RBI’s Regulatory Sandbox: Analyzing the Proposed Framework
After the announcement of a regulatory sandbox by the Reserve Bank of India (“RBI”) governor at the NITI Aayog FinTech Conclave 2019, those in the fintech ecosystem waited eagerly for its criteria and features. On April 18, 2019, the RBI announced the Draft Enabling Framework for Regulatory Sandbox (“Proposed Framework”), detailing the proposed features of the sandbox. The Proposed Framework is a draft for public comments, and is not effective yet. Nishith Desai Associates (“NDA”) has on May 8, 2019 submitted its comments on the Proposed Framework (see Annexure).
The Indian fintech sector has witnessed exponential growth and, by some accounts, is presently the world's second largest fintech hub with more than 2,000 entities operating in this sector.1 While the term “fintech” has emerged from a combination of the words “finance” and “technology”, there is no universal consensus on what innovations fall under the “fintech” umbrella. Some of the major products and services that are now synonymous with fintech innovations include the digital payments ecosystem, peer-to-peer lending platforms, crowd-funding, crypto-assets and blockchain technology, distributed ledgers technology, Big Data, smart contracts, robo-advisors and aggregators.
However, as traditional law and policy development is slow to catch up with the rapid pace of technological innovation, innovators look towards regulators to develop new approaches to support this rapid speed of growth.
In view of the growing significance of fintech innovations,2 the RBI set up an inter-regulatory ‘Working Group on FinTech and Digital Banking’ in July 20163 to study the regulatory responses to such innovations across the globe. The Group included representatives from the RBI, Securities Exchange Board of India (“SEBI”), Insurance Regulatory and Development Authority of India (“IRDAI”), and Pension Fund Regulatory and Development Authority (“PFRDA”), select financial entities regulated by these agencies, rating agencies and fintech consultants and companies.
On February 08, 2018, this Working Group released its report, which, among other things, recommended the formulation of an appropriate framework for a regulatory sandbox. The Working Group noted that sandboxes offered benefits including limited testing which would answer questions, before the product is made available more broadly, on the product’s concerns as well as its potential for success. It observed that the objective of a sandbox should be “to encourage more fintech experimentation within a well-defined space and duration where regulators will provide the requisite regulatory support, so as to increase efficiency, manage risks better and create new opportunities for consumers.”
The Proposed Framework was announced with the above objectives.4
B. What is a Regulatory Sandbox?
The Proposed Framework describes a regulatory sandbox (“RS”) as the live testing of new products or services in a controlled regulatory environment, for which regulators may or may not permit certain regulatory relaxations for the duration of the testing.
Broadly speaking, the objectives of an RS are: (i) for the innovator / fintech entity to test its product in a regulated environment, where regulations are otherwise absent or may be too stringent for the entity; (ii) for the regulator to examine whether existing regulations need to be changed to accommodate that financial innovation; and (iii) to bring benefits to consumers where the proposed innovation shows promise of significantly easing the delivery of financial services.
The Proposed Framework notes that regulators in a sandbox (in this case, the RBI) receive the novel opportunity to conduct carefully monitored field tests and gather first-hand evidence pertaining to the benefits and risks arising out of fintech innovations. Therefore, an RS may potentially replace a “ban first and think later” approach with a more evidence-based regulatory approach.
C. Eligibility Criteria
The eligibility for RS applicants is provided as a list of ‘fit and proper’ criteria,5 which include the following:
o The entity should have been incorporated less than seven years ago, from the time of the RS application;
o The turnover of the entity should not have exceeded INR 25 crore in any financial year;
o The entity should be “working towards innovation, development or improvement of products or processes or services” or be “a scalable business model with a high potential of employment generation or wealth creation.”
(Some of the above criteria raise concerns regarding potentially subjective interpretation).
Industry Verticals: Positive List
The products, services, and technologies expressly stated to be eligible for the RS are: payments, remittance, marketplace lending, digital KYC (Know Your Customer), financial advisory services, smart contracts, financial inclusion products, cyber security products, mobile technology applications, data analytics, API (Application Programming Interface) services, blockchain technologies, and artificial intelligence and machine learning applications.
Industry Verticals: Negative List
The RS expressly provides that the following are excluded from its scope: credit registry, credit information, crypto-currency/crypto-asset activities including Initial Coin Offerings (ICOs), chain marketing services, and any product or service banned by the government. The Proposed Framework also states that financial services already being offered in India may not be suitable for the RS, unless the RS applicant demonstrates that either “a different technology is being gainfully applied or the same technology is being applied in a more efficient and effective manner”.
Since crypto-assets are essential to public blockchain technology,6 it remains to be seen how blockchain projects which are based on public blockchains such as Ethereum (or otherwise use tokens or crypto-assets) will be considered by the RBI. The Ethereum blockchain is used by the Enterprise Ethereum Alliance, which includes Accenture, Deloitte, Government of Andhra Pradesh, HP, Infosys, J.P. Morgan, Microsoft and Samsung as its members.
