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In this episode of the Fintech Focus podcast, we’re talking about regulation when it comes to financial tech instead of bending the ear of a venture capitalist or C-Suite exec. We’re heading west to Arizona where fintech startups are being welcomed with open arms into the state’s fintech sandbox, which also happens to be the only one of its kind in the entire nation.

We chat with Evan Daniels, in-house counsel for the Arizona Fintech Sandbox. The sandbox, spearheaded by the state’s attorney general, Mark Brnovich, has gone off like gangbusters so far with three companies getting in the mix and another dozen applying to jump in.

Listen to the podcast below to hear about how Arizona has become an X on the map for fintech startups looking to develop their operations in the fintech space.

Speaker 1: 00:02 Welcome to Benzinga’s Fintech Focus Podcast, your weekly dive into the world of Fintech, featuring conversations with leaders on the front lines of the financial revolution.

Spencer Israel: 00:17 Hey, folks. Spencer Israel here with the Fintech Focus Podcast. Little bit of different show today. Rather than talk to a venture capitalist or a C-suite exec, today we’re talking to a regulator, and not just any regulator, but a state regulator. Evan Daniels, he is the Fintech Sandbox Counsel for the Arizona Fintech Sandbox.

Spencer Israel: 00:37 You’re probably wondering, what is the Arizona Fintech Sandbox? Well, in 2018, Arizona became the first state to launch a regulatory fintech sandbox. Yes, they are the first state to have created a sandbox specifically to foster innovation in fintech and help attract the industry to their state. It was launched at the direction of their AG, Mark Brnovich, and so far has three companies already as members, and another dozen have applied.

Spencer Israel: 01:05 So I spoke to Evan about that. Why did Arizona go out of their way to create a sandbox specifically for Fintech? What do they hope to achieve? And what the terms of the sandbox are? So without further ado, here is my chat with Evan Daniels of the Arizona Fintech Sandbox.

Spencer Israel: 01:27 Evan Daniels, thank you so much for joining the Fintech Focus Podcast.

Evan Daniels: 01:31 Thank you for having me.

Spencer Israel: 01:34 You are the general counsel for the Arizona Fintech Sandbox. Explain exactly why that exists.

Evan Daniels: 01:44 The Arizona Fintech Sandbox was created as a way to foster innovation in Arizona. The fundamental idea behind a regulatory sandbox is that it involves a trade. It’s a trade between existing state regulations and complying with those in the normal course of things before you could start offering certain types of products or services like a money transmission product or a consumer lending product. A business would need to obtain a license from the state regulator here in Arizona that regulates those things.

Evan Daniels: 02:22 What the sandbox does is it lowers some of those barriers to entry in exchange for some more direct involvement with a regulator early on. The trade-off is that you don’t have to comply necessarily with all of the requirements that we have on the books. You get a license, but in exchange, you have to tell us, the Attorney General’s Office, exactly what it is you want to test, and give us access to your books and records. We get to ask a lot of questions to make sure we fully understand the product before it’s approved to begin testing.

Spencer Israel: 03:00 Did the idea for this start … Because I saw that your AG, Mark Brnovich, had written in sort of an op-ed in American Banker way back in 2017. Is that when this was hatched? Or has it been [inaudible 00:03:16]?

Evan Daniels: 03:18 That’s certainly the official kickoff to our involvement. And certainly, Attorney General Brnovich has been a champion for this idea since that time. But really, the idea began when our office, our attention was draw to these programs that were starting to popup around the world, in particular in the United Kingdom where the Financial Conduct Authority, the financial regulator there. Really, I think we’re the first to run with this idea and show that it can be successful and demonstrate that it could be done in a responsible way. As we saw what they were doing and looked into it and researched as much as we could, we thought, “Why not? Why couldn’t we do that as a state here in the US?”

Spencer Israel: 04:08 Why fintech? There are so many emerging industries out there. Why fintech?

Evan Daniels: 04:15 That’s a good question. I think, in the United States, it starts with the fact that financial regulation is so complicated. You have over 20 federal agencies that are involved in financial regulation in some form. You have 50 states. It’s really difficult, especially if you don’t have resources to start a business that services one of these areas that works in these areas.

