not the only state where lawmakers have been eyeing the possibility of establishing a regulatory sandbox for fintech companies. Similar legislation is currently under consideration in Illinois, where it has also drawn opposition from consumer advocacy groups.