Tech innovations get tryout in regulatory sandboxes

States are experimenting with regulatory sandboxes that enable companies to test technologies that may conflict with state laws.

“The regulatory sandbox is a way that innovators can apply for a temporary waiver to the existing regulations,” said Jake Morabito, director of the Communications and Technology Task Force at the American Legislative Exchange Council (ALEC). “That way, they can test out a new technology, such as AI or blockchain or autonomous technologies,” without it being licensed or subject to state regulations.

The sandbox also allows state legislators to learn what regulations inhibit innovation. “We can pave the way for regulatory reform and take harmful regulations off the books,” Morabito said. “In the case of AI, the information gleaned by the state legislators can help inform how regulations should be adopted in the future in a way that does not hurt free market and growing businesses,” he said.

North Carolina launched a website for a fintech regulatory sandbox in December 2022, in accordance with an October 2021 law that established the N.C. Innovation Council to oversee it.

The law states that “a person who makes an innovative product or service available to consumers in the regulatory sandbox may be granted a waiver of specified requirements imposed by statute or rule, or portions thereof, if these statutes or rules do not currently permit the product or service to be made available to consumers.” 

Applicants who receive a waiver have 24 months after its approval to test their product or service, although the law calls for an option to extend that, if needed. 

Calling the launch of the sandbox website a milestone for North Carolina, Tariq Bokhari, Charlotte City Council member and leader of the Carolina Fintech Hub, said: “These ideas are foundational in determining what the [state’s] Innovation Council will focus on, and ultimately what the regulatory sandbox will become.”

A broader type of sandbox is called a universal sandbox, which covers all industries, not just fintech, Morabito said. “That is the preferred approach, because it would allow more businesses to access this tool and would allow states … to become more economically competitive and attract more startups,” he added.

For instance, in 2020, Utah set up a legal regulatory sandbox for companies that “have a business or service model that would not have been permitted under the traditional rules governing the practice of law,” according to the state supreme court’s Office of Legal Services Innovation, which oversees the sandbox. Between October 2020 and January, it has received 97 applications and authorized 49 (plus five that withdrew and one that was terminated). On Feb. 23, the court ordered a temporary pause on applications so that the office can work through a backlog.

Participants include LawGeex—a company that offers AI-enabled contract drafting, negotiation and management services—and another that uses blockchain.

Kentucky, South Dakota, Vermont and West Virginia have regulatory sandboxes for the insurance industry, and last year, U.S. Sen. Marsha Blackburn (R-TN) introduced a bill in Congress to create one for agriculture.

Local governments are getting into the game, too. In 2022, the Detroit City Council proposed an autonomous vehicles sandbox that “would give the Office of Mobility Innovation special permitting privileges to expedite and approve permits for companies who would use [a proposed Transportation Innovation Zone] as an incubator to develop their mobility solutions.”

Regardless of the type of sandbox—targeted or universal—governments need to keep a couple things in mind when creating them, Morabito said: “You want it to be open and transparent, and you want the onus to be that [the agency is] permitting experiments. You don’t want it to be just another bottleneck. And then you also want to make sure that the organization itself is funded enough to monitor these tests.”

ALEC has two pieces of model legislation that entities looking to set up sandboxes can use—one for a targeted sandbox and the other for a universal one.

“One path that a lot of states have taken is that they’ll start with a targeted sandbox to prove that the program can work … and then go to universal, where the new technologies like AI can be adopted,” Morabito said.

The United Kingdom was the first to set up a regulatory sandbox in 2015, and by November 2020, 73 sandboxes were established in 57 jurisdictions worldwide, including the United States, according to the World Bank. Arizona was the first U.S. state to create one in 2018, starting with a sandbox for financial technology. Last year, it expanded to a universal one.

“The states have proven that this concept can work,” Morabito said. “As we have AI, especially this new generative AI trend of ChatGPT, sandboxes would be a good way for innovators to test out how can we apply this technology to different sectors and improve economic competitiveness, support customers [and] give them more choice,” he said.