India – Fintech Investment Update: A Q&A With Cyril Amarchand Mangaldas.

19 May 2021
 

1. What are the recent regulatory developments introduced in the Financial technology (“FinTech”) space in your jurisdiction this year?

FinTech space, in the last six to eight months, has created a buzz. There have been various regulatory developments and incentives taking place at an extremely frequent interval. The key developments impacting the FinTech industry/ sector, both from an investor’s lens and from a founder’s prism, may be classified into the following heads:

a) Development in digital lending and traditional speciality finance space: Given the recent turmoil witnessed in the Indian digital lending space and collection practices, the RBI by way of its circular dated June 24, 2020 on “Loans Sourced by Banks and NBFC) over Digital Lending Platforms: Adherence to Fair Practices Code and Outsourcing Guidelines” (“Fair Practices Code Guidelines”), prescribed that all banks and NBFCs, irrespective of whether they lend through their digital lending platforms or an outsourced lending platform, are required to adhere to the Fair Practices Code Guidelines, in letter and spirit and are also required to follow regulatory instructions on outsourcing of financial services and information technology services. Followed by such prescription, the RBI, through its press release dated January 13, 2021, decided to constitute a working group on digital lending to study all aspects of digital lending activities in the regulated financial sector as well as by unregulated players, so that appropriate regulations can be instilled.

The aforementioned development, was introduced subsequent to the scale-based classification of NBFCs issued basis RBI’s discussion paper titled “Revised Regulatory Framework for NBFCs – A Scale Based Approach” on January 22, 2021. The said discussion paper proposed a framework to classify the NBFCs into the following categories i.e. – base, middle, upper and top layers, based on the principle of proportionality, which implies that an entity posing higher risk will be regulated more closely than the others.

Such classification is intended to have a massive impact on the currently existing approximately ten thousand NBFCs in India, which will re-align themselves in the aforementioned categories. Such a development may be regarded as one of the biggest regulatory/ policy developments, impacting speciality financing companies in India since, the introduction of Chapter IIIB (Provisions relating to Non-Banking Institutions Receiving Deposits and Financial Institutions) in the Reserve Bank of India Act, 1934, in the year 1963, which was issued basis the Banking Laws (Miscellaneous Provisions) Act, 1963, which created a new class of financial institutions i.e. NBFCs.

b) Relaxations by the securities regulator: Owing to the emergence of wealth tech/ FinTech companies in the Indian financial services space and to facilitate mutual funds (“MF”) innovation/ geographic penetration, for the first time since constitution of Securities and Exchange Board of India (“SEBI”) as an autonomous body on January 30, 1992, by way of an amendment to regulation 7(a)(iv) of the SEBI (Mutual Funds) Regulations, 1996, SEBI has relaxed the requirement for a MF ‘sponsor’ to have a ‘sound track record’ i.e. having profits in three out of the last five years, including the fifth year.

Going forward, MF sponsors who do not meet the above criterion, would still be eligible to set up a new or acquire an existing MF asset management company (“AMC”) and trustee company, if it has a minimum net-worth of INR 1 Billion as contribution towards the AMC’s net-worth, which is required to be maintained till the sponsor makes profits for five consecutive financial years.

The above relaxation has opened the MF floodgates with several technology/ wealth management/ product distribution platforms applying for either a fresh SEBI MF license (organic route), or through acquisition of an existing MF AMCs and trustee companies (inorganic route).

With the above hurdle crossed, all eyes are now on SEBI to see whether the pools of private and third-party capital i.e., marquee private equity funds with corpus raised from limited partners, would have a shot at either sponsoring new MFs or bidding for >40% net-worth stake in existing Indian MFs. Such entry of private equity players shall digitize the distribution of MF and bring in fresh thinking and blood in the MF space to a great extent, which till date, has been dominated by traditional players.

c) On-tap licensing of universal banks and small finance banks: The RBI, pursuant to its guidelines published on: (i) August 1, 2016 in relation to “On-tap licensing of universal banks in the private sector” (“UB Guidelines”); and (ii) December 5, 2019 in relation to “On-tap licensing of small finance banks in the private sector” (“SF Guidelines”), constituted a standing external advisory committee on March 22, 2021 for evaluating applications of universal banks and small finance banks under the chairmanship of Shri Shyamala Gopinath, former deputy governor, RBI. Further, the RBI by way of its press release dated April 15, 2021, released the names of applicants under the aforementioned guidelines i.e., four applicants each under the UB Guidelines and the SF Guidelines.

The above development is considered to be one of the biggest regulatory developments since 2013, when the last round of banking licenses were issued and two of the most credible names in the banking industry obtained their banking licenses.

