Over the past few years India has seen rapid development in the financial technology sector and it has the second highest number of Fintech startups in the world. According to certain estimates, India’s Fintech sector added about 1,300 startups from 2015 to 2018. According to the National Association of Software and Services Companies, India’s Fintech market is expected to be worth US$2.4 billion by 2020.
While the use of technology is beneficial in terms of innovation, efficiency, convenience and advanced security, it also requires identification, monitoring and regulation of new risks. The absence of regulatory certainty in the Fintech sector could hamper its development. In view of the growing number of technological innovations and their impact on the Indian financial sector, the Reserve Bank of India (RBI) had set up a working group in July, 2016, to study the Fintech landscape in India and across the globe and suggest changes to the existing regulatory framework.
The working group released its report and recommendations on 23 November 2017. One of the key recommendations of the working group was the creation of a regulatory sandbox, which, in essence, is a controlled environment where new products and services can be tested. The intent of a regulatory sandbox, from a regulator’s perspective, is to allow it to engage with the ecosystem and formulate regulations that aid and assist the delivery of low-cost products while managing risks. For startups, such a system can be an invaluable opportunity to test the commercial viability of products and to understand applicable regulations, as well as to engage in open dialogue with the regulator, before committing to a full-scale launch.
The RBI accepted the recommendation of the working group and released, for public comments, the Draft Enabling Framework for Regulatory Sandbox on 18 April 2018 (draft framework). The draft framework discusses, among other aspects, objectives, risks and benefits of the sandbox, eligibility criteria for participation, application and other processes, consumer protection and participant liability. The draft framework provides useful guidance on the types of products, services and technologies, which could be considered for testing in the sandbox such as retail payments, money transfer services, marketplace lending, digital know your customer (KYC), financial advisory services, block chain technology and machine learning applications. It also includes an indicative negative list of products, services and technologies (such as credit information, cryptocurrency, chain marketing services, etc.) which are ineligible for the sandbox, unless applicants can show that the product implements new technology or uses existing technology more efficiently.
While the draft framework clarifies that the RBI may consider relaxing regulatory requirements for the duration of the sandbox, on a case-to-case basis, it falls short of specifying the requirements an applicant should meet in order to seek such relaxations. In any event, participants are expected to comply with provisions relating to customer privacy, data protection or storage, security of transactions, KYC, money laundering, terrorism financing and certain other statutory restrictions, which have not yet been specified and there is no exemption provided from compliance with any of the above.
Many other questions regarding the implementation and working of the sandbox remain unanswered by the draft framework, although, they will hopefully be addressed along with stakeholder concerns when the final regulations are rolled out. The Fintech ecosystem will no doubt keep a close watch and study the experiences and outcomes for early sandbox applicants and participants before embracing it as a product development platform.
Sandboxes for Fintech have been in use globally, specifically in jurisdictions such as the UK, Singapore, the Netherlands and Australia. While India has borrowed several features from sandboxes in other jurisdictions, at this point, it proposes to limit participation only to startups as defined by the government.
Investors can take comfort knowing that the RBI is showing willingness to take a more collaborative approach to law making in a sector that often lacks clarity on regulatory compliance. If the final sandbox framework strikes the right balance between the expectations of the regulator, startups and investors, India could retain its position as the preferred Fintech investment destination in Asia in the foreseeable future.
Nivedita Nivargi is a partner and and Vishnu Kale is an associate at Samvad Partners.
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