Finance Ministry to modernize the Indian Stamp Act

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Archana Kejriwal | corplaw@vinodkothari.com

The Ministry of Finance, Government of India, through its Department of Revenue, has issued a draft Indian Stamp Bill, 2023[1] on 17th January, 2024 inviting public comments and suggestions within 30 days, with an intent to align it with the modern stamp duty regime. Once enacted, the Bill seeks to replace the Indian Stamp Act, 1899[2].

The Indian Stamp Act, 1899 is a fiscal legislation enacted for the purpose of generating revenue to the Government. Being enacted during the British era, the Act has undergone several amendments from time to time, however, most of the provisions still stand redundant, for instance, proviso under section 8(2) of the Act provides for the treatment of stamp duty on bonds, debentures or other securities issued by the local authority prior to 26th March, 1897, the Act at several places uses denomination of money in ‘anna’ which has no role in the present. Such transitional provisions hold no stand anymore, thus may be removed. Therefore, it has been proposed to modernise the legislation to enable it to deal with the present realities and objectives.

 In this article, we have made an attempt to analyse the changes proposed.

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NBFC Regulation turned sixty

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Vinod Kothari, finserv@vinodkothari.com

Not sure if any cake was cut[1], but NBFC regulation turned 60, on 1st Feb., 2024. It was on 1st Feb., 1964 that the insertion of Chapter IIIB in the RBI Act was made effective. This is the chapter that gave the RBI statutory powers to register and regulate NBFCs.

1964: Insertion of regulatory power

What was the background to insertion of this regulatory power? Chapter IIIB was inserted by the Banking Law (Miscellaneous Provisions) Act, 1963. The text of the relevant Bill, 1963  gives the object of the amendment: “The existing enactments relating to banks do not provide for any control over companies or institutions, which, although they are not treated as banks, accept deposits from the general public or carry other business which is allied to banking. For ensuring more effective supervision and management of the monetary and credit system by the Reserve Bank, it is desirable that the Reserve Bank should be enabled to regulate the conditions on which deposits may be accepted by these non-banking companies or institutions. The Reserve Bank should also be empowered to give to any financial institution or institutions directions in respect of matters, in which the Reserve Bank, as the central banking institution of the country, may be interested from the point of view of the control of credit policy.”

Therefore, there were 2 major objectives – regulation of deposit-taking companies, and giving credit-creation connected directions, as these entities were engaged in quasi-banking activities.

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AIFs ail SEBI: Cannot be used for regulatory breach

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Vinod Kothari | corplaw@vinodkothari.com

The alternative investment management industry in India works in the form alternative investment funds (AIFs), a SEBI-regulated vehicle. Most of the PE, VC funds, and hedge funds in India work in this mode.

AIFs have recently been at the receiving end of regulatory flak. RBI had expressed concerns on use of AIFs by regulated lenders for evergreening, and prohibited regulated entities from making any investment in such AIFs as have investments in their borrowers.

Now, SEBI, vide a Consultation Paper dated 19th January heaped a bunch of similar concerns, and required AIFs to affirm that the AIF or investments therein are not being used for regulatory breaches. These concerns, SEBI says, are a result of an ongoing thematic check on the AIF industry, and SEBI says it has already detected at least 40 cases, involving AUM over Rs 30000 crores, where the structure was used to create dents in existing financial regulations.

Based on Data relating to activities of Alternative Investment Funds (AIFs)

The AIF industry has demonstrated steady growth in recent years. As of September 2023, the assets under management (AUM) of AIFs have surged to 3.88 lakh crores, a substantial increase from the 13,000 crores recorded in September 2015. [See Graph above].   

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Sustainability linked derivatives: An instrument with a potential

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– Vinod Kothari, vinod@vinodkothari.com

Sustainability-linked loans and bonds have been surging globally. While there has been a dip in the recent periods (Q3 and Q4 of 2023) owing to tightening of regulatory conditions, the global volumes of sustainability-linked loans stood at around $ 400 billion[1].

However, there is another instrument – a derivative, which also has a linkage with sustainability targets, and that is making a global buzz. ISDA, having named this Sustainability Linked Derivatives or SLDs, is creating proper documentation basis to take this market forward. As of now, the market for SLDs is neither large nor highly standardised, but as credit defaults rose from nowhere and from a purely OTC product into being in the very thick of the global financial crisis, SLDs also merit close attention.

