Background

The Reserve Bank of India (“RBI”) has released a draft framework for Self-Regulatory Organisations (“the draft framework”) in the FinTech Sector on January 15, 2024. (click here). The draft framework has made suggestions which include the challenges in regulating FinTechs, characteristics of a FinTech Self-Regulatory Organisation (“SRO-FT”) as well as its functions, governance standards, eligibility criteria etc.

Applicability

The draft framework would be applicable to all FinTechs.

The key highlights of the draft framework are stated below:

Challenges in regulating FinTechs

The draft framework raises pertinent observations on the challenges in regulating FinTechs. It provides that while technological innovations are bringing about positive changes in the financial services sector, concerns relating to customer protection, data privacy, cyber security, grievance handling, internal governance, financial system integrity are bound to increase. Thus, the draft framework suggests self regulation within the FinTech sector. Through this approach of self-regulation FinTechs could set standards and best practices for themselves and demonstrate its commitment to responsible conduct and innovation even in the absence of formal regulation. Therefore, through this draft framework, the RBI has made suggestions to provide a broad structure as to how these self-regulating FinTechs could function.

Characteristics of an SRO-FT

The draft framework provides the following six characteristics that the SRO-FT is expected to possess:

1. Representative character of the FinTech Sector: This remark emphasizes how crucial it is for the SRO-FT to have a robust and representative membership. It is recommended that the SRO-FT seek to engage in membership agreements with a diverse range of stakeholders in order to establish realistic and widely recognized guidelines, policies, and optimal procedures. Through promoting inclusion and utilizing group knowledge, the SRO-FT may establish credibility and successfully govern the FinTech sector. It aims to be the central authority for industry standards and conduct, encouraging voluntary compliance among its members.

2. Promote development of the FinTech industry: Through training programs, the SRO-FT should aim to impart its knowledge, skills, and guidance in a development-oriented manner. It should also outline the minimal requirements for membership eligibility. This quality is essential because it enables the SRO-FT to close the skills gap and offer much-needed assistance and direction to newly established companies about the constantly evolving industry and the regulatory compliance framework.

3. Independent SRO-FT: Bias and the choices made by a few dominant stakeholders should not affect the SRO-FT. It is important for the SRO-FT to steer clear of conflicts of interest and function as a neutral and reliable entity.

4. Fair and transparent dispute resolution mechanism: Fair and transparent conflict settlement should be the goal of the SRO-FT. In addition to fostering confidence among the parties involved, this would make SRO-FT a legitimate arbiter of disputes.
5. Regulatory Compliance: The SRO-FT should build a culture where the stakeholders are compliant with all the regulations. There should be a mechanism to take disciplinary action in cases of non-compliance. Moreover, there should always be positive communication between the stakeholders and the regulatory changes to bring about changes and amendments whenever required.

6. Information database: The SRO-FT should look at collecting, analyzing and releasing data relating to the activities of its members. This could be helpful as a source of research, analysis, policy making in the FinTech sector.

General Requirements

The applicant in order to be eligible for a SRO-FT membership should a) be a not-for-profit company under Section 8 of the Companies Act, 2013; b) in the object clause of the company’s Memorandum of Association should provide for the operation as an SRO-FT as one of its primary objectives; c) have an IT infrastructure, as well as sufficient net-worth; d) have a mechanism for instances of user harm; and e) not set up an entity overseas without the RBI’s approval.

Membership Requirements

The membership requirements include a) representation of the FinTech sector by the SRO-FT involving members across entities irrespective of size, stage and activities. Even if the SRO-FT can show a roadmap to prove that they would be able to achieve this, it would be considered enough; b) members should be FinTechs and the RBI would also look at encouraging FinTechs to become part of the SRO-FT; c) SRO-FT should be an Indian domiciled entity, however, its members can be domiciled outside of India as well; d) the membership fees for becoming a part of an SRO-FT should not be excessive or arbitrary; and e) the SRO-FT should develop code of conduct for its members through membership agreements.

Fit and Proper test for Board of Directors and Key Managerial Personnel

The requirements under the fit and proper test include a) the Board of Directors (“BoD”) and Key Managerial Personnel (“KMP”) should be competent and have a reputation of being fair and being persons of integrity; b) declaration of any ongoing legal proceeding against the applicant SRO-FT, BoD or KMP while submitting the application and it should be proved that such proceedings would not harm the SRO-FT’s reputation; and c) the BoD or KMP should not be convicted of offences involving moral turpitude or economic offences.