Evan Daniels: 04:42 So I think fintech is ripe for having some barriers to entry that are lowered. I don’t know that you need, necessarily, all the barriers that exist to get a business started, and it seemed to us the sandbox was a way to allow for ideas to be tested without spending all the resources you might otherwise have to spend just to see if your idea works. And of course, our mission here in Arizona, the Attorney General’s Office is to do … We’re the primary consumer protection regulator here in Arizona, at least in terms of enforcement. We want to make sure, that’s an important duty. That’s something that we take seriously, that Attorney General Brnovich takes seriously.

Evan Daniels: 05:33 The question was, is there a way to foster innovation where it’s happening in the marketplace? And certainly fintech is an area where innovation’s happening irrespective of whether the regulators are keeping up. On top of that, can we do it in a way that maintains our consumer protection duties? In looking at the sandbox model, we thought we figured out a way to do that to accomplish both things.

Spencer Israel: 06:04 What is the fintech scene like in Arizona? It’s not the first place I would have guessed to have launched the regulatory sandbox for fintech, so can you give us an idea of what types of industries specific to fintech and what types of companies are already there?

Evan Daniels: 06:22 I think we’re looking and hoping that this program draws more fintech to Arizona. I mean, certainly as the regulator, I deal with who we have here present in the state, but I think the idea was looking at the way this industry is spread out across the United States. What you see is that venture capital is really concentrated on the coasts. I think some figures that we saw, and these are probably dated by now, but an enormous amount of the investment going into new enterprise in this country is in California, New York, and New England. For a state like ours that’s growing, the Phoenix Metropolitan Area is, I think, a top five, maybe top six in terms of size and population. For a growing state like that, we’ve got to be creative in thinking about how to attract some of these new ventures and new ideas. Now, that’s to say there isn’t tech here and there isn’t a financial presence of established companies here. My understanding is Intel is here. American Express is here. But a program like this, I think the thought is that it can be used to foster innovation and make Arizona an attractive place to come do business.

Spencer Israel: 07:52 What types of companies are you hoping to attract? I assume, typically, when people refer to fintech, usually they’re referring to consumer-facing companies and B2C companies, and that’s what most people think of when they hear the word fintech, at least those who are maybe not in the industry. They think of your Squares and your PayPals and your Venmos and your LendingClubs. All consumer-facing companies. Are you hoping to attract more, those types of companies, the types of firms that can help consumers? Or does it really not matter?

Evan Daniels: 08:27 I think that’s fair to say. I think when you look at what the scope of our sandbox does, the benefit is really to those kinds of companies, the B2C as you described them. I’m sure, of course, that our chamber of commerce and our commerce authority organization here that’s part of our state government, I’m sure that they’re hoping that it creates, or at least it demonstrates an environment that would cast an even wider net than that. But in terms of the legal scope of what the law that was passed puts on the books, I would say that most of the benefit is to those kinds of direct to consumer type companies.

Spencer Israel: 09:13 I guess it was officially launched in August, on August 3rd of 2018. The sandbox is running for 10 years. As of this recording, I believe you have three participants, right? There’s two blockchain-focused companies, and then another credit-type company. Is that right?

Evan Daniels: 09:32 That’s right.

Spencer Israel: 09:34 What types of outreach have you done to try to attract investment? Benzinga is located in Detroit, so again, not an area you would typically assume. There’s a tech scene here, too, but it’s not as large as New York, not as large as San Francisco or Chicago. People are surprised when I say, “Hey, yeah, we’re in Detroit.” So what have you done to try to, since the launch, to attract people and get the word out and try to get people to apply?

