by aabha dixit, a fourth-year student at hnlu, raipur

On June 5, 2020, the Securities Exchange Board of India (“SEBI”) rolled out the final framework enabling regulatory sandboxes for FinTech companies, after introducing draft mechanisms earlier last year – ‘Framework for Innovation Sandbox’ issued on 20 May, 2019 and the ‘Discussion Paper on Framework for Regulatory Sandbox’ issued on 28 May, 2019 (“Discussion Paper”). The framework is expected to provide a time-bound structure to mitigate regulatory uncertainty around new FinTech products.

The concept of a regulatory sandbox

The concept of a regulatory sandbox is a close-ended idea that allows FinTech companies to test disruptive technological products in a closed and controlled environment with limited regulatory relaxations. The need for such experimentation seems to arise from two evident challenges – firstly, the lack of regulations or inapplicability of existing regulations to the innovation and secondly, the trust deficit in the market to depend upon experimental FinTech products. The creation of a regulatory sandbox allows testing on innovative FinTech products in a strictly controlled environment.  Globally, over 20 other jurisdictions have successfully introduced sandboxes as a way of gradually integrating new financial innovations into the mainstream market, including the UK, Australia, Singapore etc. In the Indian scenario, the Reserve Bank of India (“RBI”) and the Insurance Regulatory and Development Authority of India (“IRDAI”) have both released guidelines for enabling regulatory sandboxes.

SEBI’s framework for Regulatory Sandboxes

SEBI’s framework for Regulatory Sandboxes (“Framework”) has strict eligibility criteria requiring genuineness of innovation, the need for live testing on real customers and relaxation of existing regulations. It also requires the participants to outline benefits for investors and/or the securities market and provide for a risk management system to control any potential threats to users. Further, the Framework mandates data privacy and disclosure of all possible risks to participating consumers along with setting up of a complaint redressal mechanism.

Changes in the final Framework on Regulatory Sandboxes vis-à-vis the Discussion Paper

The Framework extends eligibility for testing in the regulatory sandbox to all entities registered under Section 12 of the SEBI Act, 1992 either on its own or through a FinTech firm. While the Discussion Paper included the scope for SEBI to consider admitting FinTech start-ups, firms and other entities not regulated by it to the sandbox process independently, the same has not been adopted in the Framework. While this limits participation to regulatory sandboxes, the SEBI may reconsider the same based on testing results and market response.

Further, registration granted under Section 12 is based on the nature of the specific activity undertaken by an applicant entity. To widen the ambit of products that can be tested by a participant beyond its registered category, SEBI has incorporated a cross-domain approach in the Framework. This is facilitated by a limited registration certificate issued to the entity which will allow it to operate in a regulatory sandbox without being subjected to the entire set of regulatory requirements to carry out that activity. Cross-domain testing adds to the flexibility of process and will encourage participants to venture into new product categories without excessive regulatory hindrances. 

The chink in the armour

Post publication of the Discussion Paper, SEBI has addressed and made necessary provisions for complaint redressal for consumers in the Framework by mandating participants to set up grievance redressal mechanisms. However, no mechanism for grievance redressal of participants has been provided by SEBI. Further, while the RBI Regulatory Framework includes clear safeguards for exercising intellectual property rights, the same are missing in SEBI’s Framework. 

Since FinTech products may be governed by both the RBI and SEBI (and the IRDAI for products involving insurance-related solutions), the Framework needs to provide for coordination between the regulators to avoid replication of the processes and wastage of resources. For products that provide multiple solutions on the same technological platform, providing a unified channel for different regulators will simplify the compliance process. Additionally, post-testing, it is important that SEBI gives weightage to consumer feedback and complaints while drafting regulations for the new product. An inclusive and transparent approach by SEBI in this regard will benefit all stakeholders in the long run.   

In conclusion, while the Framework seems structurally sound, it is imperative that SEBI conducts frequent evaluations of the actual outcomes as well as market responses and amends the regulations flexibly to uplift the FinTech sector through regulatory sandboxes.