[Anupriya Dhonchak is a student at the National Law University New Delhi
A longer version of this post is available on the Kluwer Competition Law Blog]
One of the salient recommendations of the Reserve Bank of India (RBI) Working Group’s Report on FinTech and Digital Banking was the introduction of a regulatory sandbox in India. A regulatory sandbox is an innovative tool which allows market players to test new financial services or business models with customers in real time, subject to certain safeguards and oversight.
The Working Group included representatives from the RBI, the Securities and Exchange Board of India (SEBI), the Insurance Regulatory and Development Authority (IRDA), and the Pension Fund Regulatory and Development Authority (PFRDA) and from select financial entities regulated by these agencies, rating agencies such as Credit Rating Information Services of India Limited (CRISIL) and FinTech consultants or companies. It is relevant to note that the Group did not include representatives from the Competition Commission of India (CCI), which is evident in the criteria that have been laid down for the eligibility of applicants in the ‘Draft Enabling Framework for Regulatory Sandbox’ released by the RBI on 18 April 2019. On 20 May, 2019, the insurance regulator IRDAI and the capital markets regulator SEBI also announced similar initiatives.
According to the RBI’s Draft Enabling Framework, Indian start-ups must be worth Rs 50 lakhs or more to be eligible for testing under the regulatory sandbox, apart from providing an innovative solution for an “existing gap” in the financial ecosystem. In its first phase of testing, the RBI would choose 10-12 start-ups functioning in spaces such as microfinance, innovative small savings and micro-insurance products, remittances, mobile banking and other digital payments, etc. This excludes start-ups which may have path-breaking innovative ideas but otherwise lack investment to qualify for applying for the regulatory sandbox. The 10-12 entities so chosen will certainly gain a competitive edge in the market over these smaller players.
In this post, I will firstly argue that such a criterion may be challenged under Article 14 of the Indian Constitution on the ground that the classification between start-ups below the net worth of Rs. 50 lakhs and those above such net worth has no rational nexus with the object of the introduction of the sandbox and that such a classification impedes competition; and secondly, highlight the importance of roping in the CCI to assess the impact of such sectoral regulations on fair competition.
Reasonable classification/classic nexus test
The classical nexus test was evolved from the US Supreme Court’s jurisprudence under the 14th Amendment and enunciated by Justice S.R. Das in the case of State of W.B. v. Anwar Ali Sarkar (AIR 1952 SC 75) noting:
In order to pass the test of permissible classification two conditions must be fulfilled viz. (i) that the classification must be founded on an intelligible differentia which distinguishes those that are grouped together from others left out of the group, and (ii) that the differentia must have a rational relation to the objects sought to be achieved by the Act. The differentia which is the basis of the classification and the object of the Act are distinct and what is necessary is that there must be nexus between them.
Though, Das, J. wrote the minority opinion in Anwar Ali Sarkar, he encapsulated the principle cogently and the nexus test has been applied by various High Courts and the Supreme Court of India in numerous cases ever since.[1]
Effect, not intention, is relevant
The Attorney General argued in Anwar Ali Sarkar that the party assailing constitutionality of a measure under Article 14 must demonstrate the Legislature’s intention to discriminate against a particular group, animated by prejudice or bias. Negating this argument, B.K. Mukherjea, J. in his separate concurring opinion held that the intention in such cases is immaterial and only the discriminatory impact of the law is relevant for an Article 14 violation. Thus, the legislature could have been motivated by all things just and proper but, if the impact of a measure is discriminatory, Article 14 has been violated. The Supreme Court of India took a similar position in Bennett Coleman v. Union of India, reiterated more recently in Navtej Johar v. Union of India.
Thus, the criteria for applications for a sandbox cannot be saved on the ground that the Government actually intended to promote competition by facilitating start-ups above the net worth of Rs. 50 lakhs with a view to offering more substantive competition to mega industries with deep pockets, selling at sustained losses and never falling short of investors to back them up. The discriminatory impact on start-ups, which meet the rest of the criteria but are valued at less than Rs. 50 lakhs, cannot be justified for any other overarching benevolent governmental concern. The draft provides an indicative list of areas which could be considered for testing under a regulatory sandbox such as retail payments, money transfer services, smart contracts, cyber security products, data analytics etc. Now even existing start-ups worth Rs 50 lakhs or more, functioning in areas other than the ones indicated in the draft’s list, will find it easy to enter these indicated areas and pivot, while start-ups trying to start in these areas will be excluded from the get go.
The requirements of a robust IT infrastructure and safeguards to comply with the existing regulatory framework along with satisfactory credit scoring and demonstrable innovative ideas to promote financial inclusion suffice to fulfil the Government’s broader objectives of introducing the sandbox, i.e., to promote greater financial inclusion, reduce market barriers for innovators and promote consumer welfare through the launch of affordable and accessible products. Therefore, any start-up fulfilling the criteria specified, other than that pertaining to net worth, should be allowed to benefit from the sandbox and applications should not be restricted to only 10-12 entities because such exclusion would also impede fair competition. According to the UNSGSA 2019 Report, a regulatory sandbox is an expensive tool to use for financial inclusion, particularly by underfinanced regulators in developing countries with large unbanked populations. Thus, it is reasonable to assume that a cap is indeed necessary for testing start-ups under the sandbox due to resource constraints. However, methods to ensure minimal exclusion of competition must be devised and set criteria for selection must be notified to distinguish among start-ups fulfilling all the listed requirements to preclude arbitrariness and ensure transparency in selection.
