The Central Bank of Nigeria is launching a Regulatory Sandbox. Here’s what to know!

On December 12, 2022, the Central Bank of Nigeria (CBN) published an invitation on its website for interested startups and innovators to apply to its Regulatory Sandbox. The CBN’s Sandbox is being launched in partnership with Emtech - a modern central banking infrastructure provider - and has been anticipated since the publication of the CBN’s Framework for Regulatory Sandbox Operations in January 2021. Startups have until February 1, 2023 to apply to be in the first cohort of the Sandbox.

The purpose of the CBN's Sandbox is to enhance innovation, promote financial inclusion, and ensure consumer protection, while providing a platform for engagement with fintech companies in the payments space. This article explores the requirements, eligibility criteria, and benefits of the CBN’s sandbox, and what it might mean for Nigeria’s fintech ecosystem.

But before we dive into all that, let’s take a step back. What are sandboxes, and why are they so important?

What is a sandbox?

A regulatory sandbox is a test area set up by regulators to allow innovators and startups to try out technologies and innovations, through live experiments under the regulator’s supervision. Regulatory sandboxes have become particularly relevant in the fintech space where there’s a growing need to develop regulatory frameworks for emerging business models.

The first Regulatory Sandbox for fintechs was created by the UK’s Financial Conduct Authority (FCA) in 2016. Today, more than 60 countries globally including Australia, Germany, Singapore and Brazil have adopted regulatory sandboxes.

According to a World Bank study, Africa currently has the third highest number of sandboxes worldwide, ahead of North America and South Asia. Countries such as Rwanda, Kenya, Uganda and Sierra Leone have all adopted regulatory sandboxes to drive innovation and financial inclusion. In August, 2022, the Bank of Ghana also announced the launch of its Sandbox in collaboration with Emtech.

Why are sandboxes important?

Over the years, innovations in technology have changed how money moves. For example, mobile money, machine learning, and biometric IDs have shaped the way we conduct business, and enabled more people to participate in the formal economy. But risk is an inevitable part of innovation, and so regulation and sandboxes provide necessary guardrails. Both innovators and regulators return often to the question “how do we continue to facilitate innovations, while decreasing consumer’s exposure to risk?” and work collaboratively to find the ideal compromise.

In essence, regulatory sandboxes are a way to strike a balance between the rapid growth of fintech innovations and the need to mitigate the risks that arise from these emerging business models.

What are some benefits of sandboxes?

Real-time regulatory guidance

Regulatory sandboxes give fintechs the type of access to the regulator that enables them to gain regulatory guidance in real-time. In a regulatory sandbox, a fintech can access tailored support from regulators as it develops its products and services, and creates a space for discussions that ensure that regulatory actions strike the right balance between fostering innovation and mitigating risks.

This collaborative approach helps fintechs to navigate complex legal and regulatory requirements and reduces the legal uncertainty that they often face. This open and active dialogue influences the nature of the relationship between regulators and innovative fintechs towards a relationship characterized by mutual learning and trust.

Reduced time-to-market

As fintechs are able to interact with the regulator earlier in the product development cycle, regulators get a chance to identify problems before they become full issues, which prevents fintechs from heading down the wrong path. This collaborative process enables the smooth development of new innovative products and in turn enables these products to get to market sooner.

Enhanced credibility when seeking investments and partnerships

The fact that a startup is testing its innovation in a regulatory sandbox might give it credibility in the market when seeking investment. A report from the UK Financial Conduct Authority shows that sandboxes can facilitate access to finance for startups as the regulatory oversight can provide a degree of reassurance to investors. In the UK, at least 40% of firms which completed testing in the FCA sandbox received investment during or following the sandbox test.

Improved consumer protection

In a sandbox, fintechs can also access the regulator’s expertise to ensure that their products and services contain adequate security measures and privacy features, which benefits end-consumers.

Sandboxes can inform evidence-based law and policy

Sandboxes are a response to an urgent need felt by the regulator to understand emerging technologies. Beyond the innovator receiving first-hand guidance from regulators on their products and solutions, the regulator also gains a better understanding of emerging technologies and their associated risks. Sandboxes therefore present a mutual learning opportunity for the regulator and the innovator.

