A Self Regulatory dharmsankat: An Outlook on The Future of Fintech Through RBI’s SRO Policy

[By Adarsh Vijayakumaran]

The author is a student at the National University of Advanced Legal Studies, Kerala.

In the last few years, financial technology (or FinTech) has revamped the working of finance in India’s evolving legal system. It has changed the landscape of traditional investment instruments and brought newer fleshier techier tools and varieties at the same time, making finance look simple and faster. While for sometime FinTech instrument remained people’s favorite romp, the news of alleged data leaks in Google Pay and the great Indian crypto Ponzi schemes have created a challenging picture for the working of FinTech, thereby, calling forth the regulators of all kinds to regulate these hagfishes to protect the innocent investors. It was in light of this huge stakeholder outcry that on October 22, 2020, the Reserve Bank of India (RBI) exercised its powers under the Payment and Settlements Act, 2007 to introduce a framework for the recognition of Self Regulatory Organization (SRO) for payment system operators.

But a question that needs to be answered is if self-regulation, the most viable option for regulating FinTech? More so, if the RBI’s present policy (even though at its nascent stage) will adequately address the risks and concerns that FinTech since its inception possessed? And finally If not SRO, then what should be next?

Self-regulation represents a social organization whose origin could be traced back to the ancient time of medieval guilds, and merchants were a group of men joined together to form a pact envisaging their rights and obligations. In today’s world, self-regulatory bodies exist in different fields including law, medicine, vendors’ guild and many other sectors. The primary reason for the existence of self-regulation has always been a challenge against the government monopoly created through complex asymmetrical informational flow.

The introduction of SRO for FinTech in India was not completely blindsided. In fact, the formulation of SRO could be traced back to the report submitted by “Inter-Regulatory Working Group on Fintech and Digital Banking” dated November 2017, wherein the committee suggested that a body comprising of representatives of various FinTech companies should be formed for addressing the regulatory lacuna that it was posing. Further, this suggestion was reiterated by many other working groups until the RBI announced its intention to form such an organization in February 2020, and a policy was introduced in August for public comment in the same year. The present framework is based on the comments received after these public consultations.

The RBI’s policy framework for SRO stipulates certain touchstones for making of an SRO body and details out the governance framework and functions of SRO. The policy states the SRO should find behavioral and professional standards in the sector and enforce them based on mutual agreements. It says that SRO is answerable to the RBI and should act as the representative voice of its members in consultations with the RBI. The SRO is also asked with the duty of providing RBI with periodic reports. And further, the SRO is expected to play a constructive role in supplementing and complementing the existing regulatory frameworks.

Now, regarding the governance of the SRO, the RBI has specified that one-third of the board of SRO should be independent members and all memberships should be at the satisfaction of RBI based on the relevant-fit-and proper criteria prescribed by the former. The framework provides that the SRO will be financially viable for fulfilling its objectives, and each member will be required to pay a uniform fee for membership. Moreover, SRO will remain as a not for profit organization following a transparent practice for governance.

The promoters of the idea of self-regulation in finance based market space consider the formation of SRO to be a significant advantage over the direct government regulation as it exemplifies a market environment that is responsive, flexible, informed, and targeted. They emphasize its potential to create shared values among private players, thereby cultivating a sense of ownership and participation in rulemaking. But the reality is often bleaker than what it seems.

To evaluate a policy of an SRO in fintech, one must first understand the purpose and objectives of fintech. Fintech companies stand as a blend of technology and finance to improve and automate economic services. They fill a void in market space that legacy institutions like banks have created in catering to the needs of the wider audience at the expense of customer experience. The primary objective of fintech is to either disrupt the traditional economic space or replace it with a new financial model. On this note, self-regulation for fintech fundamentally means self-serving. Because giving the halters of the future of fintech legal space to private players indicate a transition of power from public interest to private lead. Thereby, making what one would call an illusion of regulation where the profit-seeking enterprise wanders the field as a feral maverick.

The next question that poses a threat to the working of the SRO is whether the independent directors of the SRO will truly be independent? If one was to follow section 149 (6) of the companies, Act in both the letter and spirit an obvious conclusion that will flow from it is that most of the independent directors of the companies are not really independent. The Indian experience of the working of companies over the past several years has shown that most of the independent directors are not really independent and have only been onlookers nominated by the board to witness the tussle between industrial heads. This is true in the case of SRO as well. Even though the policy in its present form stipulates a one by third independent membership, the members will not be truly independent in taking policy decisions as their minority interests could easily be thwarted by the two-third majority held by the private players.

