Co-authored by Sam Hay, vacation scheme student
Earlier this month, the UK's Financial Conduct Authority (FCA) and the City of London Corporation announced that they would run a second phase of the joint Digital Sandbox initiative focused on providing support to innovators looking to develop and validate solutions in the area of ESG data and disclosure. This announcement is clearly aligned with the FCA's most recent business plan, which indicated that in ESG matters, one of its aims was to promote innovation in sustainable finance, including making use of technology to bring about change and overcome industry-wide challenges.
In this post, we look at what the sandbox is and what it aims to achieve.
What is the digital sandbox?
The FCA notes that increasingly, innovative new products and services are data centric and has identified an opportunity to support market innovators in the development of financial services ‘Proofs of Concept’ through the creation of a regulatory digital testing environment.
Proof of Concept refers to the process of proving to stakeholders that an idea is viable and fulfills a need in the market. Proof of Concept can highlight potential issues at an early stage in development before the investment of significant resources. A robust Proof of Concept should also play an integral role in attracting investment, demonstrating that the proposed product is financially sound.
The first FCA-City of London Corporation Digital Sandbox pilot ended in February 2021 with 28 participating organisations. The participants were provided with access to a range of development tools, including synthetic data assets for testing purposes, an API marketplace, and a coding environment. Participants were also able to learn from expert mentors and observers. An evaluation of the pilot found that it had accelerated the development of innovative products and solutions within financial services.
The second phase of the initiative will focus on providing support to organisations looking to develop solutions for ESG data and disclosure. This sustainability cohort will have a particular focus on three objectives:
- Achieving transparency in sustainability disclosure and reporting.
- Providing assurance of a listed issuer’s ESG data and validation of its ESG-labelled corporate bond issuance.
- Improving consumer understanding of the ESG characteristics of the products and providers they engage with; and providing visibility of alternatives which are aligned with consumer needs and preferences.
Why focus on sustainability?
This decision to focus only on sustainability implements a recommendation of the Pilot Scheme to focus on one area per cohort moving forward. The FCA's evaluation noted that a narrower focus should result in more sustained engagement from a closer-knit ecosystem, and fewer data assets being required to meet the use cases, resulting in greater depth and granularity for those produced.
Financial services and markets have an important role to play in the transition to a more sustainable future. The FCA has indicated that it is targeting a regulatory approach that creates an environment in which market participants can manage the risks from moving to a more sustainable economy and capture opportunities to benefit consumers. This is in line with the recommendations received from the Treasury in a letter earlier in the year. The letter called upon the FCA to have regard to the government’s commitment to achieve a net-zero economy by 2050 when considering how to advance its objectives and discharge its functions.
There is also significant interest from investors on ESG investing - as investors continue to place importance on the financial and societal benefits of investing responsibly, they are increasingly considering ESG factors in order to identify new opportunities for growth. One example is that ESG and sustainable investment funds are (according to the FCA's recent letter to authorised fund managers) the fastest growing segment of the European Funds Market.
However, this rapid growth in appetite towards investments with strong ESG performance has been somewhat hindered by unsatisfactory ESG data and disclosure. This absence of reliable ESG data can make it difficult for investors to assess whether a particular investment actually fulfils their ESG requirements and preferences.
The sustainability cohort of the Digital Sandbox aims to address this issue of noninformation and misinformation, by driving innovation in the field of ESG data and disclosure. The Digital Sandbox is intended to enable participants to create viable solutions to this problem.
This cohort of the Digital Sandbox is only one of the FCA's methods for drawing out innovation in sustainable areas. The FCA is hosting a second Green Fintech Challenge in early 2022 (broadly, a package of the FCA's support services to help start-ups, incumbents and technology providers navigate regulation and support live market testing of new products and services that will aid the transition to a net zero economy) and a Sustainability TechSprint in October 2021 (aimed at promoting new solutions and proof of concepts to some of the challenges faced by regulators in the area of ESG data and disclosure).
There is clearly much to come and hopefully (!) some useful solutions in this exciting area of crossover between fintech and ESG data and disclosure.