The Securities and Exchange Board of India (SEBI) cleared a proposal to establish a regulatory sandbox for registered entities, joining its sister financial regulators, the Reserve Bank of India (RBI) and the Insurance Regulatory and Development Authority (IRDAI) in doing so. Within a span of eight months, all three regulators have established regulatory frameworks to introduce and promote innovation through ‘investor-centric experimentation’ to create better financial products. The idea is hardly novel, for the United States established the first known regulatory sandbox in 2012 to encourage consumer-friendly innovation and entrepreneurship for financial products. Internationally, this approach was formalized after the success of the UK’s Financial Conduct Authority’s sandbox established in 2015. However, amongst non-OECD countries, the decision by India’s regulators is still quite timely, even though it might be a stretch to consider it pioneering.
In order to appreciate the magnitude of opportunity that such a sandbox framework provides, it is relevant to understand the need that is sought to be fulfilled. It is hypothesized that one of the significant factors impeding the growth of the FinTech sector in India is the inability of the tech companies and banks to ‘try’ integrating products and services between the participants. This can be attributed to, among other things, the regulatory risk that ensues in case of consumer discomfort during this ‘trial’ along with the costs of running such an experiment. One of the first regulatory sandboxes set-up was, for this reason, described as a ‘safe space’ for the tech companies and the banks to interact. It entails an interaction between the banks and FinTech companies, so that the processes used by banks can move towards transparency, as opposed to a guessing game for tech companies. Generally, the integration of FinTech activities is done on existing technologies used by banks, such as application programming interface (API), cloud and artificial intelligence & machine learning (AI&ML) among others. The mushrooming of mobile wallets is a story in success of such an integration, wherein the API of the National Payments Corporation of India (NPCI) has been used as the base technology. Underneath this base technology is the trove of data that banks have, which are protected by RBI regulations. Therefore, to bypass, or at least reduce, the various risks involved in the process the RBI has decided that a sandbox might act as the required catalyst.
Prior to understanding the nuts and bolts of the regulatory framework for the sandbox, it might be useful to appreciate the context in which such a move comes. There are two movements in the Government of India bureaucracy that might be noticed.
One, from the perspective of the RBI, the sandbox is just another addition to its tool kit of measures promoting payments and clearing services. Along with its oversight of banking activities, the RBI is also the implementing authority for the Payments and Settlement Systems Act, 2007, which covers the entire gamut of clearing services, payment gateways (such as Visa, MasterCard) and prepaid payment instruments (PPIs). Evidently, there is scope for development of the FinTech sector through applications in the payment and settlement systems segment. The Indian government still has a monopoly in the clearing services section, with only the Clearing Corporation of India and NPCI offering such services. Perhaps, if the sandbox proves to be a success, FinTech companies could be exposed to the more sensitive clearing services section. It is also plain that the PPIs segment can find synergy with the FinTech sector as it is the most open, with several private companies, such as PhonePe and MobiKwik on the one end, and the Delhi Metro and other public services on the other. The RBI in 2019 has also notified regulations for semi-open PPIs as well as payment aggregators, which is expected to further increase participation in this segment. The timely infusion of technologies and services provided by FinTech companies will definitely be one of the long-term goals that the RBI has set, and this sandbox may be the first step in the realization of such goal.
Second, from the perspective of the Government of India, the decision to introduce the regulatory sandbox may be aimed at diversifying the playing field for startups. It is no secret that the Government is betting heavily on startups in accelerating economic growth. The Economic Survey of 2019-20, strongly suggests that the Government needs to adopt and nurture startups in order to see rapid expansion of employment opportunities and an overall improvement in efficiencies. As noted in various studies, India is yet to have major success stories amongst startups which are not heavily reliant on the large domestic consumption market. Even within the category of such startups, the aggregator model seems to have been overdone. Since the FinTech sector is one which has relatively less dependency on either of these two, ie the large consumption market or the aggregator model, it can be imagined as an altogether new avenue for the development of startups. The scope for integration with other Government programs for startups, such as the Fund of Funds is wide and waiting to be utilized.
Therefore, in sum: (1) the introduction of the sandbox is a recognition of the hurdles existing in easy integration of FinTech with the existing financial services sector; (2) it is an attempt to plug that gap, whether of trust or propensity to experiment, and (3) it signals that the Government intends on nurturing the FinTech industry with a focus on creating giants.
While the SEBI regulatory framework is silent on the issue of liability and insurance, the RBI sandbox mandates all companies participating in the sandbox to undertake insurance for losses that may accrue to consumers during experimentation. Several FinTech companies have scorned at this requirement, for the very point of the sandbox is defeated if the cost of participating in it increases. Escaping liability from failed experiments and reduction in cost in case of such failure are central to the success of the sandbox. The RBI has sought to balance this by providing clear entry and exit criteria from the sandbox, while laying down the manner of calculating the liability in case of loss to consumers. For instance, over-exposure to a single customer, or over-dependence on a single event with potential for multiple claims will result in increased liability. Further, since there is a requirement of determining conditions within which the experiment will take place, such as a cap on consumer losses, the target customer type, limit on the number of customers involved etc, there is an attempt to reduce the liability that may arise from a failed experiment. Unsurprisingly, crypto-currency and crypto-assets have thus far been kept out of the purview of the sandbox. While this is only in continuation of the broader governmental policy towards such assets, it is perhaps an opportunity missed, given that a Sandbox may be the best way to interact with crypto-assets. Further, the scope of crypto-products, especially in certain areas listed by the RBI for the sandbox, such as smart contracts, cyber-security products and wealth management is wide ranging.
Overall, the decision to introduce a regulatory sandbox is prudent, and shows the willingness of the central bank to engage in some experimentation itself. This globally accepted practice to spur innovation has potential to change the face of the FinTech sector in India, if approached by all entities with diligence.
Poornima Advani is a Partner at The Law Point and a Former Chairperson of the National Commission for Women.