Another significant problem faced in the working of SRO is its lack of power in enforcing policy decisions. Even though SRO will be formed under the supervision of the RBI, the policy stipulates that SRO will remain as a nongovernmental organization that sets and enforces rules of conduct of member entities. But the policy is silent on how this enforcement could work in the absence of real power and to what extent could an SRO go in penalizing the violators. The best examples of such toothless forms of organizations could be found in the Indian scenario itself. The Securities Exchange Board of India during its inception was a non-statutory body that had negligible powers. Its growth and statutory recognition were necessitated by the incidents of the famous Harshad Mehta scam of the early 1990s that made the need to regulate capital markets indispensable. Similar stories could be found in the wild wild west where the famous insider trading scandals perpetrated by the American William Duer necessitated the forming of SEC in as early as the 1800s. These historical examples show that the policymakers have always been hesitant to take preventive actions beforehand and have always waited for the evil to happen. However, such an approach in the context of FinTech will be disastrous since it already has a market capitalization of more than 1 trillion dollars, and if a breach occurs, then it is not going to be limited to less than a billion-dollar.

Finally, the working of SRO as a whole will never be truly successful unless its supervision by RBI is kept to the minimum giving the organization a certain amount of independence in making crucial decisions autonomously without the unnecessarily meddling of RBI. The RBI as a banker’s bank has a greater duty towards all the traditional banks whose working is a complete anathema to the modern functions of FinTech. While the presence of RBI could help bring checks and balances in the Indian fintech legal space, over-regulation would only halt innovation and drag the financial revolution downwards. This could have profound implications making India lag behind the other competing countries in the international marathon for the fintech revolution.

The above being the case, how should fintech be regulated? What alternative should come in place of the present self-regulatory framework?

The reintroduction of the old concept of self-regulation does not fit today’s reality in tackling global challenges posed by the increased financial activities and the coming of innovative financial products in the market where the public interest and advancement of innovation should be balanced. The policy framework adopted at this phase for self-regulation of fintech is not apt for helping innovations reach its long term goals, nor will it help hear the voice of the public at large. As what could be understood from the above discussion is that no matter how the future turns out the working of the self-regulatory body is going to be contradictory to the basic rationale of what self-regulation stands for, i.e., regulation without any external intervention.

The best way that the fintech ecosystem could be regulated is through collaborative governance. Collaborative governance brings multiple stakeholders into a joint forum with public agencies for consensus-oriented decisions making. This mode of regulation would be best suited for fintech, as it does not leave any stakeholders at the harbour in making important decisions. Moreover, the major characteristic of a collaborative governance body is the parity of power. Unlike the proposed model of self-regulation, in the collaborative model of governance and rulemaking, the minority will not be thwarted, nor will the organization have to dance based on the whims and fancies of the RBI. This mode of regulation is highly advanced and will not contradict in its working while addressing policy concerns.

However, the creation of a non-statutory collaborative body will not help the fintech companies revolutionize nor will help meet the needs of the time. Therefore, what is required is a statutory recognition and enforceable powers in punishing the breach of conduct or any kind of unacceptable behaviour that was prohibited based on a common agreement between the collaborative governance body members. This approach of collective rulemaking and enforcement powers, which are the two pillars of collaborative governance, will define the continuum of the future of fintech in India as the potential for breach of common consensus is very meager.

The traditional rationale for self-regulation in fintech is that close participation of the industrial players will generate compliance benefits that are otherwise impossible to adhere to if imposed externally. But the current SRO framework of RBI is not suitable to regulate fintech.  The financial regulatory landscape in India has undergone multiple changes over the last few decades and one thing that could be learned from the previous experiences is that a policy that is based on a common agreement from all the stakeholders will create a better governance model by amplifying public’s voice in public pursuit limiting the ill effects of self in the self-regulatory organization. Nevertheless, it’ll be interesting to see how the policymakers in the coming days will allay the dharmsankat caused by the shortsighted policy reforms, if ever.

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