Union Budget 2019-20: Impact on Corporate and Financial sector

Safe in sandbox: India provides cocoon to fintech start-ups

-Kanakprabha Jethani

kanak@vinodkothari.com, finserv@vinodkothari.com

Published on April 22, 2019 | Updated as on August 26, 2019

Background

April 2019 marks the introduction of a structured proposal[1] on regulatory sandboxes (“Proposal”). ‘Sandboxes’ is a new term and has created a hustle in the market. What are these? What is the hustle all about? The following article gives a brief introduction to this new concept. With the rapidly evolving entities based on financial technology (Fintech) having innovative and complex technical model, the regulators have also been preparing themselves to respond and adapt with changing times. To harness such innovative business concepts, several developed countries and emerging economies have recognised the concept of ‘regulatory sandboxes’. Regulatory sandboxes or RS is a framework which allows an innovative startup involved in financial technologies to undergo live testing in a controlled environment where the regulator may or may not permit certain regulatory relaxations for the purpose of testing. The objective of proposing RS is to allow new and innovative projects to conduct live testing and enable learning by doing approach. The objective behind the framework is to facilitate development of potentially beneficial but risky innovations while ensuring the safety of end users and stability of the marketplace at large. Symbolically, RSs’ are a cocoon in which the startups stay for some time undergoing testing and growing simultaneously, and where it is determined whether they should be launched in the market. In furtherance to the recommendation of an inter-regulatory Working Group (WG) vide its Report on FinTech and Digital Banking1 , the Reserve Bank of India has released the draft ‘Enabling Framework for Regulatory Sandbox’ on April 18, 20192 . The final guidelines shall be released based on the comments of the stakeholders on the aforesaid draft.

Benefits and Limitations

Benefits:

  • Regulator can obtain a first-hand view of benefits and risks involved in the project and make future policies accordingly.
  • Product can be tested without an expensive launch and any shortcoming thereto can be rectified at initial stages.
  • Improvement in pace of innovation, financial inclusion and reach.
  • Firms working closely with RS’s garner a greater degree of legitimacy with investors and customers alike.

Limitations:

  • Applicant may tend to lose flexibility and time while undergoing testing.
  • Even after a successful testing, the applicant will require all the statutory approvals before its launch in the market.
  • They require time and skill of the regulator for assessing the complex innovation, which the regulator might not possess.
  • It demands additional manpower and resources on part of regulator so as to define RS plans and conduct proper assessment.

Emergence of concept of RS

The concept of RS emerged soon after the Global Financial Crisis (GFC) in 2007-08. It steadily gained prominence and in 2012, Project Catalyst introduced by US Consumer Financial Protection Bureau (CFPB) finally gave rise to the sandbox concept. In 2015, UK Government Office for Science exhibited the benefits of “close collaboration between regulator, institutions and FinTech companies from clinical environment or real people” through its FinTech Future report. In 2016, UK Financial Conduct Authority launched its regulatory sandbox. Emergence of RS in India In February 2018, RBI launched report of working group on FinTech and digital banking. It recommended Institute for Development and Research in Banking Technology (IDRBT) as the entity whose expertise could run RS in India in cooperation with RBI. After immense deliberations and research, RBI announced its detailed proposal on RS in April 2019. Some of the provisions of the proposal are described hereunder.

Who can apply?

A FinTech firm which fulfills criteria of a startup prescribed by the government can apply for an entry to RS. Few cohorts are to be run whereby there will be a limited number of entities in each cohort testing their products during a stipulated period. The RS must be based on thematic cohorts focusing on financial inclusion, payments and lending, digital KYC etc. Generally , 10-12 companies form part of each cohort which are selected by RBI through a selection process detailed in “Fit and Proper Criteria for Selection of Participants in RS”. Once approval is granted by RBI, the applicant becomes entity responsible for operating in RS. Focus of RBI while selecting the applicants for RS will be on following products/services or technologies:

Innovative Products/Services

  • Retail payments
  • Money transfer services
  • Marketplace lending
  • Digital KYC
  • Financial advisory services
  • Wealth management services
  • Digital identification services
  • Smart contracts
  • Financial inclusion products
  • Cyber security products Innovative Technology
  • Mobile technology applications (payments, digital identity, etc.)
  • Data Analytics
  • Application Program Interface (APIs) services
  • Applications under block chain technologies
  • Artificial Intelligence and Machine Learning applications

Who cannot apply?

Following product/services/technology shall not be considered for entry in RS:

  • Credit registry
  • Credit information
  • Crypto currency/Crypto assets services
  • Trading/investing/settling in crypto assets
  • Initial Coin Offerings, etc.
  • Chain marketing services
  • Any product/services which have been banned by the regulators/Government of India

For how long does a company stay in the cocoon?

