[Karthika S. Babu and Snigdha are 3rd year B.A., LL.B. students at Gujarat National Law University, Gandhinagar]
In an attempt to align the pace of regulatory oversight with the exponential rate at which fintech is revolutionising the financial services environment, the Reserve Bank of India (“RBI”) recently released the much debated Draft Framework for Self-Regulatory Organisation(s) in the FinTech Sector. The proposed framework reflects the intent of the regulator to tread on a path of balance between innovation and growth in the sector vis-à-vis the nature and quantum of regulation thereof. With objectives such as developing industrial standards, addressing the need for consumer protection, and fostering organic development within the industry, the RBI seems to hold the framework of self-regulation to be the most effective mechanism for a balanced regulatory approach in this environment.
This post is aimed at highlighting the key aspects of the draft framework while critically analysing certain aspects which requires greater clarity and intervention on part of the regulator. The post also analyses the current framework in light of the regulatory mechanisms adopted in other jurisdictions with respect to the fintech sector.
Mapping the Extant Regulatory Context
Regulatory measures in the realm of fintech entities in India have been dealt with in a piece-meal, sector specific manner through multiple regulators such as the RBI, the Securities and Exchange Board of India (“SEBI”) and the Ministry of Corporate Affairs (“MCA”) to name a few. This fragmented design of control reflects the practical necessity to push forth an all-inclusive approach encompassing the diverse set of entities and activities thereof within the ambit of an appropriate regulatory framework.
Self-regulatory organisations (“SROs”) are non-governmental entities tasked with regulating the members of an industry that it typically belongs to. The primary objective for adopting a SRO model for regulation is to establish a system of minimum state intervention in the operational mechanism of the industry while also fostering a channel of organic, fair and ethical growth of entities within such ecosystem. The application of the SRO model for regulation within this sector first started with the RBI’s move to bring the Payment System Operators within its ambit. However, this mechanism also met with criticism on account of concerns regarding the SRO’s independence and the lack of enforcement power with them.
Key Aspects of the Proposed Framework
The traditional self-regulation principle, generally understood with its stereotypical connotations, stands as the antithesis to the purely command and control model of regulation. Policy implications of either extreme frameworks have been found to be misleading when compared to the practical realities of the foreground of law. The proposed SRO framework reflects the rejection of the traditional notion of alignment with either absolutist models while tailoring a policy towards the specific requirements of the industry. This can be garnered from certain aspects of the draft framework such as the duty of the SRO towards notifying the RBI regarding any violations by the members, supplying the RBI with any required information regarding the sector, power of the RBI to appoint Observer(s) on the board of the Fintech SRO (“SRO-FT”), and the like.
A brief analysis of the framework also suggests that the regulator’s approach through this model of self-regulation hinges upon the notion of collaboration and collective action to achieve shared goals through ethical standards. The SRO-FT, a not-for-profit company under section 8 of the Companies Act, 2013, is supposed to draw its authority from the membership agreements. The SRO is also to be provided with a formal recognition from the regulator, i.e., the RBI, for greater legitimacy in action. However, the impetus to generate incentives for membership to the organisation amongst a set of diverse unregulated entities has been placed on the SRO itself.
It is also important to note that RBI has minimised the extent of its intervention by limiting the scope of its actions to overseeing the functioning of the SRO model. The SRO is expected to be a representative body of the member players who would grant the SRO the power to create and enforce the requisite standards and codes of conducts. The SRO-FT is also expected to operate in an independent and unbiased manner, free from the dominance of particular entities within the industry. Ensuring the adherence to the set standards and codes has been manifested primarily in terms of the SRO-FT motivating the members through various channels of communication. The SROs have also been entrusted with the powers to investigate and take disciplinary action upon a manifest non-compliance.
Regulatory oversight with regards to the fintech sector is inherently a challenging act owing to the diverse nature of the entities and the activities pertaining thereof. As posed within the framework, a single overarching SRO shall not be as effective in the regulation of the fintech sector as a whole. Sectoral categorisation within the fintech industry and piecemeal regulatory measures in respect of the same could be considered as one alternative methodology. Moreover, while the Indian Fintech market is characterized by a larger number of diverse players, more than 80% of the market share is held by a few dominant ones. Establishing a self-regulating governance system would pose a significant challenge due to this highly unequal market structure which could give rise to conflict of interests. The draft framework has failed to address this scenario by placing the onus on the sector to reach a consensus regarding the number of SRO-FTs, the procedure for their establishment and governance mechanisms. A mere caveat for the SRO to act in an unbiased and transparent manner without any other safeguards or disincentives does not mitigate these concerns.
The nature of the SRO-OF being a ‘non-for-profit public good entity’ does not necessarily preclude other forms of conflict of interest that could lead to anti-competitive practices. The inherent nature of self-regulation being self-funded creates an uncertainty in balancing the conflicting interests of various stakeholders. It is highly likely that the players with dominant market shares can manipulate the structure of SROs by pooling in resources to create a governance system in their favour, creating further divide between majority and minority players. This can increase the likelihood of exclusionary practices such as barriers to entry in the market, restrictive membership and discriminatory standards. In an alternative scenario, as against the over-regulation which could preclude certain members from the market, members of the SRO might collude together and create an ecosystem of regulatory protectionism or under regulation. The only tangible mechanism of independent oversight within the organisation is independent directors, whose autonomy could be of much debate. This means that it would inevitably burden the state regulator as it would have to step in to mitigate the costs that were the result of such an inefficient system.
Further, the considerations that would help determine the number of SROs to be established should extend beyond the uniformity concerns and should address the need for multiple for a for harmonizing the interest of all stakeholders. For instance, the US has multiple SROs in addition to state and federal regulators. Such a robust ecosystem of regulators would ensure that interests of various stakeholders are brought to the forefront to strengthen its representative character. Furthermore, the draft framework should at least etch out the limitations with respect to the enforcement authority of the SROs. Simply placing the onus on SROs with subjective and vague guidelines like RBI’s finality on what is deemed to be ‘the fit and proper status of the applicant company, BoD and KMP’ would give rise to lack of objectivity and arbitrariness in the process.
The introduction of a self-regulatory system in the Indian fintech sector is challenging considering the prevailing market conditions. Though RBI’s initiative is a welcome move, the lack of clarity on the effectiveness of the self-regulating organizations still looms. As SROs usually derive their authority from the consent of the members, it would ultimately be a test of time how the SROs will perform to gain the trust of the market. At least in the initial stages the RBI would need to have a proactive approach in the regulatory oversight of the SROs in this sector as regulatory failures of the model is a probability as seen in the case of UK and Canada.
The RBI would essentially have to act in coordinative and regulatory capacities to establish the SRO model in the sector. Moreover, it would be interesting to see how the self-regulatory regime would coordinate the unregulated players such as payment service providers and technology service providers along with the unregulated players. The challenges of self-regulation cannot be overcome without efficient communication and coordination between the SROs and the RBI. Therefore, the primary objective of the framework should be to create a feedback system which can ultimately benefit the SROs and the consumers.
– Karthika S. Babu & Snigdha