[Shaswat Kashyap and Anand Vardhan are third-year law students at Gujarat National Law University]
With the ever-growing adoption of innovative technologies, coupled with the rapid growth of regulated entities, it is becoming cumbersome for the Reserve Bank of India (“RBI”) to effectively regulate the sector. Self-regulatory organizations (“SROs”) can provide a vital link between the regulator and the market participants through a less formal set-up. Its overarching objective is to support member entities in adhering to regulatory and industry standards, with a focus on customer welfare and protection. SROs can also act as a watchdog and encourage members to adopt responsible and ethical practices. SROs are not new for the RBI. In 2014, the central bank accorded recognition to the Microfinance Industry Network (“MFIN”) as an SRO for the non-banking finance corporation (“NBFC”)-microfinance industry. Other existing SROs are the Indian Banks Association, Foreign Exchange Dealers Association of India, Association of Mutual Funds in India and Fixed Income Money Markets and Derivative Association of India.
RBI in its Monetary Policy Committee Meeting 2023 (also mentioned in its press release here), had decided to issue a draft omnibus framework for recognizing SROs for its regulated entities. Pursuant to this, in its notification dated 21 December 2023, the RBI has released the draft framework for recognizing SROs for banks, NBFCs and other entities regulated by it. The framework establishes overarching objectives, functions, eligibility criteria, and governance standards, which are intended to be universally applicable across all SROs, regardless of the sector. Additionally, the framework delineates general membership criteria and outlines terms and conditions that SROs must adhere to obtain recognition from the Reserve Bank.
Summary of the Proposed Framework
The proposed framework has been made with the overarching objective of enhancing the sector it represents by addressing critical industry concerns within the broader financial system. It seeks to promote professionalism, compliance, innovation, and ethical conduct, emphasizing robust self-regulatory principles. Upholding good faith and avoiding conflicts of interest are fundamental to its operations.
Specific objectives: Collecting and sharing sectoral information with the Reserve Bank to aid policymaking, foster innovation, and coordinate the introduction of new products within regulatory frameworks. Encouraging research and development within the sector to promote innovation while maintaining the highest standards of compliance and self-governance.
Eligibility criteria: To qualify for an SRO license, applicants are required to establish a not-for-profit company with a sufficient net worth and the capability to develop infrastructure for the consistent fulfilment of various responsibilities. Additionally, the applicant must represent the relevant sector and possess the specified membership or provide a comprehensive plan outlining the steps to achieve the specified membership within a reasonable timeframe. The RBI stipulates that neither the applicant nor any of its directors should be engaged in any legal proceedings that could adversely affect the sector’s interests. Furthermore, the applicant and its directors must not have a history of conviction for any offences, including those related to moral turpitude or economic offences. The RBI emphasizes that the applicant must meet the fit and proper criteria in all other aspects.
Characteristics of an SRO: An SRO ensures credibility, objectivity, and responsibility, overseen by regulators, aiming to enhance regulatory compliance for the sector’s sustainable development. Key attributes include (i) sufficient authority from membership agreements to set and enforce ethical, professional, and governance standards, with strong governance mechanisms; (ii) objective processes for rulemaking and enforcement, transparent oversight procedures; (iii) development of standards to improve members’ compliance culture; (iv) standardized dispute resolution procedures; and (v) implementation of suitable surveillance methods for effective sector monitoring. These characteristics collectively contribute to the SRO’s role in fostering a robust and responsible regulatory environment.
Responsibilities of the SRO towards members: The primary obligation of the SRO towards its members is to endorse optimal business practices and set minimum standards and norms for professional market conduct among its members, as stated in the circular. The SRO is required to formulate a code of conduct for its members, oversee adherence to the code, ensure compliance with regulatory instructions, and establish a fair and uniform membership fee structure. Additionally, the SRO is mandated to share industry-specific information through various means to raise awareness on relevant matters. The circular also calls for the establishment of grievance redressal and dispute resolution mechanisms, emphasizing efficiency, fairness, and transparency aligned with regulatory requirements. In addition to these responsibilities, SROs are to regularly update the Reserve Bank on sector developments.
