Financial Regulatory Regime

The previous quarter witnessed some important legal and regulatory developments in the financial services space with the RBI issuing the Digital Lending Report, which sets the background for how digital lending and the increasingly popular ‘buy now, pay later’ model may come to be regulated in India. SEBI and the Stock Exchanges also took steps towards streamlining the regulatory framework around settlement procedures and businesses that a stock broking entity may undertake.

Shruti RajanPartner

Prashant PrakharSenior Associate

Vidhi ShahAssociate

The October–December 2021 quarter saw a significant recovery of the Indian economy while withstanding continued volatility in the Indian stock market. On the regulatory front, there were several interesting developments in the financial and capital markets. With the rapid advancement of technology in every sphere, the Digital Lending Report issued by India’s central bank is noteworthy, since it sets the stage for governing digital lending and its players. SEBI recently tightened the timelines under its settlement regulations while also rationalising certain factors which determine the quantification of settlement amounts. Additionally, the government gave an impetus to brokers in GIFT City by allowing them access to global securities markets.

Key Developments

  • Report of the RBI on Digital Lending

    In the backdrop of sharp growth in digital lending activities in India as well as the incorporation of technology and mobile applications in all spheres and sectors, the Working Group on Digital Lending (WG) constituted by the Reserve Bank of India (RBI) released the much-awaited Report on Digital Lending including Lending through Online Platforms and Mobile Apps (Report).

    The Report distinguishes digital lending from conventional lending based on its use of digital technologies for lending processes such as credit assessment, loan approval, loan disbursement, loan repayment and customer service.

    This Report is useful for participants in the financial sector engaged in lending activities directly as balance sheet lenders (such as banks and NBFCs) or indirectly as lending service providers, i.e. entities that provide core and ancillary lending services such as customer acquisition, loan sourcing, underwriting support, pricing support, providing a marketplace for lenders as well as borrowers etc.

    The report covers (i) legal and regulatory, (ii) technology and (iii) financial consumer protection aspects, in relation to the operation of digital lending in India. However, it does not delve into the eligibility of digital lenders or the lending model that digital lenders must adopt.

    Some of the key focus areas of the Report are:

    • The creation of a self-regulatory organisation consisting of lending service providers and digital lending apps as members.
    • The implementation of a verification process for digital lending apps and maintenance of a public register by a nodal agency, to enable identification and removal of unauthorised entities from digital lending sector.
    • The upgradation of the technological standards adopted by digital lending apps.
    • The implementation of a regulatory mechanism to ensure more accountability for balance sheet loans, particularly short-term consumer credit.
    • The protection of financial consumers and avoidance of over-indebtedness of consumers.

    The Report intends to import some strictures and controls around balance sheet lending. It proposes to restrict balance sheet lending to entities regulated by the RBI or registered with any authority under law. Alternatively, regulated entities may be required to refrain from allowing their balance sheet to be used by unregulated entities to assume credit risk in any form.

    The Report also seeks to preclude first loan default guarantee arrangements (FLDG) between regulated and unregulated entities, and regulate this kind of FLDG arrangements, which are commonplace in the Indian financial market and presently operate in a rather grey zone, from a regulatory perspective. The Report also warns against ‘buy now, pay later’ schemes which have been garnering popularity over the years, and are commonplace in developed markets.

    Comments on the Report were sought from stakeholders and members of the public. The WG may make further recommendations based on consultations and comments received from the relevant stakeholders and the Report may then serve as a guiding document for the RBI to issue directions on digital lending in the future.

    Please click here to read our detailed update.

  • SEBI tightens the timeline for settlement of enforcement actions

    As part of its effort to streamline and expedite the settlement process for enforcement actions, SEBI has reduced the timeline for filing settlement applications.

    Following these amendments, the timeline for filing a settlement application has been brought down to 60 days from the previous 180 days, from the date of receipt of show cause notice from SEBI. Prior to the amendment, while settlement applications could be filed within a period of 60 days from the date of receipt of show cause notice, such applications were also entertained by the regulator for an additional 120 days if the noticee was willing to pay an enhanced settlement amount (by upto 25%). However, now, settlement applications would only be entertained for a period of 60 days from the date of receipt of show cause notice.

