The Corporate & Commercial Law Society Blog, HNLU

Tag: crypto

  • RBI’s Electronic Trading Platforms: a Bittersweet Take on Trading

    RBI’s Electronic Trading Platforms: a Bittersweet Take on Trading

    BY ABHISHEK KAJAL, FOURTH YEAR STUDENT AT IIM, ROHTAK
    Introduction

    The Reserve Bank of India (RBI) introduced the 2024 framework on Electronic Trading Platforms (“ETPs”) in April 2024 (“2024 Draft Framework”), superseding the earlier 2018 Direction (“2018 Framework”) with some key changes.

    As defined by the RBI, an ETP means any electronic system, other than a recognised stock exchange, on which transactions in eligible instruments are contracted.It is a platform that allows trading in eligible instruments as notified by the Reserve Bank of India. The main instruments include Government Securities (“G-Sec”), Money instruments, and Foreign Exchange instruments.

    No individual or organisation, whether local or foreign, is permitted to run an ETP without first securing authorisation or registration from the RBI. A resident person under the Foreign Exchange Management Act, 1999 (“FEMA”) is allowed to do online forex transactions only on authorised ETPs by the RBI. The purpose of this blog is to analyze the Indian ETP framework by tracing its evolution, examining key regulatory changes in the 2024 draft, highlighting challenges faced by domestic platforms, and suggesting practical solutions to strengthen the framework.

    Evolution of ETPs in India

    After the global financial crisis, trading on electronic platforms was being encouraged in several jurisdictions, driven primarily by regulatory initiatives to reform Over-the-Counter (“OTC”) derivative markets through a technology-driven approach. 

    Therefore, to have more market access, increased competition, and reduced dependency on traditional trading methods, the RBI, in 2017, issued a Statement on Developmental and Regulatory Policies as a part of its fourth bi-monthly Monetary Policy Statement 2017-18, where it highlighted its intention, for the first time, to regulate the money markets instruments under their purview through ETPs.  They recommended a framework to be put in place for ETPs that will deter market abuse and unfair trading practices, leading to better price discovery and improved market liquidity. Following this, the ETP Direction was first introduced in 2018.

    More Flexibility in Trading

    Under the 2018 framework, only banks were excluded from the framework’s applicability given that they allowed trading of eligible market instruments only with their customers on a bilateral basis and did not trade with market makers, including authorised dealers under FEMA.

    However, under the 2024 framework, the RBI has expanded the relaxation of this framework. Now, scheduled commercial banks (“SCB(s)”) and standalone primary dealers are also excluded from the framework for trading in eligible instruments. They can operate ETP platforms and trade in eligible instruments even without the authorization of the RBI, given that the SCB or primary dealer is the sole provider of price/quote and is a party to all the transactions of the platform.

    Certain reporting requirements have been provided for the SCBs or primary dealers, where they have to report any data or information whenever asked by RBI, and further, to avoid any misuse, the RBI can require such ETPs to comply with the ETP Direction. This change by the RBI reflects a balance between promoting ease of doing business and ensuring market protection in the ETP market.

    Setting up and Authorisation of ETPs

    To establish itself, an ETP must meet specific eligibility criteria for authorization from the RBI. The criteria are dynamic, beginning with the basic requirement that the ETP must be a company incorporated in India. Then, the ETP must comply with all applicable laws and regulations, including those of FEMA.

    The ETP or its Key Managerial Personnel (“KMP”) must have at least three years of experience in managing trading infrastructure within financial markets. This requirement serves as a preventive measure against potential market collapses. The ETP must have a minimum net worth of ₹5 crores at the outset and must maintain this net worth at all times. The ETP must have a robust technology infrastructure that is secure and reliable for systems, data, and network operations. All the trade-related information must be disseminated on a real-time or near real-time basis. Once an ETP meets the eligibility criteria, it must submit an application to the RBI in the prescribed format to obtain authorization.

    Offshore ETPs: Opening Doors for Cross-Border Trading

    The background of offshore ETPs is closely linked to the rising incidents of unauthorized forex transactions in India. In response, the RBI has periodically issued warnings against unauthorized platforms engaged in misleading forex trading practices and has maintained an Alert List of 75 such entities.

    The reason for such unauthorized practices lies in the previous 2018 framework, where a significant barrier for offshore ETPs was the requirement to incorporate in India within one year of receiving RBI authorization. This regulation proved challenging for foreign operators, leading to their non-compliance. Under the 2024 draft framework, foreign operators are now allowed to operate from their respective jurisdictions, however, they need authorisation from the RBI.