What is an SLD?

Think of usual derivatives in financial business – it will be an interest rate swap, or cross currency swap/FX forward. An SLD adds a sustainability-linked overlay on a typical IRS or FX hedge transaction.

For instance, assume Borrower X has taken a floating rate loan of $ 100 million, say at SOFR + 100 bps. X now hedges interest rate risk by entering into an IRS with Bank A, whereby Bank swaps this for a fixed rate of 4.5%.

Here, if we add an SLD overlay, Bank A will agree to provide a discount of, say 5 bps if X is able to meet certain specified sustainability KPIs. On the contrary, if X fails to meet the KPIs, then X pays a penalty of equal or a different amount. Depending on the agreement, the discount or penalty, or bonus/malus, may either be exchanged between the counterparties or by spent by either counterparty by way of a donation  for a sustainability cause.

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LEAP to listing: India permits direct listing of shares overseas through IFSC

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MCA & MOF notify rules for the same

– Vinita Nair & Prapti Kanakia | corplaw@vinodkothari.com

January 25, 2024 (Updated on August 31, 2024)

Indian companies were permitted to raise funds from overseas either pursuant to issue of depository receipts listed overseas or having the non-residents subscribe to issuances made in India or by way of borrowing overseas. As an initiative to provide an avenue to access global capital markets, GoI had announced the decision to ease the raising of foreign funds in order to boost foreign investment inflows, unlock growth opportunities, and offer flexibility to Indian companies to raise funds. Consequently, an enabling provision for direct listing of prescribed class of securities on permitted stock exchanges in permissible foreign jurisdictions was inserted vide Companies (Amendment) Act, 2020 in Section 23 of Companies Act, 2013 (‘CA, 2013’), that deals with permissible modes of issue of securities, vide notification dated September 28, 2020, and made effective from October 30, 2023. Thereafter, the Ministry of Corporate Affairs (‘MCA’) notified Companies (Listing of equity shares in permissible jurisdictions) Rules, 2024 (‘LEAP Rules’) effective from January 24, 2024. As listing of shares abroad will result in raising funds from Persons Resident Outside India (PROI), Ministry of Finance (‘MoF’) notified FEMA (Non-Debt Instruments) Amendment Rules, 2024 amending FEMA (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’) with effect from January 24, 2024. SEBI is also expected to roll out the operational guidelines for listed companies to list their equity shares on permitted stock exchanges.[1]

Additionally, FAQs on direct listing scheme (FAQs) have also been rolled out on January 24, 2024. Further, two of the key recommendations of the working group report on Direct Listing of Listed Indian Companies on IFSC Exchanges submitted in December 2023 were to notify the rules under Section 23 (3) and (4) of CA, 2013 and notify necessary amendments in NDI Rules to permit cross-jurisdiction issuance and trading of equity shares of Indian companies on IFSC exchanges.

Presently, both the LEAP Rules as well as NDI Rules have notified International Financial Services Centre in India (‘Gift City’) as the permissible jurisdiction and India International Exchange and NSE International Exchange (‘IFSC Exchanges’) as the permissible stock exchange. International Financial Services Centres Authority (‘IFSCA’) had issued the IFSCA (Listing) Regulations, 2024 effective August 29, 2024 (‘IFSC Regulations’) however, in the absence of enabling provision under CA, 2013 and NDI Rules, Indian companies were unable to undertake listing of securities abroad.

In this article we provide an overview of the regulatory regime and deal with the procedural aspect.

Regulatory regime for listing securities in IFSC

Chapter X of the NDI Rules permits investment by a permissible holder subject to conditions specified in Schedule XI. Schedule XI inter-alia provides the permissible mode of issuance, eligibility conditions for a permissible holder and Indian companies, obligations of the companies and requirements relating to voting rights and pricing.

LEAP Rules prescribe the eligibility norms for unlisted public companies and procedural aspects in relation to timeline and form for filing the prospectus, complying with Indian Accounting Standards post listing etc.

The IFSC Regulations provide the general conditions w.r.t the principles and eligibility criteria for issuer, specific eligibility criteria for IPO, procedural requirements in case of an entity freshly listing on IFSC exchanges (Chapters I, II, III) and also norms for secondary listing of specified securities (Chapter V). Chapter VI deals with listing of special purpose acquisition companies (SPAC).  Comparison of the requirements under IFSC Regulations vis-a-vis under ICDR Regulations is enclosed as Annexure 1.