In a survey conducted by Consultative Group to Assist the Poor (CGAP), 85 percent of the regulator respondents stated that their goal in using sandboxes was to keep up with changes in the market, and to learn about emerging technologies. Sandboxes enable regulators to gain a deeper understanding of the potential uses and risks of a new technology, which can lead to the development of evidence-based regulations.

In essence, as regulators learn about the opportunities and risks that a particular innovation carries, they are able to revise and shape the regulatory framework and ultimately develop the right regulatory environment to accommodate the innovation. Importantly, regulatory sandboxes signal the openness and willingness of the regulator to evolve with the innovative times.

The Central Bank of Nigeria’s Framework for Regulatory Sandbox Operations

The CBN’s Sandbox aims to encourage fintech innovation, improve access to financial services, and enhance customer experience by improving the delivery of payment services in Nigeria, amongst other goals. We explore the key provisions of the CBN’s Sandbox Framework below.

Who can apply to be in the sandbox?

The CBN has provided two categories of applicants who can apply to participate in the Sandbox.

• Existing CBN Licensees - financial institutions and companies licensed by the CBN
• Local companies in technology, telecom and other industries, that intend to test an innovative payments product or service. This includes companies that are proposing non-regulated financial products or services using emerging technologies. They are innovators of new solutions involving technology that is not currently covered under existing CBN regulations

Applying to the sandbox is completely optional (it’s not a compulsory regulatory requirement) and is especially helpful for newer startups who are looking for a way to build a relationship with the regulator.

How to apply to the Sandbox

Startups can fill out the online application form via the CBN’s registration portal, linked here. Here are the supporting documents required to apply, and startups have until February 1, 2023 to apply to the first cohort of the Sandbox. Applicants can expect to hear back on the status of their approval within 45 to 60 working days after the application closing date.

Approved applications will receive a Letter of Approval (LoA) permitting the applicants to test their innovation when they enter the Sandbox. The CBN’s Sandbox will consist of cohorts which are groups of innovators that gained entry to the sandbox during the same period. The CBN will also continue to engage admitted participants on the scope and duration of the tests, any regulatory flexibilities that participants need, and reporting requirements.

Criteria for acceptance

To qualify for the CBN’s sandbox, products and services must meet certain requirements:

1. The product must be innovative; it must demonstrate the potential to improve accessibility, customer choices, efficiency, security, and quality in the provision of financial services; or the product must open up new opportunities for financial investments in the Nigerian economy.
2. The applicant must ensure that the proposed project stays within a limited transaction value and volume for better risk management.
3. The applicant must have conducted an adequate assessment of the product, service, or solution to confirm its usefulness and functionality. In addition, the applicant must have identified all associated risks, which should not adversely affect consumer experience.
4. The applicant must have the necessary resources to support testing in the sandbox. This includes the necessary expertise to mitigate potential risks and losses.
5. The applicant should have a business plan to show that the product, service or solution can be successfully deployed after exiting the sandbox.

What happens if a startup is successful in the Sandbox?

After completing the sandbox test, the CBN will decide whether the product, service or solution offered by the successful startup should be introduced into the market. For successful applicants, the CBN will provide guidance and support in obtaining operational licenses. This support could be in the form of guidance in filling their applications for a license or advice on the options for addressing identified risk issues, which could reduce the cost of engaging external consultants.

In essence, while successful startups would not receive a license on exiting the sandbox, they would be given a formal approval by the regulator to indicate that they have passed the sandbox requirements. This could be in the form of a Certificate of Completion, Approval-in-Principle (AIP) or other formal document. Possessing this formal approval could also expedite the licensing application process for startups, as they would have received formal backing from the regulator.

Relevant Links

• The CBN Framework for Regulatory Sandbox Operations
• The CBN Regulatory Sandbox: Invitation to Apply
• The CBN Sandbox application link
• FAQs

What can we learn from other countries that have adopted Sandboxes?