Evan Daniels: 10:12 I think we’ve done what we can to try to frankly go on programs like this and just talk with whoever’s willing to listen about the idea, about our vision for what this program could be and for it to mean. Certainly, we don’t claim that this program is going to solve all of the challenges that face financial services companies. Certainly, it’s not going to be the silver bullet that helps businesses get over all the regulatory challenges and hurdles. And certainly, we don’t mean it to signal that, “Come to Arizona, and get into the sandbox, and you can do whatever you want.” It’s definitely not a license to do whatever you want. But the key to it is engaging

Evan Daniels: 11:00 And talking about it, and I do a lot of speaking on programs like this and at conferences. And frankly, I field a lot of phone calls from interested regulators and businesses, and we’ve tried to hold ourselves out as openly as we can and be just willing to answer questions and talk things through. And certainly we learn a lot in that process as well. This is something new that no one else in the country is doing at this point, although I understand that Wyoming has now passed their bill. But I think it starts in the next calendar year, in 2020, but so I can’t say we’re the only anymore, but we’re the only one up and running at least as of this recording and to me, the key is to just keep talking about it, keep engaging and in the process, I hope that we get better at what we’re doing and everyone can see that we’re thinking about this seriously and taking our job very seriously.

Spencer Israel: 12:03 Nothing in government ever passes with 100% support, so what kind of pushback did you guys get about this?

Evan Daniels: 12:10 That is absolutely right. I think what we’ve seen in terms of pushback is some misunderstanding about what we’re trying to accomplish. I think some perhaps view this is a push to actually deregulate financial services industry. I don’t see it that way, I don’t think we’re trying to deregulate. What we’re trying to do is make regulation more flexible. One quick example of that.

Evan Daniels: 12:43 In Arizona, you need to have $100,000 of net worth and demonstrate that to our Department of Financial Institutions in order to obtain a money transmission license. $100,000 is no big deal for an established player, but for a new financial services company that’s creating a customized payment processing platform, for example, $100,000 when maybe you haven’t even obtained your first round of funding is a huge hurdle to overcome. I think the sandbox, the benefit of the sandbox to companies like that is that it allows us to take a look at what they want to do and they might say, “Look, we need a certain set of data in order to demonstrate that our platform works and maybe we only need to engage at a meaningful level with 50 or 100 or a few hundred consumers.”

Evan Daniels: 13:40 And in that circumstance, especially with the Attorney General’s office watching and obtaining real time information about how the test is going on semi-regular basis, there’s no reason why to my mind that $100,000 amount couldn’t be lowered or done away with altogether if they can demonstrate that they’ve got some kind of cash reserve on hand and are able to process those payments safely and always have the money available to process the payments that they are receiving and being responsible for completing on behalf of consumers. So, again this is about regulatory flexibility and not deregulation. I think some of the other criticism that we’ve encountered comes from the term sandbox itself.

Evan Daniels: 14:36 I think some people view that as a signal that, oh, this isn’t serious. Children play in the sandbox and adults play by the rules is one of the prominent quotes that I can recall. And respectfully, again, I just disagree with that. The sandbox term was appealing to us because it identifies a space where experimentation can happen. But it’s contained. Obviously, if we’re gonna go down the road of embracing the metaphor, a sandbox has four corners. It’s a confined space, it’s well-defined, and that’s why we thought it worked as a way to communicate what it was philosophically the program is trying to accomplish.

Evan Daniels: 15:25 So those are the two things that I can think of. The jury is still out on how effective these programs can be. I don’t think there’s a lot of, I don’t know of a single regulator out there that has one of these programs who is claiming that it’s going to solve all of our problems and overcome all the challenges that our system of regulation has. But we’ve got to try new things, we’ve gotta be willing to adopt and try new ideas and there’s some risk inherent in that, but if we don’t do it, we’re going to lose our place as one of the foremost places to do business in the financial sector in the world.

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Spencer Israel: 17:09 What are the terms of inclusion in the sandbox?

Evan Daniels: 17:15 I’m not sure I understand what you mean by that question.

Spencer Israel: 17:17 Like so I apply to get into the sandbox and let’s say I get accepted. What does that come with?

Evan Daniels: 17:26 I see. So, in order to get into the sandbox, we’re looking for businesses that of course fall within the scope of things. We’re thinking about this as a way for companies who need a particular type of authorization in the state of Arizona to come in early to the sandbox and hopefully work their way towards becoming fully licensed. So falling within the scope of what the law defines is the first important part.