Mode of Listing

Companies can raise the funds either by issuing fresh capital or by offering the existing shares. In the latter case, the existing shareholders tender their shares. Both the methods are allowed under LEAP Rules & NDI Rules for listing the equity shares on IFSCA exchanges.

Figure 2: Mode of listing

Para 2 of Schedule I to NDI Rules prohibits certain sectors for investment, meaning the company engaged in prohibited sector is not allowed to raise foreign funds[2]. The same conditions are applicable in case of listing in IFSC either by way of fresh issuance/offer for sale. Eg. Nidhi company is a prohibited sector and therefore the nidhi company cannot list its equity share in IFSC.

Further, Schedule I to NDI Rules prescribes sectoral caps which are required to be complied by the public Indian company at the time of direct listing. Refer Cap on Foreign Funds for further details.

Companies ineligible to list in IFSC

NDI Rules, LEAP Rules, and IFSC Regulations provide certain eligibility criteria for companies intending to list the specified securities on permissible stock exchanges. The same are discussed below:

Companies ineligible under LEAP Rules

LEAP Rules are applicable to both unlisted public companies and listed public companies, however, the eligibility criteria under LEAP Rules are applicable to unlisted public companies only. Rule 5 of LEAP Rules provides that the following companies shall not be eligible for listing the equity shares in IFSC;

Figure 3: Companies ineligible under LEAP Rules

Companies ineligible under NDI Rules

Para 3 of Schedule XI to NDI Rules provides the eligibility criteria for direct listing. Para 3(1) & 3(3) is applicable to unlisted public companies and para 3(1) & 3(2) is applicable to listed companies. The eligibility conditions are based on the type of issuance i.e. fresh issuance or offer for sale.

In case of fresh issuance, the following companies are ineligible:

Figure 4: Companies ineligible under NDI Rules, in case of fresh issuance

Most of the conditions above are similar to those provided in Reg. 5, 61, 102, etc. of SEBI (ICDR) Regulations, 2018 (‘ICDR Regulations’) except for the ineligibility arising on account of inspection or investigation under CA, 2013. Chapter XIV of CA, 2013 deals with the requirements relating to inspection, inquiry, and investigation. The Registrar of Companies is empowered to carry out inspection in terms of Section 206 of CA, 2013 and on the basis of the outcome of the same or for other reasons specified in Section 210, the Central Government may order an investigation. In case of inspection or investigation, it is likely that the same may continue for a longer period without any tangible outcome. In such cases, this restriction will act as a deterrent for the companies eligible otherwise. Additionally, reg. 5 (2) of ICDR Regulations, an issuer is not eligible to make an initial public offer if there are any outstanding convertible securities or any other right which would entitle any person with any option to receive equity shares of the issuer. There is no such similar restriction under IFSC Regulations.

The following companies are ineligible, in case of offer for sale by existing shareholders:

Figure 5: Companies ineligible under NDI Rules, in case of offer for sale

Companies Ineligible under IFSC Regulations

Companies incorporated in India/IFSC/foreign jurisdiction are allowed to list on IFSC Exchanges, however, the issuer, any of its promoters, controlling shareholders, directors or existing shareholders offering shares should not be

  • debarred from accessing the capital market; or
  • a wilful defaulter; or
  • a fugitive economic offender

Further, Regulation 9 of IFSC Regulation prescribes certain eligibility criteria for listing such as operating revenue, minimum market capitalization, PBT, etc. (Refer our article IFSC Gateway to Global Access for Indian unlisted companies to understand the conditions in detail). Hence, the entities that are not ineligible as per LEAP Rules, NDI Rules, and IFSCA Regulations and fulfilling the eligibility criteria of IFSC Regulation can list its equity shares in IFSC Exchanges.

Permissible holder

Para 2 of Schedule XI to NDI Rules provides the eligibility criteria for the permissible holders of equity shares listed on permissible stock exchanges. Any Person Resident Outside India (‘PROI’) can be a permissible holder. Thus, an Indian resident cannot hold such shares, however a non-resident Indian can hold such shares (FAQ no. 15 & 16). The said conditions are also applicable to a beneficial owner.[3]

Where a holder is a citizen of a country which shares land border with India, or an entity incorporated in such a country, or an entity whose beneficial owner is from such a country, they can hold equity shares of such a public Indian company only with the approval of the Central Government.

