Regulation of invoice discounting start-ups: Is RBI proposing a disproportionate regulation?

following guest post is contributed by Srinivas
, who is presently working as a legal counsel in Ola (ANI
Technologies Private Limited) advising on the regulatory and litigation aspects
of the company. Views expressed are personal.]
Securities and Exchange Board of India (“SEBI”) as the capital market regulator
rightly stepped in to regulate crowd funding through investment in securities,
whether equity, debt or fund based. The Reserve Bank of India (“RBI”) being the
money market regulator, anticipating a disruption in the financial sector, has
evinced interest (through a consultation
issued in April this year) to regulate the on-line platforms engaged
in peer-to-peer (“P2P”) lending which is also a form of crowd funding.
RBI steps in to regulate the P2P lending platforms treating them akin to
non-banking finance companies (“NBFCs”), very well recognizing the business of
financial intermediation. However, it is not yet objectively supported by any
legal considerations, apart from the likelihood that these platforms may
rapidly grow, resulting in high value transactions and thereby being disruptive.
question of whether the operations of the P2P lending platforms (that are pure
play intermediaries with minimal overlap of financial functions) may be
regulated like NBFCs, as the RBI presently intends to do, is difficult to be
answered in the affirmative. For instance, some of the startups functioning in
this space act as invoice discounting market places, where investors may invest
in the invoices of cash strapped small and medium enterprises (“SMEs), which
are raised against blue chip companies, but remain unpaid. The investor invests
at a discounted value of the invoice and achieves returns when the blue chip company
finally pays the outstanding dues. The platform only acts as an intermediary,
which enables an investor and an SME meet over its platform. All other
ancillary services such as the credit worthiness check, legal or accountancy
services are provided though separate entities (assuming that the platform has entered
into separate agreements with such entities) which are already regulated
through statutes such as Credit Information Companies (Regulation) Act 2005,
the Companies Act 2013 or the respective bodies governing professionals such as
lawyers and chartered accountants.
following are certain noteworthy points in the consultation paper:
1.         P2P lending “can be defined as the use of an online platform
that matches lenders with borrowers in order to provide unsecured loans”.
By this definition, asset backed loans against accounts receivables cannot be
treated as P2P lending. Further,
defining the usage of on-line platforms as P2P lending is itself misconstrued.
The platform is merely a facilitator and the actual lending happens between the
participants of the platform i.e. the borrower and the investor.
2.         Fixing the Interest rate – the consultation paper highlights
the risk that the platform may fix interest rates.  An intermediary should ideally not transgress
its function. If the online platform fixes the interest rate to be paid by the
borrower, the regulators may attribute such functions to be financial. A
majority of startups in this space do not determine the discount rate and it is
market driven. However, the regulator may be interested in understanding how
the market driven discount rate is determined by the platform.
3.         The platforms provide the service of collecting loan
repayments and carrying out preliminary assessment of the borrower’s
creditworthiness. The platforms do the credit scoring and make a profit from
arrangement fees and not from the spread between lending and deposit rates, as
is the case with normal financial intermediation. This a clear differentiation
between financial intermediary and an intermediary providing services in
accordance with the Information Technology Act 2000, and the intermediaries
4.         The issues regarding the need for regulating the platform
are as follows:
(a)            the financial services made available through the
platform, are provided by credit information/banking/accountancy firms or the
legal services provided by law firms, which are already regulated under various
statutes. The electronic platform, which brings these regulated institutions
and the platform-participants together, need not be separately regulated;
(b)            as no cash transactions are contemplated, there is no
scope for un-accounted transactions;
(c)            disproportionate regulation of the platform may trickle to
the investor and deter them from investing thereby affecting the working
capital requirements of MSME’s; and
(d)            even if any unregulated P2P platform adopts an unhealthy
practice it would be an anti-competitive practice which the other participants
can address to the Competition Commission of India within the present
competitive ecosystem.
ensures that the end users of the platform stay benefitted without disproportionate
regulatory interference.
5.         The platform facilitates receipt of post-dated cheques from
the borrower in the name of the lender as a proxy for repayment of the loan.
The P2P platform, in general, also helps in the recovery process and as part of
this, follows up for repayments and if need be, employs recovery agents too. Several
platforms collect cheques from the borrowers. If the recovery process only
involves collection of cheques, then in results in the platform acting in the
capacity of an agent of the investor. However, if it also engages recovery
personnel or adopts other coercive measures, then any related criminal actions
of such recovery will be dealt with by the application of penal laws.
6.         In case of NBFCs involved in accepting deposits and lending,
the RBI is clearly interested in regulating the deposits and the lending
activity of such NBFCs. As the P2P platforms by themselves are neither engaged
in the acceptance of deposits nor lending, the regulation should not overstep
the purpose.
mentioned above, any disproportionate regulation may severely impact the
technology-based platforms. The intermediaries may however be guided by prescribing
the standards of due diligence which is required to be undertaken before
providing access to the participants and the relevant stakeholders on to the
platform to avoid any illegal or unscrupulous transactions. The following are
certain instances, which may require selective regulation:
1.         The platform is to ensure that during the registration
process it shall allow only those investors and SMEs who do not fall within the
purview of section 45(s) of the Reserve Bank of India Act 1934 (“RBI Act”).
This section intends to regulate certain non-deposit accepting financial
institutions or individuals or firms engaged in receiving deposits and lending
in any manner. The facilitation exercise should not allow participation by the aforesaid
2.         Any regulations around the confidentiality, use and
processing of data collected from the participants of the platform and the
activity of the platform such as (a) custody of documents; (b) disclosure
requirements to the investors about the borrowers and (c) assured returns on
investment etc. may streamline the operations of these platforms.
3.         Any further regulation beyond the participation on the
platform should only be undertaken under section 45 (JA) of the RBI Act (to
regulate the financial system of the country) only after any tangible effect of
the P2P lending on the financial system is statistically established.
4.         Any regulation under section 45(L) of the RBI Act, which
solely seeks information and statements, may be adhered to. The regulatory
intent appears to be only to gauge the exposure of NBFCs (also when P2P
platforms are treated as NBFCs) to volatility and the likely impact on the
markets. While the information sharing with the regulator may be seemingly
harmless, any direction, which may follow, is unknown territory for a P2P
addition to the above and to put things into perspective, we are directed
towards a question whether operating a platform for trading the receivable of
an SME is actually unregulated or if the Guidelines for
setting up of and operating the Trade Receivables Discounting System