Mathew, J., in his dissenting opinion in Bennet Coleman vs. Union of India, noted in the context of restrictions on free speech of newspaper dailies that “one cannot promote competition by making the strong among the competitors stronger or the tall, taller but by making the weak among them strong and the short, tall.” It is the less resource-intensive start-ups that require more support to benefit from a less expensive and faster roll out in the market with a lower and customized regulatory burden than start-ups with a net worth of Rs. 50 lakhs and above. The RBI was held to be “State” within the meaning of Article 12 of the Constitution by the Supreme Court in Reserve Bank of India v. N.C. Paliwal. In this case, one of RBI’s employment schemes was challenged for violation of Articles 14 and 16 of the Constitution. Thus, fundamental rights can be enforced against the RBI and the discriminatory impact of its regulations and criteria to test the sandbox falls foul of Article 14 and cannot be said to have a reasonable nexus with the Government’s democratic objectives of promoting FinTech solutions.
Competition risks involved within sectoral regulation- roping in the CCI
India has the cheapest mobile data in the world. With over 460 million Internet users, it is the second largest online market, ranked only behind China. Further, it also has the world’s second largest unbanked population and around 191 million Indians above the age of 15 do not have bank accounts. This has justifiably given rise to burgeoning corporate interest in FinTech as it promises to be an extremely lucrative industry given India’s market conditions.
According to the RBI Working Group’s Draft Enabling Framework, one of the stated objectives for the introduction of a regulatory sandbox allows for a bespoke accommodation if the product is found economically viable but is impeded from market entry due to a traditional regulatory framework out of pace with the demands of the evolving FinTech industry. In the past, Indian regulatory bodies have suspiciously relaxed regulatory standards for large market players. The example of Reliance Jio, a mobile network operator and subsidiary of Reliance Industries Limited (RIL), India’s largest private company, taking over the telecom market by offering services initially for free and subsequently for negligible prices is a clear instance of the same. A favourable regulatory environment such as the elimination of data share from the definition of ‘significant market power’ by Telecom Regulatory Authority of India bolstered Jio’s spectacular rise and allowed it to evade scrutiny for monopolisitic practices and drive out competitors.
The CCI could do precious little to check anti-competitive actions by Reliance Jio or undo the damage caused to competition in the telecom sector, once the sector had already been disrupted. This makes it important to rope in the CCI at the crucial policy making stage itself. It also ought to alert us to the potential ramifications of the absence of CCI representatives at the drafting stage of the enabling framework for a regulatory sandbox.
As per the National Association of Software and Services Companies (NAASSCOM), the Indian Fintech Service sector is expected to grow to USD 45 billion with a Compound Annual Growth Rate (CAGR) of 7.1%. It is important to pre-emptively analyse the competition concerns that will predictably arise in this sector. The regulatory sandbox as an innovative tool must be implemented while taking into account the competition concerns arising out of fewer firms’ control over a significant market share, aggressive pricing, tying and bundling and information network effects. Finally, competition law has a pivotal role to play in ensuring that the cost of undertaking FinTech experimentation is not detrimental to the market entry and survival of equally or more efficient, albeit smaller innovators.
Interestingly, the introduction of the Regulatory Sandbox in Taiwan through the passage of the Financial Technology Development and Innovative Experimentation Act (FTDIEA) was criticised by scholars as the Taiwan Fair Trade Commission (TFTC) was excluded from the consultation procedure regarding the implementation of the sandbox, which involved an advisory group consisting of representatives from related government agencies.
It is essential to include the CCI at the policy drafting stage itself because introducing a sandbox in the FinTech sector is not an industry matter devoid of competition concerns. The CCI can offer valuable suggestions and perspective by foreseeing predictable competition hazards and tailoring policy drafts to better safeguard against them. It is noteworthy that the CCI already has a mechanism in place to review economic legislations and policies and assess their impact on fair competition in the country. Under section 49(1) of the Competition Act, the CCI has to give its opinion, upon reference by the State or Central Government, on the impact that a particular government policy or legislation causes on competition. According to section 49(3), the CCI is mandated to promote competition advocacy. As part of its advocacy ex ante to ensure fair competition and under sections 49(1) and 49(3), the CCI issued Competition Assessment of Economic Legislations and Policies Guidelines in 2016 to assess “upcoming /existing economic legislations and policies made by the Parliament/ a State Legislature /a Ministry/ Department of Central/ a State Government/ a Statutory Authority” from a competition lens and share the assessment with the relevant stakeholders. These guidelines have been in force since 1 January 2017 and the CCI’s Advocacy Division must take a more proactive role in enforcing these guidelines in scanning, assessing and identifying such upcoming/existing economic legislations and policies for their potential adverse impact on competition.
[1] R.K. Dalmia v. Justice Tendolkar, AIR 1958 SC 538 and In re Special Courts Bill, 1978, (1979) 1 SCC 380 summarise the application of the nexus test (as evolved in Anwar Ali Sarkar) to ascertain Article 14 violations.