Technological innovation in the financial space, popularly known as ‘fintech’, has been at the forefront of regulatory thinking in recent times and is widely considered to be the panacea to the thorny issues of financial inclusion and ease of access to financial products/solutions, etc.
In 2018, the inter-regulatory Working Group (WG) set up by the Reserve Bank of India (RBI) to review the granular aspects of fintech and its implications, released a report being the ‘Report of the Working Group on FinTech and Digital banking’. One of the WG’s key recommendations was the introduction of an appropriate framework for the creation of a regulatory sandbox (RS) where the RBI could provide the requisite regulatory guidance to test products in a controlled environment.
Pursuant to the recommendations of the WG, the RBI has issued a draft proposal on April 18, 2019 (Draft Proposal) highlighting the clear principles and objectives of the proposed RS, as well as a broad outline on how the RS would operate.
Simply stated, regulatory sandboxing refers to the virtual testing of new products or services, in a controlled environment, with broad regulatory oversight. Typically, regulators provide the appropriate regulatory support by relaxing specific legal and regulatory requirements, which would otherwise be applicable for the duration of the sandbox testing. The regulatory sandbox model is popular in many jurisdictions, such as the US, Hong Kong and Singapore, where regulators have identified it as a channel to drive and facilitate innovation.
Objectives of the Regulatory Sandbox
Regulatory sandboxes offer a number of benefits to developers of financial products/ services. Participants in the RS model can test the product’s viability without the need for a larger and more expensive roll out, not just from a regulatory compliance standpoint but also from a customer acceptability perspective. If the product appears to have the potential to be successful, the product might then be authorised and brought to the broader market more quickly. To the extent any regulatory/operational deficiencies are identified, the same may be rectified while the product is in the sandbox.
The RBI’s proposed RS is, at its core, a formal regulatory programme for market participants to test new products, services or business models with customers in a live environment, subject to certain safeguards and oversight. The Draft Proposal anticipates the following benefits to arise out of the RS:
- The RBI would obtain first-hand empirical evidence of the benefits and risks of emerging technologies and their implications, enabling them to take a considered view on the regulatory changes or new regulations that may be needed to support useful innovation, while containing the attendant risks.
- Incumbent financial service providers, including banks, also improve their understanding of how new financial technologies might work, which helps them to appropriately integrate such new technologies into their business plans.
- Innovators and fintech companies can improve their understanding of regulations that govern their offerings and shape their products accordingly.
That said, there are certain aspects of the RS, as currently envisaged in the Draft Proposal, which may benefit from a re-evaluation.
RS Paradigm: What Needs to be Tweaked
Illustratively, the Draft Proposal identifies certain selection criteria for entities to participate in the RS, which may be too restrictive. For an entity to be selected as a participant for the proposed RS, the entity must have a minimum net worth of INR 50 lakhs, turnover not exceeding INR 25 crores and must be registered/incorporated for not more than seven years.
As a result of such restrictive selection criterion, embryonic start-ups whose net worth is less than INR 50 lakhs will not be able to participate in the RS. Further, established fintech firms and financial institutions will also not have the opportunity to beta test their fintech products within the proposed RS.
The Draft Proposal is silent on the protection of intellectual property rights of the participants of the RS. Given that the RS is for beta testing of fintech products, it can potentially reveal the technology solutions of the start-ups and compromise the security of the intellectual property. Recognising this issue, Singapore has a FinTech Fast Track that provides early certainty to the patent application and expedites the file-to-grant process for FinTech patent applications to as fast as six months. The RBI should also take appropriate measures to protect the intellectual property rights of the participant start-ups in the RS.
Further, the RBI has adopted a one-size-fits-all approach for each stage of the RS process. Divided into five, each stage has a definite time period : preliminary screening (four weeks), test design (three weeks), application assessment (three weeks), testing (12 weeks), and evaluation (four weeks). Given the uniqueness of each fintech product/innovation, the RBI should ideally decide the sandbox process on a case-by-case basis.
It remains to be seen if the Draft Proposal is implemented in its current form or undergoes significant modifications before being rolled out. While providing developers a sandbox to perfect their products is undoubtedly a step in the right direction, it is critical to ensure that compliances and conditions do not stifle innovation. Given that the fintech sector in India is still nascent and requires flexibility to further evolve, the RS framework may also benefit from adopting a “light touch” framework.