To ensure that the investor is aware of the above conditions of the permissible holders, the Indian company is required to indicate the same in its offer document issued while raising funds in Gift City.

Voting rights on such equity shares will be exercised directly by the permissible holder or through their custodian pursuant to voting instruction only from such permissible holder.

As per RBI Master Directions – Liberalized Remittance Scheme (LRS) investments in IFSCs in securities except those issued by entities or companies in India (outside IFSC) were permitted. RBI Circular dated July 10, 2024 permits availing of financial services or financial products[4] (which inter alia includes securities)within IFSC. However, this cannot be construed to override the eligibility of ‘permissible holder’ prescribed under NDI Rules.

Investment Limit for permissible holder

A permissible holder can invest upto the limits prescribed for foreign portfolio investors i.e. less than 10% of the total paid-up equity capital on a fully diluted basis. That means one single investor can hold less than 10% of the equity share capital on a fully diluted basis of the public Indian Company.

Manner of Purchase/Sale

A permissible holder is allowed to pay the purchase/subscription consideration either to a bank account in India or deposited in a foreign currency account of the Indian company held in accordance with the FEM (Foreign currency accounts by a person resident in India) Regulations, 2015, as amended from time to time.

In case of a sale, the consideration may be remitted out of India or can be credited to the bank account of the permissible holder maintained in accordance with FEM (Deposit) Regulations, 2016 i.e. NRO/ NRE/ FNCR/ SNRR account.

Cap on Foreign Funds

Schedule I to NDI Rules provides the sectoral caps, i.e. the maximum foreign investment permissible in a particular sector. The said conditions are to be complied in case of listing on permitted stock exchanges as well since, listing on IFSC will result in raising funds from PROI. Accordingly, amounts offered to PROI in permissible jurisdiction along with equity shares held in India by PROI should be compliant of the sectoral cap. The aggregate amount held by PROI should not exceed the limits prescribed.

Further, wherever Government approval is required under Schedule I, the same shall be obtained while raising funds from permitted foreign exchange. Eg. in case of print media, foreign investment upto 26% is permitted under government route, therefore a company engaged in print media business can raise only upto 26% from permitted stock exchanges after obtaining requisite approval. 

Also, the company has the option of receiving the funds either in the bank account maintained in India or in the foreign currency account maintained outside India. Indian companies are allowed to keep funds in the foreign currency account maintained with the Bank outside India, until its utilization or repatriation to India. 

Pricing of Equity Shares

Para 6 of Schedule XI to NDI Rules provides for pricing of equity shares to be listed on the permitted stock exchange. LEAP Rules does not prescribe any pricing conditions.

Figure 6: Pricing of equity shares

Other actionable

  • The unlisted public company is required to file the prospectus in form LEAP-1 with ROC within a period of seven days after the same has been finalised and filed in the permitted exchange.
  • Post listing, the company will be required to prepare the financial statements as per Ind AS in addition to any other accounting standard, if applicable.
  • The Indian company will be required to report to RBI through AD Banks in form LEC (FII) about the purchase/subscription of equity shares listed on IFSC Exchanges.[5]

Direct listing overseas v/s depository receipts

Issuance of depository receipts is governed by Depository Receipt Scheme, 2014 read with FEMA NDI Rules and SEBI’s framework for issue of depository receipts. The regime is different from the issue of ADR/ GDR and listing on overseas exchanges.

  • While the Scheme provided for any Indian company being eligible to issue depository receipts, SEBI restricted the eligibility to issue only by ‘a company incorporated in India and listed on a recognised stock exchange in India’. Therefore, unlisted entities are not eligible to issue depository receipts.
  • Mode of listing of DRs are similar to present regime i.e. fresh issuance or OFS of permissible securities.
  • There are 8 permissible jurisdictions for ADR/GDR issuance[6] as compared to just IFSC in case of direct listing.
  • The concept of permissible holder for depository receipts is similar to permissible holder in the context of direct listing (discussed above) such that residents are not eligible to hold the same even as a beneficial owner. In case of depository receipts, even NRIs are ineligible to invest. However, as clarified by SEBI vide circular dated December 18, 2020 issue of DRs to NRIs is permitted pursuant to share based employee benefit schemes which are implemented by a company in terms of SEBI (Share Based Employee Benefits) Regulations 2014[7] and pursuant to a bonus issue or a rights issue;
  • The norms relating to pricing and voting rights are also on similar lines in both cases.