The aforementioned development will usher in an era of digital banking in India as it may appear from the review of publicly available information that the applicants under the UB Guidelines and the SF Guidelines primarily intend to venture into digital banking as compared to traditional banking. This will be very fascinating as it will go a long way in deepening not just the banking space, but will also tie up with RBI’s financial inclusion story, because ultimately, for financial inclusion to happen, an application based banking, given the penetration of phone network in India, would be required. Hence, the way forward brings us excitement and this theme encompasses multiple sub-themes.

d) RBI’s internal working group: The internal working group (“IWG”) released a report titled “Ownership Guidelines and Corporate Structure for Indian Private Sector Banks” on October 26, 2020. The same was released in the public domain on November 20, 2020. The IWG plans to issue new banking licenses and upon finalisation of the aforementioned guidelines, large industrial houses would be granted an option to obtain banking licenses.

Further, the IWG also permits large NBFCs/ speciality finance companies, having completed more than 10 years of existence and having more than INR 500 Billion asset size, to convert into a bank.

Separately, the IWG grants an option to merge a non-operative financial holding structure (“NOHFC”), where a NOHFC holding a bank alone may become a single entity. This has been done to do away with the depressed valuation at the NOHFC level, which will unlock a great amount of value. As a result, the management bandwidth would be focused on business development, instead of structuring the financial institution.

The abovementioned developments that have evolved in the last six months are key to the FinTech space and the same theme can be expected to be witnessed over the next six to eight months.

2. What are the recent regulatory/ government incentives introduced in the FinTech space in your jurisdiction this year?

There have been numerous incentives introduced by the Government in the FinTech sector, especially on account of COVID, in the last eight to twelve months. The top three incentives impacting the said industry/ sector may be classified under the following heads:

a) Setting up a FinTech hub at Gujarat International Finance Tec-City International Financial Services Centre (“GIFT-IFSC”): The Union Budget 2021 suggests setting up a FinTech hub at the GIFT-IFSC, with an intention to provide a platform for FinTech start-ups to expand globally and access capital. Such development may be deemed to be one of the most important developments in the last decade, which will provide a great fillip and impetus to the growth of the International Financial Services Centres Authority going forward.

b) Extension of deadline for processing of e-mandates for recurring online transactions: In August 2019, the RBI had issued a framework for processing of e-mandates on recurring online transactions (“E-Mandate Framework”). Initially applicable only to cards and wallets, the said framework was extended in January 2020 to cover UPI transactions as well. The E-Mandate Framework has put in place various safety and security measures for recurring card payments, including the requirement of additional factor of authentication (“AFA”) for registration, pre-transaction and post-transaction notifications to the cardholder by the bank/ merchant, online facility for customers to withdraw any e-mandate subject to AFA validation and a dispute resolution and grievance redressal mechanism for cardholders.

RBI, by way of its circular dated March 31, 2021, observed that the progress of onboarding existing as well as new mandates of customers, as per the E-Mandate Framework, has not been satisfactory. In order to prevent possible large-scale customer inconvenience and default, the RBI extended the erstwhile deadline of March 31, 2021 by six months i.e. till September 30, 2021.

The said extension is a welcome step for payment system operators and payment aggregators working with digital services and platform providers that provide email and cloud services and regular media subscriptions, amongst many others. However, it is to be seen as to what action the RBI will take against entities for non-compliance to create an infrastructure that implements the E-Mandate Framework.

c) Sandbox regime by various regulators: In the last eight to twelve months, various regulators published their own sandboxes including sandboxes on FinTech, wherein a platform is provided to innovators and testers, which can be used to mimic the characteristics exhibited by the production environment on a real-time basis. Such analysis helps the concerned players to simulate responses from all the systems that an application interface with.

Every sandbox is unique and has its own set of advantages. However, to pick one which may be deemed to cater to the need of the hour was the sandbox released by way of RBI’s press release on December 16, 2020 titled “Second Cohort under the Regulatory Sandbox” having ‘cross-border payments’ as its principal theme. Considering cross-border payments on the student payment side or peer-to-peer lending side and the impact of COVID on inward and outward remittances, this can be the best-timed sandbox, as the future of payments, given the whole coupling of Indian economy with Payment/ FinTech sector of the world (especially with Singapore and San Francisco Bay area).

3. What are the recent regulatory developments governing the use of FinTech in the fund-based market in your jurisdiction this year?