Application Requirements

The application submitted to the RBI should include a) copy of MoA, Articles of Association of the applicant; b) details involving the board of the applicant and the roles and responsibilities assumed by their members; c) if required, a roadmap showing how they are going to achieve comprehensive membership; d) the submission of application should be authorized by the board of the applicant; and e) any other information/clarification if required by the RBI. In case an application is rejected, the applicant shall be given the opportunity of being heard.

Recognition of the SRO-FT

The RBI shall grant a letter of recognition to the SRO-FT provided the following conditions are fulfilled: a) information is true and not misleading; b) requirements under the framework would be adhered to continually; c) the recognition would be subject to periodic review by the RBI if necessary; d) recognition can be invoked if it goes against public interest or activities are not in line with the objectives of the SRO-FT; and e) compliance with all other acts, rules, regulations etc. as issued by the RBI.

Functions of the SRO-FT

The functions of the SRO-FT include:

1. Setting of Standards: The SRO-FT should play a central role in establishing and enforcing standards for the FinTech industry. This includes developing clear and transparent processes for creating rules and standards, as well as customized codes of conduct for members. The SRO-FT shall also set industry benchmarks for areas such as transparency, data privacy, and technology standards. To further promote responsible and ethical practices, the SRO-FT shall develop standardized documents, establish an accreditation mechanism, and define responsible advertising practices. Additionally, the SRO-FT should also strive to develop governance standards and enforce consequences for non-compliance.

2. Oversight and Enforcement: To ensure a well-functioning FinTech sector, the SRO-FT needs a robust oversight and enforcement system. This means having clear frameworks for its actions, utilizing technology and tools to actively monitor industry activity for any irregularities, and offering guidance to discourage practices that could harm the sector's growth. Thus, the SRO-FT should be a proactive watchdog, both enforcing rules and promoting healthy practices for a thriving FinTech ecosystem.

3. Development of the FinTech Sector: The SRO-FT should strive to be a knowledge hub for the FinTech sector. It should actively educate members on regulations and compliance, promote best practices through information sharing, and encourage innovation through research and development. To ensure everyone benefits, the SRO-FT should also offer support and guidance, especially to smaller players, and share best practices publicly, fostering a healthy and thriving FinTech ecosystem.

4. Redressal and Dispute Resolution: The SRO-FT shall establish a grievance redressal and dispute resolution mechanism for its members and also strive to educate customers on products and services offered by the sector.

Responsibilities of the SRO-FT

The responsibilities of the SRO-FT include:

1. SRO-FT as a representative of the FinTech sector: The SRO-FT shall represent the members collectively to the RBI, focusing on sector-wide concerns, not just specific interests and further ensure fair treatment for all members.
2. SRO-FT as FinTech watchdog: The SRO-FT shall regularly update the RBI on sector developments and promptly reports member violations of regulations;
3. Data insights for informed policy: The SRO-FT shall collect and share detailed FinTech data with the RBI to aid policymaking. It should have discussions on the introduction of new products;
4. Refining FinTech classification: The SRO-FT shall work with the RBI to improve the categorization of FinTech entities;
5. Supporting the Reserve Bank: The SRO-FT shall carry out assigned tasks, reviews proposals, and provide requested information;
6. Transparency and accountability: The SRO-FT shall submit annual reports and regular returns as prescribed by the RBI;
7. Holistic perspective on FinTech: The SRO-FT shall provide informed views and suggestions to the RBI, considering the FinTech sector as a whole;
8. Open to scrutiny: The SRO-FT shall allow the RBI to inspect or audit its books, covering all expenses;
9. Adapting to new needs: The SRO-FT shall fulfill additional functions and follows directions stipulated by the Reserve Bank;
10. Guiding FinTech regulation: The SRO-FT shall advise the RBI on how to effectively regulate the FinTech sector.

Conclusion

The RBI’s proposal to establish a Self-Regulatory Organisation is a game-changer for India's FinTech industry. The draft framework suggests self-regulation within the FinTech sector by setting standards and using best practices for themselves and to demonstrate their commitment towards responsible conduct and innovation even in the absence of formal regulation. The structuring of the robust mechanism by ensuring it covers all the entities and thus builds the customer confidence remains a big challenge. The RBI has extended stakeholders and the public comments and feedback by end February 2024.

Please find a copy of the RBI’s Draft Framework here.

This update has been contributed by Jitendra Soni (Partner) and Harsh Garg (Associate).

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