Status after listing

In case of direct listing, Indian companies would be listing its ‘equity shares’ and/or ‘convertible securities’. The Companies Act, 2013 defines the term ‘listed company’ as a company which has any of its securities listed on any recognised stock exchange. However, clause (c) of Rule 2A of the Companies (Specifications of Definitions Details) Rules, 2014 (‘SDD Rules’) provides that public companies which have not listed their equity shares on a recognized stock exchange but whose equity shares are listed on a stock exchange in a jurisdiction as specified in sub-section (3) of section 23 of the Act shall not be considered as a listed company.

Therefore, the status of an unlisted public company will not change upon direct listing and consequently, the additional compliances as applicable to a listed company under CA, 2013 will not apply to such company in view of express carve-out in terms of the SDD rules.

However, every Indian company getting its securities listed on stock exchanges in IFSC will be required to comply with Chapter XII[8] of the IFSC Regulations dealing with listing obligations and disclosure requirements, as applicable.

Minimum Public Shareholding Requirement

Securities Contracts (Regulation) Rules, 1957 (‘SCR Rules’) mandates listed companies in India to have a minimum public shareholding (MPS) of atleast 25% of each kind of equity shares.

On the requirement for minimum offer and allotment to public, Ministry of Finance vide notification dated 28th August, 2024, amended Rule 19 of SCR Rules prescribing a minimum of 10% irrespective of the post issue paid up capital (as opposed to 25% applicable to listed entities in India) for companies intending to list their securities on recognized stock exchanges in IFSC. Further, the continuous listing requirement in Rule 19A has also been amended prescribing MPS requirement of atleast 10%. In case it falls below 10% at any time, the company will be required to bring the public shareholding to 10%  within a maximum period of 12 months from the date of such fall[9].

In this regard, the working group committee suggested that the public holding fulfilling the definition of public shareholding as per SCR Rules[10] should be considered towards MPS and such requirements should be complied in both jurisdictions separately to ensure free float in both jurisdictions. Basis the recommendations, the working group committee recommended making appropriate changes in the SCR Rule. In view of the aforesaid amendment, it seems that MPS norms are required to be separately maintained.

Tax incentives available to permissible holders

Non-residents i.e. permissible holders are exempt from the applicability of capital gains tax in case of transfer of foreign currency denominated equity shares of a company where the consideration is payable in foreign currency pursuant to Section 47(viiab) of Income Tax Act, 1961 read with Notification dated 5th March, 2020. Also, Securities Transaction Tax, Commodities Transaction Tax, and stamp duty in respect of transactions carried out on IFSC exchanges is exempt.

Conclusion

The initiative is quite encouraging and will benefit India Inc. in fundraising, however, the ineligibility on account of pending inspection/investigation needs to be revisited. The requirements post listing, as per IFSC Regulations are also numerous, several of them being on similar lines as provided under Listing Regulations.

[1] As per the press release by PIB.

[2] Prohibited sectors include- Lottery business, Gambling and betting, Chit funds, Nidhi company, Trading in TDR, (a) Real estate business or construction of farm houses, Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes, Atomic energy, Railway operations, Foreign technology collaborations in any form for lottery business and gambling and betting activities.

[3] Beneficial owner as defined as per proviso to sub-rule (1) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005

[4] “financial product” means—(i) securities; (ii) contracts of insurance; (iii) deposits; (iv) credit arrangements; (v) foreign currency contracts other than contracts to exchange one currency for another that are to be settled immediately; and (vi) any other product or instrument that may be notified by the Central Government from time to time.

[5] Inserted vide FEM (Mode of Payment and Reporting of NonDebt Instruments) (Amendment) Regulations, 2024

[6] 1. United States of America – NASDAQ, NYSE 2. Japan – Tokyo Stock Exchange 3. South Korea – Korea Exchange Inc. 4. United Kingdom excluding British Overseas Territories- London Stock Exchange 5. France – Euronext Paris 6. Germany – Frankfurt Stock Exchange 7. Canada – Toronto Stock Exchange 8. International Financial Services Centre in India – India International Exchange, NSE International Exchange.