Evan Daniels: 17:59 The second part is that we’re looking for things that are innovative. We define innovative in our law as something that might re-imagine a business model or uses technology to provide something that’s truly new, or uses technology to provide consumer benefit in a way that isn’t widely available. We defined it pretty broadly and that was intentional because innovation isn’t, by definition I guess, and just thinking about it, innovation isn’t something that you can anticipate fully. So we wanted it to be broad to make sure that we captured all of the different ways someone might come to us and present a new idea or a new idea of thinking about something that’s been around for a long time. And in doing so, making sure that they can come into the program.

Spencer Israel: 18:56 Are there any specific guidelines or rules that have to be followed once a company gets into the program?

Evan Daniels: 19:05 Yes, the Attorney General’s office is very involved with our participants and with the tests that are taking place in the sandbox. We have monitoring and communication. We talk with our participants regularly to ensure that we understand how the tests are going and what’s going on. Of course our state consumer Fraud X still applies and some of the specific consumer protection focused statutes that are specific to some of the types of products and services that can come into the sandbox still apply.

Evan Daniels: 19:42 Like, for example, in the investment advisor space, there’s a particular requirement that defines particular unfair, dishonest trade practices, and those types of statutes still apply for the things that fall within the sandbox scope. And then apart from that, we work with our applicants to set up data reporting and whatever procedures we feel like we need to understand fully, what’s taking place in the test.

Spencer Israel: 20:18 So assuming everything is by the books and all the T’s are crossed and the I’s are dotted, these companies, they’re basically free to go about building their business, right?

Evan Daniels: 20:29 Yes. Yes. Of course part of our application process is that they really define for us exactly what their test is going to entail. So once we’re on the same page about that, yes, once the test is approved, they are authorized to begin offering their product or service as they told us they’re going to do so.

Spencer Israel: 20:54 And when you say test, you’re referring to the two years that they essentially have, I guess is that to make an MVP?

Evan Daniels: 21:00 To make a what? I’m sorry.

Spencer Israel: 21:02 A minimum viable product, they essentially have two years to get their product out into the marketplace?

Evan Daniels: 21:08 That’s correct. So they have two years to offer their product or service to consumers, and they can do so widely. There are certain limitations on the number of consumers that they can serve. It’s presumptively 10,000. If they demonstrate certain things to us, like capital requirements or anti-money laundering programs. If those kinds of things are in place, of course depending on what the type of product is, they can get up to 17,500. But those caps are hard. We wanted to create some limitation on their ability to offer the product widely. This isn’t a full license of course. This is a test, so the thought is that that kind of participation

Evan Daniels: 22:00 Participation if somebody gets to that point ought to be able to provide enough market data. And I would think if a business is serving 10,000 consumers in Arizona, they’ve probably got a pretty good thing going. And maybe they won’t even need the two years before it’s time to leave the sandbox and become fully licensed. But yes, the two years they have, they can offer the product within that time period.

Spencer Israel: 22:27 So they have to get it to 10,000 consumers or they can’t go over 10,000 consumers?

Evan Daniels: 22:34 Can’t go over 10,000 consumers.

Spencer Israel: 22:36 Okay. What is the ultimate best case scenario for the sandbox?

Evan Daniels: 22:44 I think our best case scenario is that businesses are able to come in, test their ideas. And, of course, we hope that they’re successful. We hope that the idea that they have they’re able to build it out and offer it and there’s value in what is being offered and consumers see the value and benefit from it. And they go from being a sandbox participant to being a fully licensed business in the state of Arizona. I think that’s of course the best case. We don’t see our role though as ensuring that every test is successful. To our mind it’s entirely possible that a test could prove to not be successful. And in that case, the best case scenario is that a wind down occur where no consumers harmed, no one loses their money. Everybody understands exactly the risk that they’re taking in using the product or service. And we live in a marketplace where not everything works out unfortunately. And recognizing that, we view our role as the Attorney General, as making sure that when that happens consumers aren’t harmed as a result.

Spencer Israel: 23:56 Have you heard from other states in the six or so months that the sandbox has been live?