As mentioned in response to question #1, in furtherance to paving way for FinTech companies to be sponsors of MFs, SEBI issued a circular titled “Circular on Mutual Funds” on March 4, 2021 (effective from March 5, 2021), which inter alia mandates the trustees to obtain SEBI’s comments before effecting a ‘change in the fundamental attributes of a MF scheme’ which may seem burdensome, as the regulator’s role and oversight already guarantees for the requisite checks and balances to govern MF schemes, including for MF scheme transfers through separate regulations and circulars in that regard.

Hence, the modification may add another layer to the merger and acquisition deal-making, impacting deal costs and timelines, especially if a ‘new sponsor’ application may be involved, from a process, governance and unit holders’ standpoint.

4. Has there been any change in the legal status of virtual currency in your jurisdiction this year?

It is a difficult question to answer. Whilst there have been developments in cryptocurrency/ virtual currency regime, a lot of concrete developments are awaited as ‘The Cryptocurrency and Regulation of Official Digital Currency Bill, 2021’ (“Cryptocurrency 2021 Bill”) is yet to be tabled before the Indian Parliament and a copy of the same is not yet in the public domain. However, basis the description of the purport of the Cryptocurrency 2021 Bill, it seeks to: (i) create a facilitative framework for creation of the official digital currency to be issued by the RBI; and (ii) prohibit all private cryptocurrencies in India.

The Cryptocurrency 2021 Bill as compared to its 2019 edition titled “Banning of Cryptocurrency and Regulation of Official Digital Currency Bill, 2019”, conspicuously omits the words ‘banning of’ from the title. Therefore, it would be interesting to see the approach that the Government will sway towards cryptocurrency, i.e., whether there will be a soft-touch approach of regulating entities or an outright ban on such existing private cryptocurrencies.

In addition to the steps undertaken by the RBI, the Ministry of Corporate Affairs is also now tracking the companies which are investing in cryptocurrencies and by way of a notification dated March 24, 2021 (effective from April 1, 2021), has prescribed that there shall be a requirement for all the companies to disclose details of their investments/ trading activities in cryptocurrencies during a given financial year in their financial statement submitted with the concerned registrar of companies.

Having said that, once the Cryptocurrency 2021 Bill sees the light, it is hoped that it shall help in streamlining the FinTech sector and ensure that this sector thrives and achieves its maximum potential, subject to various belts and suspenders and in particular, the underlying technology i.e., blockchain, which may be used in the banking and non-banking sector (including payments).

Additionally, as and when the decision of the Central Government is made concrete to release India’s ‘Central Bank Digital Currency’ (as in the case of China and proposal of Russia), it will usher into a new era of cryptocurrency alongside of fiat currency, as there have been attempts made in the past to launch India’s digital currency “Laxmicoins” developed/ mined by a group tech players from Silicon Valley, the United States of America. According to the founders, Laxmicoins will use blockchain technology similar to bitcoin and will expectedly have a total coin supply of thirty million.

As of date, unlike Singapore, which under its Payment Services Act, 2019, requires: (i) registration of cryptocurrency exchanges with the Monetary Authority of Singapore, involving detailed KYC/ CFT/ AML obligations; and (ii) due diligence on cryptocurrency exchange and issuer, there are no such similar requirements for registration/ license with the RBI for undertaking cryptocurrency business in India.

With the recent listing of a cryptocurrency exchange on NASDAQ, the Indian cryptocurrency evangelists await the promulgation of the Cryptocurrency 2021 Bill and see the fate of centralized cryptocurrency, having the adequate regulatory governance measures. India has witnessed a shift from a traditional banking system to a digital banking system.

Hence, with the expansion/ significance of cryptocurrency in the world market, now may seem to be the right time to regulate cryptocurrency appropriately in India, essentially balancing out the pros and cons of cryptocurrency with appropriate security measures to amplify innovation and invention in this space.

5. What regulates the use of FinTech in the insurance sector in your jurisdiction?

Companies engaged in the insurance technology sector (“InsureTech”) in India are on booming spree and moving and growing hand-in-hand with FinTech companies and have also started joining the “unicorn league” (a unicorn is a privately held start-up company valued at over USD 1 Billion).

On the InsureTech side, the explicit legal changes are still underway. Currently the FinTech business in the Insurance sector is governed under the Insurance Regulatory and Development Authority of India (Insurance Web Aggregators) Regulations, 2017 (“Web Aggregators Regulations”).

The Web Aggregators Regulations have led various new players to enter in the InsureTech sector and many of them are very credible names and well-funded and ensuring financial inclusion in the Insurance sector.

Having said that, the answer of merging/ managing one asset class with another is still in doldrums, as each asset class such as MF, loan, banking is running in silo. Therefore, it is important that InsureTech marries wealth tech and FinTech.