D. How the Sandbox Works
The RS is proposed to work by selecting cohorts of participants, each with a limited number of entities (proposed to be 10-12 entities initially). Cohorts will be based on themes (e.g., financial inclusion, payments, KYC etc.) and are taken through an end-to-end sandbox process under the oversight of the FinTech Unit (“FTU”) of the RBI. The estimated timeline for each RS cohort is approximately six months.
Each thematic cohort of the RS shall have the following five stages and timeline:
The RS would also be subject to a set of ‘boundary conditions’, which are intended to limit the consequences of failure. These conditions include:
Extensions or exits
RS participants may apply to the RBI for an extension one month prior to the scheduled completion. The participation may also be discontinued at the discretion of the RBI if the intended purpose is not achieved or regulatory requirements are not complied with. Participants may also exit voluntarily with one week’s notice.
Under the Proposed Framework, the RBI may relax specific regulatory requirements (which the RS entity will otherwise be subject to) for the duration of the RS.
While the Proposed Framework does not elucidate the types of regulatory relaxations that may be provided, possible regulatory relaxations that may be considered by the RBI, as contemplated by the Working Group’s report, include: i) quantitative prudential requirements, such as statutory or liquidity requirement, minimum paid-up capital, capital adequacy, license fees, and financial soundness; ii) corporate governance requirements such as board composition, management experience, and fit and proper criteria; and iii) risk management, which includes technology risk management and outsourcing guidelines.
However, compliance with certain regulatory requirements has been stated to be mandatory in all circumstances. These mandatory requirements include customer privacy and data protection measures, secure storage of and access to payment data of stakeholders, security of transactions, KYC/AML7/CFT8 requirements, and statutory requirements (which presumably refers to legislative provisions which the RBI cannot relax).
E. Sandboxes Abroad – Australia, Singapore, U.K.
Globally, an RS is meant to be a safe space for innovators to test their products and services while granting regulatory relaxations for a specified period of time. The Australian Securities and Investments Commission (“ASIC”) released a detailed regulatory framework in May 2016 allowing eligible fintech businesses to test certain specified services in an RS without holding an Australian financial service (AFS) or credit license. This allows eligible businesses to notify the regulator and then commence testing without a licensing process.
The Financial Conduct Authority (“FCA”) of the U.K. introduced a regulatory sandbox in June 2016 which comprises various types of regulatory co-operation including restricted authorisation, individual guidance, informal steers, waivers and no enforcement letters. The Monetary Authority of Singapore (“MAS”) issued the FinTech Regulatory Sandbox guidelines in November 2016.9 Under the Singapore RS, the MAS stated it will provide regulatory support by relaxing specific MAS regulatory requirements for the duration of the sandbox.
The Proposed Framework has borrowed many features from the U.K. and Singapore, which were pioneers in initiating RS regimes. However, Singapore and the U.K. permit regulated financial institutions to apply for the RS, whereas the Proposed Framework is applicable only to ‘start-ups’ as defined by the Government of India.
Additionally, these regulators have innovation hub agreements / fintech bridge agreements among each other. For instance, the FCA Innovation Hub has an agreement with the ASIC Innovation Hub. The U.K. (HM Treasury and the FCA) and Singapore (MAS) also concluded a “FinTech Bridge” agreement under which, among other things, they share information and commit to facilitating the entry of fintech start-ups from the other jurisdiction into their respective regulatory sandboxes.
The RBI has taken an important pro-innovation step by announcing the Proposed Framework. The expectation is that a ‘learning by doing’ approach adopted under the Proposed Framework would allow it to take an empirical approach towards fintech innovation, while both the RBI and RS participants can learn from the sandbox testing to improve regulations and fintech solutions respectively. Additionally, the RS can potentially yield better outcomes for consumers through an increased range of products and services, reduced costs, and an improvement of financial inclusion.
However, the Proposed Framework also presents some challenges such as a high net-worth requirement, ambiguous phrasing of eligibility conditions and other requirements, and the inclusion of crypto-asset activity, which is essential to blockchain technology, in its negative list.
Feedback on the Draft Enabling Framework for Regulatory Sandbox
Recognizing the Proposed Framework as a positive step, NDA took the opportunity to contribute its suggestions, comments and feedback on the Proposed Framework that the RBI kindly put up for public consultation.
– Harshil Agarwal, Aaron Kamath, Jaideep Reddy & Rohan Singh
You can direct your queries or comments to the authors
1 India Fintech Report 2019, Available at https://mediciinnercircle.com/wp-content/uploads/2019/03/FintegrateReport_ExecutiveSummary_Final.pdf
2 Pursuant to a decision of the Government of India’s Financial Stability and Development Council - Sub Committee.
5 Unlike the usual use of ‘fit and proper’ by the RBI, this extends to the RS applicant entity and not just the officers of
6 Since crypto-assets or tokens create the incentive for blockchain participants (hence leading to decentralization
8 Combating the Financing of Terrorism
10 “Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.”