Financial Regulatory Regime

The last quarter saw key changes in the financial regulatory landscape. SEBI eased strictures on investments by Foreign Portfolio Investors by permitting them to invest in exchange-traded commodity derivatives. Additionally, the RBI limited the ‘buy now pay later’ enthusiasm by precluding the loading of Prepaid Payment Instruments through credit lines while also joining the ‘Digital India’ initiative by issuing guidelines to establish digital banking units.

Shruti RajanPartner

Prashant PrakharSenior Associate

Khyati GoelAssociate

The second quarter of 2022 saw several interesting developments in financial regulation. Foreign Portfolio Investors (FPIs) have now been permitted to participate in exchange-traded commodity derivatives, which most likely, is one of the measures that the Indian government has been adopting to strengthen the Indian rupee. On the other hand, the Reserve Bank of India (RBI) has issued an interesting clarification in the background of the growing ‘buy now pay later’ trend, that credit lines cannot be extended to load Prepaid Payment Instruments (PPIs). Lastly, chiming in with the digital India move, RBI has introduced guidelines to establish digital banking units.

Key Developments

  • SEBI allows FPI investment in exchange-traded commodity derivatives

    In a move that seeks to increase liquidity in the market at a time when commodity exchanges are witnessing a fall in trading volumes, the Securities and Exchange Board of India (SEBI), in its board meeting on 29 June 2022, has permitted FPIs to transact in exchange-traded commodity derivatives (ETCD).

    Accordingly, any foreign investor wishing to participate in Indian ETCDs, with or without actual exposure to Indian physical commodities, can do so through the FPI route. Trading shall be permitted in all non-agricultural commodity derivatives and select non-agricultural benchmark indices. FPIs participating in Indian ETCDs shall be subject to prescribed risk management measures and position limits.

    With this, SEBI has now discontinued the Eligible Foreign Entity (EFE) route, which required actual exposure to Indian physical commodities. SEBI observed that the existing framework acted as a deterrent for the EFEs to participate in the Indian ETCDs. Therefore, the number of EFEs participating on exchange platforms had been negligible and the extent of their participation was zero. By permitting FPIs with significant purchasing power to access ETCDs, SEBI is optimistic of increased institutional participation, enhanced market depth and efficient price discovery.

  • Loading of PPIs through Credit Lines

    On 20 June 2022, the RBI directed that the Master Directions on PPIs do not permit the loading of PPIs from credit lines, and that this practice should be stopped immediately. It further clarified that PPIs would be permitted to be loaded/reloaded by cash, debit to a bank account, credit and debit cards, PPIs, and other payment instruments issued by regulated entities in India and in Indian currency only.

    This decision stems from growing concerns regarding the usage of PPI license as a credit instrument as opposed to a payment instrument. This direction has created a frenzy in the fintech lending industry, especially impacting fintech companies operating in the ‘buy now, pay later’ space. Given the sudden adverse impact on market players, discussions are being undertaken with the RBI to reconsider its decision and to provide a way forward causing minimum disruption to customers.

  • Establishment of Digital Banking Units

    With digital banking emerging as the preferred banking service delivery channel in the country, the RBI introduced the concept of Digital Banking Units (DBUs) by issuing guidelines to establish DBUs by commercial banks (DBU guidelines) on 7 April 2022.

    Some key provisions of the DBU guidelines are:

    • Establishing DBUs would be an integral part of the digital banking strategy of banks. Their operational governance and administrative structure should be aligned with the digital banking segment of the bank.
    • Each DBU must offer certain digital banking products and services, both on the liabilities and assets side of the balance sheet of the digital banking segment. The DBU may not offer any product or service which a bank is not permitted to offer in terms of the Banking Regulation Act, 1949.
    • DBUs must onboard customers in a fully digital environment and offer hands-on customer education on safe digital banking services, products and practices.
    • Banks must ensure both physical and cyber security of the DBUs.

    In line with the RBI’s measures to improve the availability of digital infrastructure for banking services, and in furtherance of its objective to accelerate and widen the reach of digital banking services, DBUs should help to increase the digital footprint of banks in India.

The next quarter seems to have started on a critical note with the SEBI issuing a consultation paper to modify its insider trading framework to cover mutual fund units. The move comes in the backdrop of redemption of mutual fund units by ‘insiders’ with an informational edge over the markets. The proposal would import a significant change within the extant insider trading framework in India, and potentially impact the way investments into funds and redemption of fund units are treated from an insider trading standpoint. It will be interesting to see how listed companies and SEBI registered intermediaries ramp up their corporate governance framework in response to SEBI’s consultation paper on the treatment of mutual fund units under insider trading law, pending issuance of formal amendments.

We also expect more guidance from SEBI and/or stock exchanges on the clarifications issued by the exchanges in relation to Rule 8 of the Securities Contracts Regulations Rules, 1957 earlier this year, which identify activities that brokers must not engage in, given the chaos that the clarifications caused amongst broker-dealers.

Further, the RBI has been encouraging digital lending while at the same time controlling the spread of recent trends such as ‘buy now pay later’ and restricting the number of digital lenders in the Non-Banking Financial Companies arena. The market awaits a regulatory framework on digital lending in India to get a clearer sense of the way forward for new-age fintech firms engaged in digital lending.

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