Evan Daniels: 24:02 We have. We’ve talked to several states. You know I mentioned earlier that Wyoming had just passed their version of this program. I understand that there are builds out there in Texas and Utah. I think West Virginia. I understand the District of Columbia, the mayor there has instructed their financial regulator to look into whether a sandbox is a good idea for them. So this is an active space and of course the CFPB the Consumer Financial Protection Bureau is contemplating instituting a product sandbox of its own. So this is definitely an active space and I think we’re going to see more programs of this type. And even if they’re not called sandboxes, I think these innovation-fostering programs are important and hopefully more jurisdictions begin to institute them.

Spencer Israel: 25:01 We’re obviously very early on in the lifespan, the sandbox as I mentioned. Only opened in August but what have you seen so far?

Evan Daniels: 25:13 Well, I think we’ve had over a dozen applications at this point and what that tells me is that there’s a real desire in the marketplace for this sort of interaction with a regulator. As I understand it, of course I’m not out in the business world, but it’s not difficult for me to understand how intimidating it could be to approach a regulator, especially when you have an idea and you’re not sure about whether it’s going to work in the marketplace. It can be very intimidating to go to a regulator and try to present the idea and get some sort of comfort that pursuing this idea in the marketplace isn’t going to result in some kind of adverse regulator action.

Evan Daniels: 26:02 So I think the sandbox is a way for regulators to be a productive participant in the marketplace. I mean, obviously, our mission is different. We’re not there to ensure that every business is successful and makes a profit or accomplishes its aim. We’re there to make sure that the public is safe and protected in accordance with what the law requires of us. But at the same time, I think there’s definitely a responsibility that regulators have to not just interact with those that they regulate but to have the humility to recognize that we don’t necessarily have all the answers and that it behooves us to get out there and learn where the market is heading.

Evan Daniels: 26:54 So I think there’s an educational component to having a program like this where we can go out and we can see some of the new ideas that are being presented in the marketplace and hopefully start to get ahead of some of these things or at least understand them better. And that will inform our work elsewhere. But all that say, I think the lessons that we’ve learned thus far as that there really is an appetite for this kind of program and interaction. I think we are also learning that we have to be judicious with our own commitment of resources.

Evan Daniels: 27:35 This can be a pretty time-intensive endeavor and to do our due diligence requires thoughtfulness and an effort. And some sandboxes, as I understand it, deal with that by resorting to a cohort system, where they look at a set amount of applications and maybe only accept a few. We’ve done it on a rolling basis and we haven’t been overwhelmed yet, but I think it’s important to us that we fully do our due diligence and not be afraid to say no. And I think we’ve demonstrated that by having the number of applications that we’ve had. But only having three participants, I think shows that that we’re taking our duty seriously in this regard.

Evan Daniels: 28:26 So those are the impressions that I have six months in. I think I’m optimistic that in the next six months, we’ll see more regulator involvement and certainly my hope is that we can get out there and talk to more regulators and learn how to work together. Because in this area, I think it’s right for regulators learning how to work together to better maximize the reach and benefits that these programs can provide to the public.

Spencer Israel: 28:56 All right. Evan Daniels is the FinTech Sandbox Council for the Arizona FinTech Sandbox. Evan, thank you so much for joining the FinTech focus podcast today.

Evan Daniels: 29:06 My pleasure. Thanks very much.

Spencer Israel: 29:11 That was our chat with Evan Daniels, the FinTech Sandbox Council for the Arizona FinTech Sandbox. If you enjoyed this interview, leave us a review on any of the platforms through which you get your podcasts, whether it be iTunes, Stitcher or Spotify, all your Google podcasts. Leave us a review. Tell us what you thought. Also subscribe to the Fintech Focus Newsletter, which comes out every Friday. You can get that by going to benzinga.com and clicking on FinTech focus on the right hand side of the page.

Spencer Israel: 29:40 Real quickly, we want to tell you about some upcoming events on the Benzinga calendar next month. April 17 and 18th in Toronto. The third cannabis capital conference is happening. Go to benzingacannabisconference.com to learn more about that. And then the first week of June is the first ever Benzinga trading summit. Go to benzingatradingsummit.com for more information there. That is it for today’s show. Thanks everyone for listening, and we’ll see you next week on the FinTech focus podcast.