SEBI’s Framework for Innovation Sandbox – Infusing FinTech into India’s Securities Markets

[Mansi Mishra is a 2nd year B.A.LL.B. (Hons) student at National Law Institute University, Bhopal]

The Securities and Exchange Board of India (SEBI), amidst much speculation in the securities market, proposed the “Framework for Innovation Sandbox” by way of its circular dated 20 May 2019. This post seeks to analyse the key proposals of the SEBI framework and to highlight the takeaways for the financial technology (FinTech) players in securities and exchange market. Furthermore, a comparison shall be drawn between the SEBI framework and the draft Enabling Framework for Regulatory Sandbox released by the Reserve Bank of India (RBI).

About the SEBI Framework

In order to encourage the adoption and usage of FinTech in the securities market, SEBI proposed an Innovation Sandbox (IS), which would be a testing environment where FinTech firms and entities not regulated by SEBI including individuals may use the environment for offline testing of their proposed solutions in isolation from the live market, provided they meet the eligibility criteria that would be based on market-related data made available by depositories, qualified registrar and share transfer agents (RTAs) and stock exchanges. For becoming eligible for testing in the IS, the applicants would have to fulfil all the criteria listed below:

  • entity which intends to innovate products/services/solutions in commodities or securities market in India;
  • entity with genuine need to test the proposed solution in IS resources;
  • entity with necessary resources to support testing in IS;
  • entity with a post-testing plan;
  • entity with solution offering (direct/indirect) identifiable benefits to consumers and Indian capital markets at large; and
  • entity whose solution is validated for cyber security parameters.

Features and Structure of the Proposed Innovation Sandbox

There are three broad categories into which components and structure of IS have been divided:

  • Design
  • Legal
  • Administrative

Design

The IS would use the datasets approach in to make the securities market-related data available to participants. The datasets so provided would be clearly defined and brought into the knowledge of the market participants. A confidentiality agreement would govern the use of datasets along with an ’end user agreement’. However, the use of datasets would be restricted to the respective participants, and the same cannot be shared or sold to other entities. Datasets would be shared by means of an application program interface (API) which would be published and made available to participants from time to time. Possible examples of datasets include stock exchange data, RTA data and depositories’ data.

Legal

The legal framework of the IS would provide enough flexibility to enhance adaptability of IS to incorporate changes. In fact, there would be a provision for setting up the IS as a separate not-for-profit entity for reinforcing impartiality in the process. The IS would ensure that no regulatory barriers and compliances, including know-your-clients (KYC) norms, are broken while applicants test their products or services. The rights and obligation of all the participants would be clearly defined according to the SEBI Framework. Intellectual Property Rights (IPR) would also be addressed by making provisions for their protection and guidelines for their use after the testing period. The IS would also aim at preventing data misuse and cyber threats.

Administrative

Applications would be assessed through rule-based self-assessment facilitating automatic entry of eligible entities into the IS. Furthermore, a governance body would be formed comprising of representatives from the stock exchanges, depositories and qualified RTAs. This body would be responsible for supervision of operations of the IS and ensuring that the IS fulfils its objectives. An operational team would be constituted to carry out the day-to-day activities of the IS. In order to regulate the rights and responsibilities of the participants vis-à-vis the IS, rules would be framed. A grievance redressal system would be formulated to deal with grievances of IS applicants. The entire IS process would be made digital to ensure transparency.

The Scheme for Implementation

A steering committee (SC) would be set up to develop the operating guidelines regarding the components and structure of the IS. The SC would comprise of representatives from qualified RTAs and the market infrastructure institutions (MIIs). Once guidelines are issued, the SC would be responsible for carrying out the administrative components and for registering or on-boarding the applicants after their applications are approved. The SC would also supervise and monitor the participants throughout their lifecycle of the project and maintain and objective and key result areas (OKRA) document for effective recording. Before exiting the IS, participants would have to make a presentation to the SC. The participation lifecycle of any participant would not exceed 24 months. The SC would take decisions on the basis of consensus and would have a chairperson. The SC would be constituted within 15 days of the Circular and would provide operating guidelines within two months of the Circular.

Takeaways for FinTech Firms from the SEBI Framework

The SEBI framework is a welcoming step and would open up a plethora of opportunities for FinTech players in securities and exchange market. It would provide a platform to the firms to showcase their solutions to the stakeholders in a protected environment. This would especially give a boost to start-ups which would be able to secure more funding due to this feature. FinTech firms would be able to test their solutions beforehand in order to test their compliance with SEBI’s regulations before venturing out in the open market, thereby promoting readiness in meeting statutory requirements. A secured platform would facilitate testing of interoperability of new solutions and reinforce innovation among the developers, who would not only be able to test viability of their solutions but also explore the industry and prepare for challenges ahead.

Comparison between the SEBI and RBI Frameworks

The RBI released its draft “Enabling Framework for Regulatory Sandbox” on 24 April 2019 wherein the apex bank had proposed to set-up a regulatory sandbox (RS) for FinTech firms to test their products or services in a regulatory-relaxed environment. However, the SEBI framework differs from the RBI framework in certain fundamental aspects. Unlike the RS, which would be made open only to those FinTech firms that meet the criteria of start-ups, the IS would be open to all the FinTech players with an intention to test innovative solutions in the securities and exchange sector, thus making it more inclusive. While the RBI framework seeks to provide for an explicit prohibition on the use of crypto-assets, this exclusion does not find a place in the SEBI framework, thereby creating a gap between the stances of both the regulators. Interestingly, the RBI framework absolves the RBI of any liability or responsibility in case of any dispute or grievance arises among between customers and participants. However, the SEBI framework has envisaged a grievance-redressal system and placed the onus of defining rights and obligations of participants of the IS on the Steering Committee. The RBI Framework is silent on how the IPR issues are tackled, which is contrary to the SEBI framework that not only provides for addressing IPR related aspects inside the IS but also once the testing ends. Hence, SEBI framework provides for a more comprehensive, inclusive and responsible mechanism with regards to sandbox-testing as compared to the RBI Framework.

Conclusion

The SEBI Framework for setting up IS appears to be a promising step towards boosting innovation in the securities and exchange market along with bringing twin-benefits to consumers in the form of increased ease of services and facilitating a wider range of services to choose from. It would also go a long way in development of the emerging FinTech sector in India.

Mansi Mishra

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