[7] The onus of identification of NRIs holders, who are issued DRs in terms of employee benefit scheme, would lie with the listed company. The listed company is required to provide the information of such NRI DR holders to the designated depository for the purpose of monitoring of limits.

[8] Part A: General Obligations; Part B: Companies with Specified Securities Listed on Recognised Stock Exchanges as a Primary Listing and Part C: Secondary Listing of Specified Securities.

[9] Manner of achieving MPS has been prescribed vide SEBI Circular dated February 3, 2023.

[10]Rule 2(e) of SCR Rules defines public  shareholding  as equity shares of the company held by public including  shares underlying the depository receipts if the holder of such depository receipts has the right to issue voting instruction and such depository receipts are listed on an international exchange in accordance with the Depository Receipts Scheme, 2014.

Provided  that  the equity shares of the company held by the trust set up for implementing employee benefit  schemes under the regulations framed by the Securities and Exchange Board of India shall be excluded from public shareholding.

Provided  that  the equity shares of the company held by the trust set up for implementing employee benefit  schemes under the regulations framed by the Securities and Exchange Board of India shall be excluded from public shareholding.

Regulatory oversight over Self Regulatory Organisations in the Fintech Sector 

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Analysis of the Draft Framework for Self Regulatory Organization(s) in the Fintech Sector

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[1] Based on a survey of 2 SROs in the digital lending space

Other articles related to the topic:

Rebuilding Regulatory Infrastructure: The New SRO Norms

RBI (Commercial Paper and Non-Convertible Debentures of original or initial maturity upto one year) Directions, 2024

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Harmonising computation for concentration limits across NBFCs

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– Kaushal Shah, finserv@vinodkothari.com 

Reserve Bank of India (RBI) has recently announced amendments to the Credit and Investment concentration norms, specifically targeting Base and Middle Layer Non-Banking Financial Companies (NBFCs). The circular, dated January 15, 2024, brings about notable changes aimed at ensuring uniformity and consistency across NBFCs while computing the concentration norms. 

What has RBI done?

For Middle Layer NBFCs (NBFC-MLs) :

  1. In addition to the use of Credit Default Swaps (‘CDS’), RBI has now allowed NBFC MLs to offset the aggregate exposure with the following additional Credit Risk Transfer (CRT) instruments: 
  • Cash margin/caution money/security deposit held as collateral on behalf of the borrower against the advances for which right to set off is available;

It is pertinent to note that, as per para 84 of the SBR Directions, already requires the NBFC for the purpose of assignment of risk weight to net off the amount of cash margin/ caution money/security deposits held as collateral against the advances out of the total outstanding exposure of the borrower. 

  • Central Government guaranteed claims which attract 0 per cent risk weight for capital computation;
  • State Government guaranteed claims which attract 20 per cent risk weight for capital computation; and 
  • Guarantees issued under Credit guarantee Schemes of Credit Guarantee Fund Trust for Micro and Small Enterprises, Credit Risk Guarantee Fund Trust for Low Income Housing and individual schemes under National Credit Guarantee Trustee Company Ltd
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Decoding the New Norm

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Framework for SROs for financial sector entities

-Srinithi Sreepathy | finserv@vinodkothari.com (Updated as on 29.03.2024)

On December 21, 2023, the Reserve Bank of India presented its first  ‘Draft Omnibus Framework for recognising Self-Regulatory Organisations for Regulated Entities’(‘Draft Omnibus Framework’) in pursuance of its Statement on Developmental and Regulatory Policies dated October 06, 2023. RBI subsequently finalized and issued the Omnibus Framework for  SROs on March 21, 2024.

The Omnibus Framework is in response to a vacuum located between Regulators and the ever-evolving industry dynamic. The RBI had proposed a draft and later finalised the framework, for Self-Regulatory Organisations (SROs) indicating a willingness to enter a collaborative approach to regulatory frameworks.

The Omnibus Framework, taking the increasing number of regulated entities and their growing scale of business into consideration recognises the lack of sufficient industry standards for self-regulation. Identifying this need and being aware of the futility of increasing the burden on regulatory bodies like the RBI, SEBI, or IRDA, (in this case, specifically: the RBI) the framework finds a middle ground by recognising self-regulation amongst members of various industry entities.