    The authorization process involves adhering to a comprehensive set of criteria aimed at ensuring regulatory compliance and market integrity. To qualify, the offshore ETP operator must follow some conditions, which include incorporating it in a country that is a member of the Financial Action Task Force (“FATF”). This will enhance the transparency and integrity of Indian Markets. It ensures adherence to global standards in combating money laundering and terrorist financing. This can enhance the overall credibility of India’s financial markets, making them more attractive to global investors.

    Then, the operator must be regulated by the financial market regulator of its home country. This regulator must be a member of either the Committee on Payments and Market Infrastructures (CPMI) or the International Organization of Securities Commissions (IOSCO), both of which are key international bodies that promote robust financial market practices and infrastructure. Once an offshore ETP operator meets these criteria, they must then follow the standard ETP application process for registration with the RBI.

    While analyzing this decision of the RBI, it is a promising initiative. The reason is that it does serve the purpose for which it was intended to be implemented, i.e., preventing unauthorized forex trading. The fundamental issue of unauthorized forex trading was about mandatory incorporation or registration in India, which has been done away with.

    Further, the framework specifies that transactions on these offshore ETPs can only involve eligible instruments that include the Indian rupee or rupee interest rates, and these transactions must strictly be between Indian residents and non-residents.

    Transactions between residents are not permitted under this framework, which indicates that the offshore ETP serves a cross-border trading function rather than facilitating domestic transactions. This is the right step in increasing Foreign Portfolio Investment in India and ensuring risk mitigation that may arise by allowing offshore ETPs to allow transactions among Indian residents.

    The Domestic Game

    However, when it comes to domestic ETPs, the 2024 draft framework is not very effective, the reason being that they do not incentivize domestic operators to apply for authorization. To date, over a span of six years, the RBI has authorized a total of only five ETP operators, one of which is the Clearing Corporation of India and four other private players.

    The reason for such slow adoption is that the operators are ineligible to apply for authorization due to stringent eligibility criteria (Regulatory Restriction). For example, the general authorization criteria for an ETP require that the applying entity or its Key Managerial Personnel must have at least three years of experience in operating trading infrastructure in financial markets. The issue here is that the requirement focuses solely on prior experience in operating trading infrastructure. This effectively limits eligibility to entities already active in this space, leaving little to no opportunity for new entrants to participate and innovate in the ETP market.

    This missed opportunity to foster domestic competition and innovation could limit the full potential of ETPs in India. Therefore, the RBI should take a liberalized approach towards domestic ETPs and ensure that the domestic ETP climate is conducive. To address this, the RBI should broaden the eligibility criteria to allow entities from other financial sectors, not just those with experience in trading infrastructure, to apply for ETP authorization. To ensure market safety, this relaxation can be balanced by imposing stricter disclosure requirements on such entities.

    A phased approach could also be taken by RBI where it could require new players with insufficient experience to first test their platform in the regulatory sandbox operated by RBI and then after rigorous testing, the same could be granted authorization. This will allow more domestic players to participate and will lead to enhanced forex trading in India which will potentially increase FDI investment in India.

    Way Forward

    Another potential change to increase the adoption rate of domestic ETPs might include examining and changing the eligibility requirements. Tax exemptions or lower net worth (less than 5 cr.) entry with certain restrictions could be considered to attract more participants, improving the entire market environment and addressing the low adoption rate found under the existing framework.

    The inclusion of offshore ETPs to register and operate in India has been the most favorable move towards facilitating foreign investment in India. The sturdy registration process ensures that only serious firms join the Indian market, which sets the pace for a market overhaul. The exclusion of scheduled commercial banks and standalone primary dealers is also a significant step forward in simplifying banking operations and increasing FPI.

    Finally, the 2024 Draft ETP Framework may be favorable to foreign ETPs, but the game is not worth the candle for domestic ones. With continued advancements and strategic enhancements, as suggested, India’s ETP framework has the potential to drive significant economic growth and elevate its position in the global financial landscape.