(TReDS) are applicable.
Guidelines are issued by the RBI under section 10(2) read with section 18 of
Payment & Settlement Systems Act, 2007. Further, the intent behind
regulating a trade receivable discounting system appears to be the fact that
the platform is a payment and settlement system and not an NBFC.
there is a likelihood of drawing parallels between the mode of operation of these
platforms and the applicants under the TReDS scheme. However, the significant
difference appears to be the fact that under the model followed by the
start-ups, the financier is an individual investor or an institutional investor,
whereas under the aforementioned guidelines a conventional bank or NBFC is
contemplated to be the party investing in the receivable (invoice). Evidently, the
platforms have not opted to be applicants for an in-principle approval under
the guidelines. The relationship also depends on the kind of contractual
obligations that these platforms have undertaken with each of the platform
is a strong likelihood that these platforms may be asked to assist in ensuring
the compliance with the settlement cycle as prescribed by the RBI as there are payment
obligations by an investor to the SME and subsequently between the blue chip
company and the investor. If a platform is also facilitating the payment
process, it may also be required to keep a track and record of all payments
made between the participants and also to coordinate between the banks of the
the platforms operate currently, the information whether these platforms assist
in the settlement process between the participants on the platform, which is
usually done through the banking channels of the participants, is not known. If
these platforms are is engaged in the same, though they are not applicants
under the aforementioned guidelines, any of the successful applicants who
themselves stand regulated as a payment and settlement system may also want
other similarly functioning entities to also be regulated, thereby requesting
the RBI to act to bring such platforms within the regulatory net.

Srinivas Medisetty

Information Technology (Intermediaries Guidelines) Rules, 2011

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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