What are Self-Regulatory Organisations? What do they Do?

Self-Regulatory Organisations (SRO) are not-for-profit organisations that attempt to bridge the gap between regulation and industry-specific requirements.

Read more: Decoding the New Norm

In the Indian context, the most popular example remains the Association of Mutual Funds India, or the AMFI, an entity incorporated under Section 8 of the Companies Act 2013 as a not-for-profit organisation with the stated intent to act as a facilitator between the Regulatory Body of SEBI/RBI/the Government of India and the Mutual Fund ecosystem. It also aims at formulating standards or “best practices” which shall in turn become the industry status quo for all members to follow and live by. The AMFI also acts as a licensing body for all Mutual Fund distributors in India as per the duties assigned to it by the SEBI.[1] MFIN (Mutual Fund Investment Network) is another example of a successful SRO infrastructure in India. With the emergence of the FinTech Sector in India: Section 8 companies like FACE and DLAI have cropped up with both significant membership and the aim to establish industry standards and Codes of Conduct. The current omnibus[2] offers these institutions the opportunity to get regulatory sanction from the RBI.

The Omnibus Framework defines its intent by stating:

“Self-Regulatory Organisations (SROs) enhance the effectiveness of regulations by drawing upon the technical expertise of practitioners and also aid in framing/ fine- tuning regulatory policies by providing inputs on technical & practical aspects, nuances and trade-offs involved. SROs can also help in fostering innovation, transparency, fair competition, and consumer protection. In sum, self-regulation shall complement the extant regulatory/ statutory framework for better compliance, in letter and spirit.”

To enable the SRO to fulfill the above obligations, the  Omnibus Framework gives power to the SROs to frame necessary standards or codes within the regulatory framework prescribed by RBI. The adoption of the code, however, should not be a substitution for adhering to the necessary RBI Regulations.

What is the purpose of an SRO? Why do they exist?

As per the Omnibus Framework, SROs are expected to primarily act as an interface between the regulatory body and regulated entities. Thus, one of their primary duties extends toward collecting and providing relevant industry-specific data[3] to the Reserve Bank to aid more efficient policy making. Apart from this SROs are also expected to foster greater research, promote compliance practices, ensure inclusive development and effectively act as an industry representative before the regulatory body.

SROs have certain general objectives, as well as specific responsibilities to be undertaken toward both its members as well as the RBI that gives it its credibility. Their responsibilities can be construed in a trifecta of general and specific duties, with specific duties being toward their members and the regulatory body to whom they represent their members. The Omnibus Framework defines “members” as the Regulated Entities which accept the membership of SRO.

Figure 1 SRO General Objectives

[Clause(s) 6 and 7 of the Omnibus Framework]

Through the establishment of “best practices” and industry benchmarks that may be emulated by most if not all entities in a particular industry and recognising that it may be impossible for the average pedestrian to undertake thorough due diligence independently, the SRO acts as a “stamp of approval” toward the validity and trustworthiness of a particular entity. To ensure that the SRO in itself is reliable, they may be subject to periodic audits by the regulatory body, and are also required to submit their annual reports to the Reserve Bank within three months of completion of the accounting year.

They are also required to frame a code of conduct that should be adhered to by their members, provide periodic sector-specific information through bulletins, pamphlets and magazines to increase awareness amongst its members, establish grievance redressal and dispute resolution mechanisms for its members and also educate the public about the grievance redressal mechanisms available to them. The Omnibus Framework allows the SROs to counsel, caution, reprimand, and expel the members as a consequence of violation of the code established by it. However, such consequences cannot result in the imposition of a monetary penalty on the member.

Figure 2: Responsibilities Towards Members and Regulators

Clause(s) 8 and 9

What are the eligibility criteria for forming an SRO?

Figure 3: Eligibility Criteria for SRO Recognition

Further, the Omnibus Framework specifies that the shareholding of an applicant should be sufficiently diversified. The applicant will not be eligible if an entity either singly or acting in concert holds 10% or more in the paid-up share capital of the applicant.

Who are the key stakeholders?

The RBI envisions the present omnibus primarily for entities regulated by the RBI. The SRO, once it receives its Letter of Recognition from the RBI will consequently impact the institutions/entities that comprise the sector it is representative of.