A cohort generally operates for a period of 6 months. However, the period can be extended on application of the entity. Also, RBI may, at its discretion discontinue testing of certain entities which fails to achieve its intended purpose. RS operates in following stages:

S.No. Stage Time period Purpose
1 Preliminary screening 4 weeks The applicant is made aware of objectives and principles of RS.
2 Test design 3 weeks FinTech Unit finalises the test design of the entity.
3 Application assessment 3 weeks Vetting of test design and modification.
4 Testing 12 weeks Monitoring and generation of evidence to assess the testing.
5 Evaluation 4 weeks Viability of the project is confirmed by RBI

 

An alternative to RS

An alternative approach used in developing countries is known as the “test and learn” approach. It is a custom-made solution created by negotiations and dialogue between regulator and innovator for testing the innovation. M-PESA in Kenya emerged after the ‘test-and-learn’ approach was applied in 2005. The basic difference between RS and test-and-learn approach is that a RS is more transparent, standardized and published process. Also, various private, proprietary or industry led sandboxes are being operated in various countries on a commercial or non-commercial basis. They conduct testing and experimentation off the market and without involvement of any regulator. Asean Financial Innovation Network (AFIN) is an example of industry led sandbox.

Globalization in RS

A noteworthy RS in the Global context has been the UK’s Financial Conduct Authority (FCA) which has accepted 89 firms since its launch in 2016. It was one of the early propagators to lead the efforts for GFIN and a global regulatory sandbox. Global Financial Innovation Network (GFIN) is a network of 11 financial regulators mostly of developed countries and related organizations. The objective of GFIN is to establish a network of regulators, to frame joint policy and enable regulator collaboration as well as facilitate cross border testing for projects with an international market in view.

Final framework for RS

RBI introduced final framework[2] for the RS on August 13, 2019 which is almost on the same lines as the Proposal as mentioned above. However the RBI has relaxed the minimum capital requirement to Rs 25 lakhs in place of Rs. 50 lakhs as required under the draft framework with a view to expand the scope of eligible entities.

Conclusion

Regulatory sandboxes were introduced with a motive to enhance the outreach and quality of FinTech services in the market and promote evolution of FinTech sector. Despite certain limitations, which can be overcome by using transparent procedures, developing well-defined principles and prescribing clear entry and exit criteria, the proposal is a promising one. It strives to strike a balance between financial stability and consumer protection along with beneficial innovation. It Is also likely to develop a market which supports a regulated environment for learning by doing in the scenario of emerging technologies.

[1] https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=46843

[2] https://www.rbi.org.in/scripts/PublicationReportDetails.aspx?ID=938

 

Foreign Entities getting into Payment Systems in India

By Vinita Nair, Vishes Kothari, Rajeev Jhawar & Simran Jalan

(finserv@vinodkothari.com)

India is one of the most exciting markets for fintech startups. Several overseas entities, having already established businesses overseas, want to set up mobile wallets or payments systems in India. This makes them run into two laws, first by virtue of being an overseas entity desirous of moving funds in some form or the other into India, and second because it is entering the payment and settlement systems  space. These bring complexities of foreign direct investment covered by Foreign Exchange Management Act, 1999, and nuances of skeletal, regulation-based law under Payment and Settlement Systems Act, 2007. This article intends to provide an easy-to-comprehend guide to the applicable regulations for overseas entities getting into payment systems in India. Read more

Cryptocurrency on the path to Legalisation?

By Vineet Ojha (finserv@vinodkothari.com)

From conservative investors to cryptocurrency enthusiasts, cryptocurrency has been the hot button issue. In the tech world, a common phrase is “that’s so crazy it just might work”, and hence, an open-source, unregulated, P2P currency has been thriving for the better part of the last decade. The Indian regulators have not taken lightly to the phenomenal increase in the transaction of cryptocurrencies including Bitcoin, in India and globally as they don’t have any intrinsic value and are not backed by any kind of assets. The price of cryptocurrencies therefore is entirely a matter of mere speculation resulting in spurt and volatility in their prices. The recent introduction of crypto tokens by the Government of India may be the first step to the legalization of cryptocurrencies.

This year saw the gradual restriction on cryptocurrency investment by the regulators. The government went all out to eliminate its use in financing illegitimate activities. RBI, on 5th April 2018, directed lenders to wind down all banking relationships with exchanges and virtual currency investors within three months. Yet, it says the feasibility of these coins is being studied and hints at launching its own digital currency. This move saw protests from various exchanges through detailed representations to the RBI on why this ban should be lifted.