    Moreover, in a move to encourage settlements, the regulator has also rationalised the ‘proceeding conversion factor’ which is a key metric in the settlement regulations, that goes on to determine the quantum of settlement amount which will eventually be payable by the noticee in the facts of a case. Simply put, the rationalisation of this factor will result in lesser settlement amount when the noticee opts to settle in the initial stages of proceedings. As and when the proceedings advance, the amount of settlement also increases, on account of a higher proceeding conversion factor.

    Holistically, these measures would not only be beneficial for market participants who can obtain quick resolutions and closure, but also reduce the burden on the regulator, given that such regulations are likely to shorten otherwise long-drawn litigation.

  • Restriction on certain business activities by stock-brokers

    The National Stock Exchange of India (NSE) recently issued a clarification-cum-warning to all its members, in consultation with SEBI and other stock exchanges, regarding the interpretation and applicability of Rules 8(1)(f) and 8(3)(f) of Securities Contracts (Regulation) Rules, 1957 (SCRR), which requires the members of stock exchanges to not undertake any business other than that related to securities and / or commodity derivatives.

    In this regard, there have already been two clarifications by the market regulator in the past permitting (i) borrowing and lending of funds in connection with securities business, as well as (ii) business in goods related to the underlying commodity, and business in relation to trading in commodity derivatives, within the ambit of Rule 8 above. Despite these clarifications, it was brought to the notice of stock exchanges that its members have been engaging in a range of diverse business activities, in contravention of the SCRR.

    Accordingly, the recent NSE circular sets out certain business activities, which brokers should refrain from engaging in. These include (i) issuance of corporate guarantees towards credit facilities and pledge of deposits with banks for overdraft facilities availed by any entity including group entities and related parties, insofar as such activities are not related to securities or commodity derivatives business, (ii) borrowing of funds for the purpose of granting onward loans, (iii) issuing and funding commercial papers to raise money, (iv) schemes of unauthorised collective investments, (v) scheme for accepting securities from any client/entity other than through the approved SLB mechanism, (vi) pledging of client securities, and (vii) providing a platform to the clients for buying and selling of digital gold or any other product not covered under the definition of securities as per SCRR.

    Accordingly, given these explicit directions, brokers must now be mindful of the nature of activities that they engage in or associate themselves with, particularly in the backdrop of increasing regulatory and quasi-regulatory scrutiny on stockbrokers following recent broker-default incidents.

  • GIFT City allows global access to broker deals

    In an interesting move, which has attracted brokers to set up shop in Gujarat International Finance Tech-City (GIFT City), the International Financial Services Centre Authority issued a circular on 25 November 2021, granting registered broker-dealers incorporated in GIFT International Financial Services Centre (IFSC) access to exchanges in jurisdictions outside the IFSC.

    To facilitate access to foreign exchanges, registered broker dealers may either enter into a cross border arrangement with entities regulated in their home jurisdiction to obtain access to an exchange outside the IFSC or register itself as a trading member with a stock exchange outside the IFSC.

    However, the permission for global access by broker-dealer is limited for the purpose of proprietary trading and not client trading, which is a significant limitation to a rather flexible approach of the IFSC. Therefore, it remains to be seen if the permission of global access is extended to client trading subsequently.

    The opportunity to avail global access comes with certain obligations for broker-dealers, including the need to ringfence IFSC related capital market activities from those in other jurisdictions, adequate disclosures as well as ensuring segregation of securities and funds belonging to clients trading on IFSC exchanges from those pertaining to global access.

During the next quarter and beyond, we expect some clarity in the cryptocurrency space, and more decisiveness in relation to the path that the Indian government seeks to adopt, i.e., whether to regulate cryptos and introduce SEBI as a regulator for crypto-exchanges or ban the trading of private cryptocurrencies altogether. Parallelly, we expect to see an uptake in the adoption of the blockchain technology by fintech platforms and the response of regulators to this evolving market infrastructure.

We also see growing interest from foreign entities in setting up shop at GIFT City, whether as broking houses or as tech-centres in the SEZ area of GIFT City, depending on the nature of their business. Meanwhile, domestic brokers are likely to continue to explore solutions to allow clients access to foreign securities on their platforms. While brokers have been achieving this through referral arrangements, further guidance from the market regulator in this regard is expected in the coming months.

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