How much regulation can intermediaries bear?

By Shilpa Mankar Ahluwalia, Shardul Amarchand Mangaldas & Co
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Payment gateways (PGs) and payment aggregators (PAs) are payment intermediaries (PIs) that facilitate payments online between a customer and a merchant. The Reserve Bank of India (RBI) has, so far, adopted a light-touch approach to regulating such intermediaries. The RBI issued a set of Intermediary Guidelines in 2009, which required payment aggregators to maintain at a bank a nodal account from which debits, credits and settlement cycles were monitored and controlled. PIs had to meet no direct licensing, capital adequacy, reporting or other requirements.

Given the tremendous growth in digital payments, the RBI has said on a number of occasions that it intended to reconsider the regulatory framework for PGs and PAs. On 17 September 2019, the RBI released a discussion paper setting out: (1) three possible approaches to the regulation of PIs; and (2) a draft regulatory framework on the assumption that it decides to adopt a full licensing regime.

The need to increase scope of regulation

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Shilpa Mankar Ahluwalia
Partner
Shardul Amarchand Mangaldas & Co

The RBI has pointed out that PIs perform a critical role in enabling online payments. They handle not only customer funds but also sensitive customer data. However, customers have limited direct access to PIs to resolve complaints. These factors prompted a re-evaluation of the existing regulatory framework.

The RBI has articulated three approaches to regulation of PIs: (1) status quo: continue with the existing approach, which appears to have worked well in the past decade; (2) limited regulation: PIs will be required to comply with minimum net worth requirements, guidelines concerning the settlement of funds, standards for technology and security platforms and escrow account requirements, but will not be licensed immediately, the licensing regime to be introduced in a phased manner; and (3) full licensing: PIs will require a licence from the RBI to operate under the Payment & Settlement Systems Act 2007 with existing players being given a period of 12 months to comply with the framework.

What full licensing regime will entail

The framework will apply to all online payment transactions except transactions where payments are made against delivery. It focuses on:

  • Net worth: A full licensing framework will impose a significant capital requirement on PIs. This will be the same as prescribed for Bharat Bill Payment operating units, which is currently `1 billion (US$14 million).
  • Fit and proper criteria: There will be an assessment of promoters to ensure they are fit and proper persons when eligibility for licensing is determined, as is done for licensed entities in all other financial services. There will be a requirement for licensed PIs to be professionally managed, although it is unclear whether this will prevent promoter-managed entities from being granted a licence.
  • Know Your Customer (KYC): Most significantly, PAs and PGs will be required to undertake KYC assessment of merchants. Increased KYC requirements have been key challenges for fintech players and have greatly increased costs. The draft outlines an onerous set of procedures that require PIs not only to undertake a full KYC check of a merchant, but also to ensure merchants: (1) do not have malicious intentions of duping customers; (2) do not sell fake, counterfeit or prohibited products; and (3) disclose key merchant policies on their own platforms. This will significantly add to costs, and PIs will face practical difficulties in complying with these procedures. A key question is whether these rules will apply to merchants already on-boarded, as was done in respect of KYC obligations of issuers of payment protection insurance.
  • Data localization: A comprehensive licensing framework will also require data localization in respect of payment-related data to PAs and PGs. This is currently only applicable to entities licensed under the act.
  • Operational changes: The regulations will likely tighten settlement timelines and require customer float to be placed in an escrow account.

Impact of more regulation

PIs are already struggling with recent announcements concerning zero MDR (merchant discount rate) in online transactions. A full licensing requirement will mean higher costs of operation due to compliance obligations, reporting requirements, minimum net worth stipulations and enhanced KYC costs. These changes may not even be necessary, given the limited systemic risk that payment intermediaries pose to the payments ecosystem as a whole. The enhanced level of proposed merchant KYC is not entirely practical. The key areas that limited regulation can improve are the benefits of escrow as against nodal account structures, the infrastructure for customer redress and less onerous KYC obligations.

Shilpa Mankar Ahluwalia is a partner at Shardul Amarchand Mangaldas & Co. and leads the firm’s Fintech practice.

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