It looks like the plea of the investors and exchanges might have been heard as the government is considering launching crypto tokens in India for financial transactions and is evaluating if they can replace smart cards. Unlike cryptocurrency, crypto tokens do not impact the country’s monetary policy as one will have to pay physical money to buy a token. Although, the existing ban on cryptocurrencies is said to continue, it seems like the government is working on regulations and specific actions, including a roadmap for permitting cryptocurrencies in India sometime in the future.

Scenario in India

November 2017, Indian investors made a beeline for cryptocurrencies. The price boom being irresistible, registered an increase in the costumers enrollment for the currency. The value of the cryptocurrency breached the USD 11,000 per bitcoin effectively doubling within a single month. This was despite the murmurs that RBI could potentially declare bitcoin and its kin illegal in India.

December 2017, the regulators buckled up and issued the second warning against these currencies, with the first one being issued way back in December 2013. The finance ministry compares virtual currencies to ponzi schemes.

January 2018, the government continued issuing caveats to clarify that cryptocurrencies are not legal tender. The income tax department reportedly began sending tax notices to investors. Banks suspended the withdrawal and deposit facilities of some exchanges. Some lenders disassociated with them completely.

April 2018, investors were directed to slow transactions in cryptocurrencies on RBI’s command as it considered a proposal for issuing its own digital currency. It said that the feasibility of these coins was under consideration. Exchanges drag the central bank to court in protest.

July 2018, the ban became effective. Some petitioners sought  a stay order from the Supreme Court on the ban at least till the next date of the hearing. However, their request was denied.

August 2018, the government introduced crypto tokens, assuring the exchanges that they are considering a future for cryptocurrency in the economy.

Why Crypto Tokens?

The concept of crypto tokens is different to that of cryptocurrency. Although, terms like cryptocurrency, altcoins, and crypto tokens are often erroneously used interchangeably in the cryptocurrency cosmos, they are all different terms. Cryptocurrency is the superset, and altcoins and crypto tokens are its two subset categories. A cryptocurrency is a standard currency which is used for the sole purpose of making or receiving payments on the blockchain.

The foremost reason for the introduction of crypto tokens is to replace smart cards.  In words of a  senior government official

The committee is examining if crypto tokens can be used to replace smart cards such as metro cards in the public sector to start with. Similarly, in the private sector, it can be used in loyalty programs such as air miles where its use is limited to buying the next ticket and can’t be converted into money,”[1].

The convenience of the token is that it could be stored as a code in any basic mobile feature phone. Secondly, as stated above, tokens don’t expose the monetary policy of the economy as the transaction is basically done through physical money. Hence, the underlying currency is the Rupee. It seems that tokens are more like an experiment by the government or a method to slowly establish a regulated environment for crptocurrencies to thrive.

Conclusion

The government seems to be testing waters with the introduction of tokens. Their intentions are still unclear, either it be to bring back cryptocurrency or to introduce their own digital currency. We will have to wait and see the performance of tokens for a clearer picture.

Please read our related articles on cryptocurrency here:

Legal Nature of Bitcoins: the encrypted digital currency by Vallari Dubey: http://vinodkothari.com/blog/legal-nature-of-bitcoins-the-encrypted-digital-currency-by-vallari-dubey/

Cracking The ‘Bitcoin’ Nut This Budget Session: http://vinodkothari.com/blog/cracking-bitcoin-nut-this-budget-session/


[1] https://www.moneycontrol.com/news/business/markets/sensex-likely-to-be-in-40000-42000-range-by-next-independence-day-2019-poll-2835741.html

Furniture rental startups: A financial perspective

Estimates peg the global furniture rental market at anything between $5-8 billion. Leasing/renting of home durables has seen steep growth. The idea of ownership has been superseded by the desire to gain better experiences by renting or sharing resources. Whatever the absolute numbers, the growth in mobility and intra-country migration suggests that there is a large and ever growing clientele of urban professionals with transferrable jobs and disposable income. Increasing numbers of furniture and appliance rental startups have sprung up to cater to this clientele. This article takes a quick look at the market and its potential in time to come. Read more

SEBI proposes favourable amendments for “Angel Funds”

Integration of Financial Markets and Capital Markets

Cracking the ‘Bitcoin’ nut this Budget Session

Vallari Dubey & Saloni Mathur

finserv@vinodkothari.com
corplaw@vinodkothari.com

Introduction

In the words of Mr. Nassim Nicolas Talib, “Bitcoin is the beginning of something great, a currency without a government, something necessary and imperative.” Read more