March 27, 2018

How the CFPB and Other Federal Regulators Can Help State Sandboxes without Messing Them Up

CFPB Should Offer Expertise to States, Certainty to Firms

Brian Knight

Director of the Program on Financial Regulation

I have previously written about how the Consumer Financial Protection Bureau (CFPB) could help state regulatory sandboxes by exempting the conduct of firms operating in, and consistent with the requirements of state regulatory sandboxes from Title X of Dodd-Frank. This assistance is largely defensive in nature, in that it removes regulatory risk from firms. However, with the passage of Arizona’s regulatory sandbox (the first in the country!) it might be worth thinking about how the CFPB (and other federal regulators) could provide positive assistance to the states in a way that doesn’t undo the benefits of the sandbox. I’ll focus on the CFPB here, but similar issues may exist for other relevant federal regulators.

One major way that the CFPB could potentially help is by lending its expertise to assist state regulators in assessing data. This isn’t to imply that states necessarily lack expertise on any given issue, but the CFPB has a lot of economists on staff who should be both able to help the states where needed and interested in the results of the sandbox. Assisting the states without stepping on their toes would help improve the markets for consumer services, and be consistent with the vision Acting Director Mick Mulvaney laid out when calling on state attorneys general to serve as primary enforcers with the CFPB providing assistance.

Of course, one of the potential problems with the CFPB helping is that it risks damaging the trust between companies and state regulators. The sandbox relies on trust, and while a company may be able to trust its state regulator to abide by the terms and limitations of the state sandbox, the CFPB and other federal regulators are not bound by those rules. This means that while the company may feel comfortable with the potential risk they take on at the state level by participating in a sandbox, the federal risk is unknown.

 But is that a bad thing? Do we want companies to avoid risk for violating regulations? It is important to take a moment to clarify something: the firms we are talking about are not bad actors trying to defraud customers, but firms trying new means of serving customers needs in collaboration with state regulators who, in turn, are incentivized to care about consumer protection because the consumers in question are citizens of the state. Discouraging this experimentation is not in the best interests of the consumer.

This is why, if we want state sandboxes to be maximally effective, the CFPB needs to be credibly limited in how it uses the data it obtains if and when it participates in state sandboxes. The ability of the CFPB to exempt certain firms mentioned above could help, but as previously acknowledged, even that exemption only goes so far. While the CFPB can exempt a firm from Title X of Dodd-Frank, it can’t exempt a firm from other federal consumer protection laws, leaving the door open for other federal regulators to intercede.

Congress stepping in to address this would be ideal, but it seems unlikely that Congress will act quickly. Still, the regulators themselves could address at least some of these risks. Regulators could resolve uncertainty via memoranda of understanding between regulators clarifying that they will generally defer to the states.

However, that still leaves the firms seeking some additional level of certainty. My colleague J.W. Verret has argued the answer may lie in regulatory contracts. Under one of these contracts the firm and the regulator would agree to take or refrain from certain acts, such as the regulators using data obtained in the sandbox for an enforcement action outside the sandbox’s terms. If the regulator breaks their promise, the regulated entity can get monetary damages or even an injunction. These agreements could limit regulatory risk for firms entering state regulatory sandboxes, encouraging their use.

The rise of state regulatory sandboxes is a potentially exciting development. The federal regulators have a role to play, both in providing expertise to help the sandbox provide the most useful information for firms, policymakers, and the public, and by showing forbearance and humility to ensure that firms and the states get the benefits of their bargain. This will require transparent, credible, and binding agreements between federal regulators, their state counterparts, and the firms using the sandbox. Hopefully they will be forthcoming.