As mentioned before, other countries have operated sandboxes over the years. This provides a rich collection of examples from which to learn. What are some approaches that other countries have taken when implementing their sandboxes?

Clear exit requirements

It’s important that sandbox frameworks provide legal clarity on the available exit options for startups in the sandbox. The CBN’s Sandbox Framework is clear on the exit options for successful and unsuccessful sandbox participants. There is however, the gray area of startups that successfully complete the sandbox, but there’s no existing licensing regime for the innovation under the existing regulatory framework.

The approach adopted in Kenya by the Capital Markets Authority of Kenya in cases where a license doesn’t yet exist under the current regulatory framework, is to issue a formal approval which authorizes the startup to carry out temporary operations until an appropriate regulation is adopted.

Access to capital for startups

It's a common misconception that regulatory sandboxes are created to provide funding for startups. It’s important to clarify that unlike startup incubators or accelerators, regulatory sandboxes are created to deliver regulatory outcomes. While there are exceptions where regulators have set up a fund to promote innovation, as is the case in Singapore, this is typically not the norm. While this is not the norm, one cannot deny the importance of access to capital for startups. In essence, how do we graduate startups from sandboxes, with the capacity to go to market if they don't have access to capital?

To support startups during the sandbox, some central banks have adopted "private-sector facilitated sandboxes." This is where a central bank partners with a private sector organization to implement the sandbox. For example, the Bank of Sierra Leone (BSL) launched its Regulatory Sandbox Pilot Program in 2018 in conjunction with the Sierra Leone Fintech Challenge, supported by Financial Sector Deepening Africa (FSD Africa), and the United Nations Capital Development Fund (UNCDF). The Fintech Challenge offered cash prizes and seed capital in addition to the opportunity for admission to the Bank of Sierra Leone’s Sandbox. This partnership with the private sector proved valuable as it helped to mitigate funding constraints for startups participating in the sandbox.

The CBN’s Sandbox currently does not offer capital to startups, but if it does decide to go down this path in future, that could prompt an increase in applications to the initiative.

Cross-sector collaboration

It’s important to mention that the CBN’s Regulatory Sandbox is not the only sandbox in Nigeria. In June 2021, the Securities and Exchange Commission (SEC) released the guidelines for its Regulatory Incubation program. There is also the Financial Services Innovators (FSI) Nigerian Industry Innovation Sandbox which was launched in 2019 with backing from both the Nigeria Inter-Bank Settlement System (NIBSS) and CBN.

Against this background and given the rapid growth of financial innovation, it’s very likely that startups will create innovations that cut across more than one regulator. These cross-sectoral products create the need for coordination and alignment between regulators.

In dealing with this challenge, some regulators have adopted a collaborative approach to regulatory testing. For example, the Fintech Supervisory Sandbox (FSS), launched by the Hong Kong Monetary Authority in 2016, collaborated with the Securities and Futures Commission (SFC) and the Insurance Authority (IA) to set up a single point of entry for pilot trials of cross-sector fintech products. The unique feature of this collaboration was that each regulator maintained its own sandbox. In practice, if a startup wanted to test a cross-sector fintech product, it would apply to gain access to the most relevant sandbox. The regulator would then act as a primary contact and liaise with the other regulators, so the startup can access their sandboxes concurrently.

If the CBN were to adopt a similar approach, this would mean that fintechs with innovations that cut across more than one regulator could have access to multiple regulators through a single point of contact. This formal coordination mechanism would also help in coordinating sandbox tests across multiple regulators. This collaborative model has been a significant enabler in the Hong Kong fintech ecosystem.

Other methods of ensuring regulatory alignment for cross-sector fintech products include joint committees, referral mechanisms, or alignment through memoranda of understanding.

Learn even more about regulatory sandboxes with the Decode Fintech Roundtable

We hope this piece has been helpful in understanding the role of the CBN sandbox in supporting fintech innovation in the ecosystem.

If you’d like to learn even more about the role of regulatory sandboxes in financial ecosystems, watch the latest Decode Fintech Roundtable where we chat with Tunji Odumoboni, the Executive Director of Emtech, and explore further the ramifications of the CBN’s sandbox.