Financial Regulatory regime

Previous quarter witnessed some important legal and regulatory developments in the financial services space with SEBI proposing to shift from the current T+2 settlement cycle to T+1 settlement cycle for trading, and RBI clarifying its position on customer due diligence processes for trading in virtual currencies as well as introducing measures to strengthen the security of digital payments in the country.

Shruti RanjanPartner

Prashant PrakharSenior Associate

As the Indian economy picks up steam post the second wave of the pandemic, the financial regulatory space has also seen a corresponding surge in activity. The targeted regulatory measures to mitigate the impact of the pandemic are being rolled back while measures to boost businesses and make markets resilient are on the anvil. SEBI has proposed a T+1 settlement cycle - to allow trades to be settled the day after the transaction is done. While this means some short-term operational difficulties for stakeholders, it promises long-term benefits for the health of markets. On the other hand, RBI has taken note of the difficulties faced by cryptocurrency traders and clarified that banks must continue carrying out customer due diligence processes related to virtual currency trades. The RBI has also introduced various measures to strengthen the security of digital payment ecosystem.

Key Developments

  • Introduction of T+1 settlement in Indian securities markets

    On 7 September 2021, SEBI introduced T+1 settlement cycle for trading on Indian stock exchanges, i.e., payment and delivery of the stocks traded on the stock exchange will now be completed within one day from the date of the trade as against two days after the trade in the earlier regime. However, its enforcement has been deferred till 1 January 2022, for the stakeholders to make necessary infrastructural arrangements required for an effective implementation of T+1 settlement cycle.

    While adoption of T+1 settlement cycle has been kept optional at this point, it is imperative that it is uniformly implemented across the board to discourage arbitrage opportunities across the market.

    A shorter settlement cycle has its advantages, such as reduced counterparty default risk, improved liquidity, and lower margin requirements. However, the journey to its implementation will be challenging, particularly for the foreign institutional investors, who have expressed concerns on account of operational and business challenges that come with a shorter settlement cycle.

    Institutional investors trading through algorithms or pre-defined software, often experience trade shortages due to the time lag between trade execution and actual delivery of securities into the demat account. In such cases, introduction of T+1 settlement cycle is likely to benefit institutional traders by reducing their risk of default and trade shortages. However, due to the shift from the global practice of T+2, several institutional investors, who use a common algorithm for trading across multiple jurisdictions, may be forced to change their strategies to suit the new Indian requirements. The risk assessment for local brokers will also change significantly, and their ability to leverage and manage settlement risks will have to be evaluated.

  • Virtual currency (i.e., cryptocurrency) business in India

    Previous quarter witnessed a surge in the demand for virtual currencies, after the RBI issued a circular on 31 May 2021, clarifying that the banks can continue to carry out customer due diligence processes related to virtual currencies trading, in line with regulations governing standards for Know Your Customer (KYC), Anti-Money Laundering (AML), Combating of Financing of Terrorism (CFT) and obligations of regulated entities under Prevention of Money Laundering Act, 2002 (PMLA) in addition to ensuring compliance with relevant provisions under Foreign Exchange Management Act, 1999 (FEMA) for overseas remittances.

    Increase in demand for virtual currencies in India has also caught the attention of several global players who are now exploring the potential of setting up virtual currency exchanges in India. Currently, there are no specific laws governing virtual currencies or the operation of virtual currency exchanges in India.

    However, the Supreme Court of India in its ruling in the case of Internet and Mobile Association of India v. Reserve Bank of India, has recognized the fundamental right of virtual currency exchange operators to freely practise the profession, or carry on the occupation, trade or business, subject to any reasonable restrictions applicable under the laws of India.

    Accordingly, the current position of law with respect to virtual currency businesses incorporated in India is that such operations can be undertaken in accordance with general laws in India, including but not limited to FEMA, PMLA and the Companies Act, 2013 and the rules and regulations issued thereunder.

  • Digital payments

    In the last quarter, the RBI took several key steps to strengthen the security of digital payments in the country.

    In the wake of a number of data breaches from payment intermediaries, the RBI, in August 2021, introduced a regulatory framework governing the outsourcing activities of payment system operators (PSOs). The framework restricts PSOs from outsourcing key functions like customer data management and imposes heightened compliances such as vendor due diligence for outsourcing.

    The RBI also issued a new Master Direction on Prepaid Payment Instruments (PPIs). The directions simplify the classification of PPIs, further the agenda of interoperable PPIs and also make 'additional factor of authentication' (AFA) such as OTP mandatory for wallet transactions. On a related note, as per RBI's instructions, from 1 October 2021 auto-debit transactions based on customers' standing instructions cannot go through unless they have registered for e-mandate facility with the issuer of the payment instrument. Each transaction will now need to be authenticated by the customer through AFA.

    The RBI had previously restricted payment aggregators and merchants from storing actual card data. It has now extended this mandate to all entities other than card issuers and card networks in the payment chain, requiring them to purge any actual card data available with them by 1 January 2022. To ensure that customers do not have to type in their card credentials for every transaction as a result of this measure, the RBI has, from September 2021 permitted card issuers and networks to provide 'card-on-file tokenisation services'. This will permit online merchants to store a unique ‘token’ or code instead of the card details and use it for subsequent transactions. Tokenisation will also reduce security risk arising from breach of merchant's stored card data.

    It is expected that all these steps taken by the RBI will give a fillip to digital payments.

During the next quarter and beyond, we expect regulators to continue this proactive approach and implement some more robust and investor friendly policies that should positively impact Indian markets. For instance, SEBI has decided to allow resident Indians (other than individuals) to become constituents of Foreign Portfolio Investors that are registered as Alternative Investment Funds in the International Financial Services Centres. It is also planning to amend the criteria for determination of ‘Fit and Proper Person’ and introduce an Investor Charter which would prescribe the dos and don’ts for investors in securities market.

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