Thus, in the present context, some of the primary stakeholders are:

  1. Banking and Financial Institutions: As the RBI framework is directly impacting regulated entities, the Banking and Financial Institutions Sector becomes the primary stakeholders as they need to ensure compliance with the new standards.
  2. Industry Associations: As the Omnibus Framework aims to solemnise industry bodies and associations for responsible growth in the Financial Sector, these bodies will need to comply with the new framework. These bodies need to comply with the new standards as well as ensure that their members are similarly compliant. For e.g.:
    1. DLAI (Digital Lenders Association of India): Comprising over 80 members and involved in over $5 Billion in annual disbursements, DLAI’s stated objective remains the support of development and best practices in the Digital Lending Industry.
    2. FACE (FinTech Association for Consumer Empowerment): A Section 8 Company, stated to be a “Self-Regulatory industry body of fintech lenders” FACE aims to establish an ecosystem of responsible lending and borrowing.

Figure 4: Stakeholder Action Items

Regulated Entities are advised to proactively comply with emerging industry and governance standards, as well as emerging trends or shifts in interpretation of applicable guidelines/regulations/laws. It is recommended that REs promptly align with these standards, effectively articulate their challenges, and ensure full compliance to maintain industry integrity and operational excellence.

SRO Governance

To ensure a systemic and reliable mode of self-governance, and the ideal operational excellence envisioned above, the SRO in itself, must be reliable. Thus, SROs are subject to certain stringent governance standards.

Figure 5: SRO Governance Mechanism

The Omnibus Framework requires the Board of SROs to frame a policy on the rotation of directors for important positions in the Board of SROs.

How does an entity get recognised as an SRO?

For an entity to be recognised as an SRO it must receive a “Letter of Recognition” from the Reserve Bank. To receive the same, it is required that the SRO submit certain documents to the RBI including but not limited to: A copy of its Memorandum of Association and Articles of Association, details regarding the constitution of its board: its duties, and mode of discharge of obligations. It shall contain the roadmap to achieve minimum membership as prescribed by the RBI within prescribed timelines (which shall not be greater than two years from the date of recognition) and any such further documents as may be necessary. Whilst membership should ideally be achieved by the time of application itself, if not, a clear roadmap on achieving the requisite membership should be provided. The RBI may stipulate a timeline (not exceeding two years) within which this should be achieved.

Membership in SROs shall be voluntary for the members.

Application that does not fulfil criteria liable to be rejected. A fifteen day window, commencing from date of dispatch of intimation from RBI, will be provided to the applicant for rectification.

Figure 6: SRO Application Process

Way forward:

In summary, SROs are the necessary bridge between the regulatory body and the industry. They represent the industry to the regulatory body and interpret directions issued by the regulatory body to the industry so as to ensure consensus and uniformity in interpretation.

Whilst the Omnibus Framework is fairly comprehensive and takes most relevant factors into account, some clarifications and further considerations are required as presented herein:

  1. There is no specific provision as to how many SROs shall be recognised per sector/vertical. As the objective of the SRO is primarily to act as a facilitator between industry bodies, ensure consensus in interpretation and represent the interests of the industry before regulatory bodies, the objective may be defeated if the sector is populated by too many SROs. This issue warrants more comprehensive and detailed attention.
  2. The Omnibus Framework characterises the relationship between the SRO and RBI as an “allyship”. However, further clarification is necessary to define the specific terms and nature of this relationship.
  3. It is essential to clearly delineate the status of Section 8 Companies that undertake SRO functions but fail to secure recognition from the RBI, ensuring a comprehensive understanding of the implications and subsequent procedural actions.
  4. Introducing a mechanism whereby SROs shall grant accreditation to compliant members could also be beneficial and serve dual purposes: it would incentivise new members to join and simultaneously enhance the SRO’s credibility. This practice could also foster an atmosphere of competitive excellence in governance.
  5. It is also imperative that issues of conflict of interest are comprehensively and meticulously addressed to pre-empt potential challenges and maintain operational integrity

[1] However, it is to be noted that the current Omnibus does not make any specific mention of licensing activities that may be carried out by SROs in the future. At this stage it is difficult to predict whether licensing powers similar to AMFI will be granted to other SROs.

[2]  read with the RBI SRO-FT Framework

[3] Omnibus Framework for Recognizing Self-Regulatory Organizations for Regulated Entities, Page: 3

[1]