  • Assessing the Deal Value Threshold: Shortcomings and the Way Forward

    Assessing the Deal Value Threshold: Shortcomings and the Way Forward

    BY DHRUV MEHTA, FIFTH-YEAR STUDENT AT JINDAL GLOBAL LAW SCHOOL, SONIPAT

    introduction

    Recently, the Parliament passed the Competition Amendment Act, 2023, which makes substantial amendments to the Competition Act, 2002 (‘Act‘). Amongst the plethora of amendments, the most prominent amendment is the introduction of the deal value threshold (‘DVT‘). DVT is the additional threshold that requires notification (in the absence of any exemption) of a merger or acquisition with a deal value threshold of INR 2,000 crores (USD 0.24 billion) where either of the party to the deal has ‘substantial business operations in India’ (‘SBOI‘). Through the introduction of the Competition Commission of India (Combinations) Regulations, 2023 (‘Draft Regulations‘), the Competition Commission of India (‘CCI‘) has brought more clarity with respect to the ‘transaction value’ and ‘substantial business operations’ under the DVT framework. Through this blog post, the author examines the limitations in the CCI’s interpretation of the DVT and offers recommendations to enhance its clarity and effectiveness.

    Once the Amendment Act was passed, the onus was now on the CCI to quickly define what constitutes ‘value of transaction’ and ‘substantial business operations’. The CCI has followed the footsteps of Germany and Austria by rightly defining what exactly constitutes ‘value of transaction’ and ‘substantial business operations’. However, there are a few shortcomings as to how transaction value has been interpreted and defined by the CCI.

    Transaction Value: Shortcomings and Recommendations

    a. Incidental Arrangements

    Regulation 4(1)(c) of the Draft Regulations requires the value of a consideration to include ‘incidental arrangements’ for calculating DVT. The definition of ‘incidental arrangement’ is confusing and excessively broad. Examining whether a transaction is notifiable would be difficult if an incidental arrangement is accepted in its current form as it may encompass unconnected transactions that weren’t anticipated by the parties when entering into the main transaction.

    To ensure certainty for parties involved in a transaction and to reduce ambiguity in applying the DVT, the CCI should limit ‘incidental arrangements’ to those arrangements foreseen by the parties when the transaction was initiated. Such arrangements should also be explicitly documented in the transaction records. Furthermore, under Regulations 9(4) and 9(5) respectively, read along with Regulation 4(1)(b), the CCI has the power to review interconnected steps of a single transaction when the transaction meets the test of interconnection. In the past, the CCI has exercised its powers by reviewing interconnected transactions in proceedings against the Canada Pension Plan Investment Board and ReNew Power Limited under Section 43A of the Act.  

    This makes the proposed provision unnecessary if ‘incidental arrangements’ are linked to the transaction because the CCI already has the power to look at subsequent transactions that are interconnected. It is recommended that given CCI’s ambit to assess interconnected transactions, it should reconsider the need for incorporating ‘incidental arrangements’  under the value of a transaction. Furthermore, in the event that the CCI decides to retain the said clause, ‘incidental arrangements’ should only include, transactions foreseen by the parties which are included in the transaction documents during execution.

    b. Uncertainty in the Valuation of Non-Compete Clauses

    The draft regulations require that the value of any non-compete clauses be included while calculating the value of a transaction for DVT. There are a few shortcomings with the said requirement.

    Firstly, it is often difficult to attribute value to non-compete clauses. The value of such non-compete clauses is often reflected in the purchase price listed in the transaction documents. When a non-compete clause is not listed in the transaction document, it is often challenging to assign an exact value to such a clause, and assigning an exact value would compromise the DVT’s inherent predictability and clarity. This would be against the ICN Recommended Practices for Merger Notification and Review Procedures, which highlight how important it is for merger control systems to have clear, transparent rules- especially in light of the growing number of deals happening across several jurisdictions.

    Secondly, the value of the transaction is the value that is attributed to the non-compete provision. If the CCI wants to attribute a separate and distinct value to a non-compete agreement that is separate from the value of a transaction, it should not speculate on assigning the value to the non-compete agreement. Rather, when the board of directors of the acquirer or the seller gives a specific value to the non-compete agreement at the time of the transaction, the CCI should also value the non-compete at the same specific value as given by the board of directors.

    It is recommended that the CCI amend the Draft Regulations to include the value of non-compete clauses and agreements as part of DVT as listed in the transaction documents. It should also be made clear in the Draft Regulations that the CCI can only assign a value to a non-compete agreement if it has been given careful thought and approval by the boards of directors of the target company and the acquiring company.

    c. Valuation of Options and Securities

    According to the Draft Regulations, the whole value of the options and securities to be acquired, along with the assumption that such options would be exercised to the fullest extent possible, must be included in the consideration for the DVT for a transaction.