Responsibilities of the SRO towards the Regulator: The SRO serves as a collaborator with the RBI, ensuring regulatory compliance, sector development, stakeholder protection, innovation, and early warning signal detection. It keeps the RBI informed about sector developments, promptly reports member violations, and carries out assigned tasks. The SRO provides data as needed, follows RBI directions, and may undergo inspections, with expenses borne by the SRO. Compliance with regulatory guidelines, reporting violations, and cooperation with the RBI define the SRO’s responsibilities in maintaining a robust and transparent regulatory framework.
Governance Framework for SDOs: The RBI’s draft framework states that the SRO should be professionally managed and have suitable provisions in their articles of association to ensure the same. The directors of SRO shall fulfil the ‘fit and proper’ criteria as framed by the SRO board on an ongoing basis and at least one-third of members of the board of directors, including the chairperson, shall be independent and without any active association with the category of REs for which the SRO is established. Further, any change in the directorship or any adverse information about any director shall be immediately reported to the RBI. The RBI shall revoke the recognition granted to the SRO if it deems that the functioning of the SRO is detrimental to the public interest. The SRO shall also keep the RBI regularly informed of the developments in their respective sector and shall “promptly” inform the regulator about any violation by its members. The SRO shall carry out any work assigned to it by the RBI and examine the proposal or suggestion referred to it. It shall also provide data, and information, sought by the central bank, periodically or as advised.
Further, the framework also acknowledges the possibility of the RBI prescribing sector-specific additional conditions when soliciting applications for the recognition of SROs within a specific category or class of regulated entities. This would be done within the broader framework while considering the unique characteristics of the respective sectors.
The recent guidelines issued by the RBI closely follow its directive for digital lenders to establish SROs within a year. By empowering the industry to establish a self-regulatory body, the RBI can alleviate some of its regulatory burdens, allowing the SRO to oversee certain aspects of governance. This approach also provides the industry with an effective platform for expressing its opinions and requirements. The government envisions that as regulatory frameworks advance, SROs can significantly contribute to upholding ethical standards and promoting responsible growth. A self-regulatory strategy can foster the development of a sustainable and reputable financial ecosystem, balancing growth while mitigating potential risks. SROs have deep industry understanding and unique qualifications for developing and enforcing effective sector-specific rules. The role of an SRO is considered crucial in this context.
The necessity for this initiative arose due to the rapid expansion of regulated entities in both quantity and operational scale. Additionally, the increased adoption of innovative technologies and expanded customer outreach posed challenges for the RBI in effectively regulating the sector. The outlined objectives collectively outline the anticipated role and responsibilities of the SRO. These encompass guiding the sector towards heightened professionalism, compliance, innovation, and ethical conduct.
SROs contribute to regulatory effectiveness by leveraging practitioners’ technical expertise and aiding in the refinement of policies by providing insights into technical, and practical aspects, nuances, and trade-offs. They also foster innovation, transparency, fair competition, and consumer protection. In essence, self-regulation complements existing regulatory frameworks, promoting better compliance in both letter and spirit.
Once finalized, it will pave the way for recognizing SROs across various sectors of regulated entities. As the RBI seeks feedback and stakeholder perspectives, the collaborative approach emphasizes industry-wide participation in shaping regulations. The final omnibus framework, incorporating stakeholder comments, will enable the RBI to issue notifications inviting SRO applications within its defined parameters. This SRO framework is a positive step in addressing challenges in regulating emerging sectors and is poised to play a constructive role in supplementing the existing regulatory framework. The RBI will subsequently issue separate notifications inviting SRO applications for specific categories or classes of its regulated entities within the broader contours of the final omnibus framework.
– Shaswat Kashyap & Anand Vardhan