Indian Law Updates May 2019 Corporate Practice

SEBI Circular on Framework for Innovation Sandbox

The Securities and Exchange Board of India (SEBI) issued a circular on 20 May 2019 laying down the framework for an innovation sandbox, wherein FinTech firms and entities not regulated by SEBI will be provided an offline testing environment for their products or solutions.

The products / services or solutions should be intended for securities or commodities market in India, with the help of the datasets available in the sandbox and should be able to reach secure solutions which have clear benefits for consumers and the capital markets.

The data sets include data from depositories, stock exchanges and Registrars and Transfer Agents (RTAs) in a phased manner to conduct their testing, depending upon the validations. Such data shall be governed by comprehensive confidentiality and end user agreements. The testing on the datasets shall be conducted offline, in isolation from the live market, but with configurations similar to the live market for testing the innovative solutions. It will be ensured that such testing can be conducted without any regulatory breaches, and in compliance with the applicable laws on investor protection, KYC, data protection and integrity etc. This will help to have a testing process which is overseen by the regulator, thereby preventing non compliance or impact on the market due to malfunctioning of the product.

A steering committee comprising of Market Infrastructure Institutions (MIIs), Qualified Registrar and Transfer Agents (QRTAs), members from FinTech startups, academia, angel investors and a SEBI nominee shall develop operational guidelines for the features, structure and eligibility criteria for the innovation sandbox. Once such operational guidelines are in place, the steering committee shall be involved in the registering, onboarding and monitoring of the applicants. Clearly, the intention is to expedite the framework because the steering committee is to be constituted within 15 days of the circular and the committee is to provide the operating guidelines within 2 months of the circular.

The innovation sandbox can be set up in the form of a non-profit entity with a governing body comprising of representatives from stock exchanges, depositories and QRTAs. An operational team shall also be constituted in order to carry out the day to day tasks of the sandbox.

The whole participation process, including the application, tracking, onboarding, monitoring, reporting etc. is proposed to be made digital within a period of 24 months.

The outcome that is sought to be achieved through the innovation sandbox is to showcase working prototypes of solutions which can be used across industries and which would also be in compliance with the SEBI regulations. Such showcasing may help the FinTech firms to secure funding and encourage the use of financial technology.

It may be noted that the Reserve Bank of India (RBI) had also, in April 2019, released the draft guidelines for a regulatory sandbox, providing for the controlled testing of new products or services, with a similar objective.

The RBI guidelines stated eligible innovations as those which did not have governing regulations, those where there is need to ease the regulations and in cases where a proposed solution promises the ease / effectiveness of delivery of financial services. The RBI guidelines also provided an indicative list of the innovative products or services such as money transfer services, digital KYC, smart contracts etc. This reflects RBI’s recognition of transaction types in which fintech firms are currently most active.

The RBI criteria however, restricts the eligibility to companies incorporated in India which meet the start up criteria as per the Department of Industrial Policy and Promotion (DIPP) notification dated 11 April 2018 and should have a minimum net worth of INR 50 lakhs. This will be a huge disincentive for young fintech companies which have not been able to generate such monetary resources to participate in the sandbox.

In line with RBI not wanting the sandbox to stray into regulatory sensitive areas, the RBI guidelines also have an indicative negative list of products or services similar to those already available in India such as credit registry, crypto currency or initial coin offerings etc.

The RBI guidelines also provide for an established process for movement through the sandbox with laid down timelines, covering preliminary screening, test design, application assessment, testing and evaluation.

The RBI guidelines were however in a draft format inviting comments, while in case of SEBI, the framework has been issued by means of a circular.

Earlier, the Insurance Regulatory and Development Authority (IRDA) had also constituted a committee on a regulatory sandbox in the insurance space, which had provided its report in February 2019 with following major recommendations:

  1. The objective of the sandbox shall be to encourage innovations in the InsureTech and FinTech sectors by giving them flexibility to deal with regulatory requirements, without compromising on policyholder protection.
  2. Eligible applicants would be insurers and insurance intermediaries or other entities (but not individuals) having a minimum net worth of INR 25 lakhs for the last three years;
  3. Though there would be defined criteria for eligibility, process flow, timelines, success factors etc., there would also be flexibility to encourage wide experimentation, including no enforcement actions, waivers and relaxed reporting requirements. However, data would be subject to strict confidentiality restrictions.