    It is observed that by including the whole value of options, DVT could be breached or relatively small transactions could also be flagged. Moreover, including the full value of options that could potentially be exercised may lead to an overstatement or understatement of their value, as the price at the time of exercise could differ from the price when the option is initially granted. In the USA, the Hart-Scott-Rodino (‘HSR‘) rules state that valuation reports presented to the board of directors would be used as a point of reference for determining the value of a consideration when the same value is unknown but capable of being estimated. The CCI could adopt the practice as stated by the HSR rules, where it could consider the value of an option not on the basis of assumption but instead based on valuation reports presented to the board of directors.

    In line with the stance in other countries and the CCI’s own decisional practice, it is advised that the whole value of shares received upon exercising an option be considered only if and when the option is exercised. Further, to eliminate any doubt regarding the value of the options, the CCI could only take into account the entire value of the options if they are exercised at the per-share price paid to shareholders (perhaps as a way to assign a portion of the transaction value to particular persons).

    Substantial Business Operations: Shortcomings and Recommedations

    Under the Draft Regulations, SBOI is established if, within the 12 months preceding the transaction, the business demonstrates that 10% or more of either (a) its global user/subscriber/customer/visitor base, (b) global gross merchandise value, or (c) global revenue from all goods and services in the prior financial year, is attributable to India. The author welcomes the CCI’s target-only approach for judging local nexus. However, to ensure that transactions having a limited nexus to the Indian markets are adequately filtered out, the CCI needs to make a few amendments to the SBOI framework in India.

    • Redefining ‘Users, Subscribers, Customers, and Visitors’

    Considering ‘every download’ as a ‘user’ would be an overstatement and therefore the threshold of ‘users, subscribers, customers, and visitors’ could lead to double counting as the said requirement is extremely expansive. For a single product business, such as a social networking website, there is a possibility to have a different number of subscribers than users or visitors, and these subscribers may not be active users or visitors. Thus, such ‘visitors’ might not contribute towards the economic value of the target enterprise and should be discounted from the threshold.

    Furthermore, the CCI could have taken inspiration from Germany and Austria who have provided adequate guidance on how to compute the user threshold for digital markets. The Digital Markets Act of the EU also includes clear definitions for terms such as ‘active end users’ and ‘active business users‘ tailored to various products and services such as online intermediation services, search engines, social networking platforms, video sharing services, and more. The measurement of such users, subscribers, customers, and visitors should be carried out according to industry standards as providing an exhaustive list is nearly impossible.

    The CCI through a guidance note could narrow down the ambit of ‘users, subscribers, customers, and visitors’ to that of ‘monthly active users’, ‘unique visitors’ and ‘daily active users’ in the digital markets for assessing SBOI as done by German and Austrian Competition regulators. The CCI could further bring more clarity to its implementation of DVT by referring to the rulings of Meta’s Acquisition of Kustomer and Meta’s acquisition of GIPHY.

    Under the ambit of ‘users’ the CCI could consider both direct and indirect users. Taking inspiration from the aforementioned cases, the CCI could define direct users as those who were paying for the product as well as who are licensed customers. Indirect users would be considered as those who accessed the application, for example, GIPHY library through third-party mediums/applications such as Facebook, Instagram, Twitter, and Snapchat. Moreover, it is important to highlight that the CCI ought to establish distinct standards for evaluating activities across various sectors, just as the German and Austrian guidelines on transaction value threshold do.

    Thus, the author suggests that the criteria of ‘users, subscribers, customers, and visitors’ be replaced by ‘active users which consists of daily, monthly, yearly, direct and indirect users, and unique visitors’. Further, as specific definitions are provided in the Digital Markets Act for ‘active business users’ and ‘active end users’ the CCI could provide guidance for the same across various sectors.

    Conclusion

    The CCI is seen to be taking some major strides in regulating competition in new-age deals within the digital sphere. Taking inspiration from Germany and Austria, the Competition Act was amended to introduce the deal value threshold, which effectively provides the CCI the jurisdiction to assess those digital mergers with little or no assets or revenue. The CCI has tried its best to bring more clarity with regard to the interpretation of transaction value and substantial business operations under the DVT framework. However, it remains to be seen as to how the practical implementation of DVT would be undertaken by the CCI. As highlighted, under the ‘substantial business operations’ prong, the CCI should bring more clarity by clearly redefining ‘users, subscribers, customers, and visitors’.  Towards the final step, the CCI also needs to streamline its approach to reviewing interconnected transactions and the valuation of non-compete clauses.