Recently, Spain took an important step towards achieving a more innovative, competitive, and secure financial sector, thanks to the Council of Ministers’ much awaited approval of draft legislation aimed at encouraging the digital transformation of the financial system. Its primary objective is the creation of a test bed environment, known popularly as a regulatory sandbox. A regulatory sandbox is a supervised and ring-fenced testing environment, where businesses can trial cutting-edge projects with real customers.

We can cite three reasons why this is good news for the Spanish national fintech ecosystem, which includes both traditional banks and new entrants. First of all, by providing a level of regulatory certainty and flexibility, the regulatory sandbox can contribute to reducing the cost and time businesses expend to innovate. Secondly, it represents a key tool for the authorities as they face the challenges of a new digital environment. By providing regulatory authorities with direct visibility to the early development phases of innovative projects, regulatory sandboxes contribute to their learning process, which in turn accelerates the modernization of the regulatory framework, based on prior, empirical evidence. Finally, the approval of the draft bill places Spain among a small number of other countries — six in Europe and less than 30 worldwide — that are at the forefront of innovative policy-making for the financial sector. Spain could very well become an innovation hub attracting global talent and investments.

But what makes a sandbox such a powerful public policy instrument? Just as in any sector — let’s think about the pharmaceutical industry, for example — a trial process that involves real customers is an essential part of any innovative process, because it enables companies to learn and iteratively adjust their value proposition during the early stages.  Of course, this testing phase should be conducted with authority oversight, with maximum guarantees for participants, and ensuring adequate identification and control of potential risks. In heavily regulated sectors, however, this early pilot process is not easy. This is precisely the problem regulators are trying to solve with the creation of regulatory sandboxes. One of the most powerful characteristics of this approach is that it strives for a balance between regulatory flexibility, certainty about supervisory expectations, and security. This is accomplished through the combination of a solid yet innovative legal umbrella — as provided by the bill — and ad-hoc agreements between participating companies and authorities when establishing the rules for each pilot. These agreements contain the roadmap for the testing phases, in which the applicable rules and responsibilities will be detailed, aspects such as the scope and duration of the trial, and the safeguards delivered by the company in order to ensure utmost protection for the participants.

Correctly defining these agreements is therefore a key step for the launch of the regulatory sandbox. Still, there is a long way to go before getting to that stage of the process. Once the parliamentary proceedings are finalized, the Secretary of the Treasury is expected to open the process to the first wave of applications, which in principle can be submitted by any company — regulated or not — with a project that uses innovative technology for the delivery of financial products and/or services. Candidate projects should be far-along enough in the definition phase that they can be tested with real customers, and they should  provide benefits to consumers or the market as a whole. Project applications will be studied and assessed by the Department of Treasury and the corresponding authority or authorities, for example Spain's central bank (Banco de España), the National Securities Market Commission, and/or the General Directorate of Insurance. Once the applicant companies receive the green light from the authorities, and with the prior drafting of the previously mentioned test plan, the experimentation phase will get underway.

In short, we have a few months of intense work ahead, which will undoubtedly require significant effort and coordination on the part of the authorities, but also by the private sector. The expected outcome is promising, because we can move closer to the long-awaited balance between innovative development and necessary financial stability. This step represents an important milestone on that journey.