LEGAL AND REGULATORY FRAMEWORK FOR FINTECH BUSINESSES IN INDIA

OVERVIEW OF THE FINTECH INDUSTRY

India’s fintech market is one of the largest globally.The key fintech sectors in India include Digital payment,Digital lending, Wealthtech, Insurtech and the Virtual digital assets (VDAs).

Digital payment and digital lending have emerged as the most preferred fintech sectorsfor investments.The key factors impacting growth of these sectors include internet penetration; availabilityof skilled human resources; supportive regulatory environment; mature startup ecosystem to attract foreign investments and India’s Digital Public Infrastructure(DPI) comprising of Aadhaar,  Digilocker, Unified Payment Interface (UPI) and Account Aggregators (AAs).

Wealthtech refers to digital solutions which transform the investment management industry. India’s wealthtech market is expected to grow in the years to come and some products that are already disrupting the space include discount brokering platforms which facilitate low-cost and easyinvesting; robo-advisory platforms which enable investments using automated algorithms; fractional investments platforms which enable investments in real estate and other assets through special purpose vehicles; personal finance management platforms which invest savings in the securities market; and copy trading platforms which letinvestors copy investments of expert traders.

Insurtech refers to technology innovations designed to find cost saving and efficient solutionscompared to the current insurance industry model.  Indian insurtech market is anticipated to expand in future and some products that are already disrupting this space aretech-based tools that help insurers underwrite customers;embedded insurance products (like travel insurance offered while booking flight tickets);insurance distribution platforms; andclaim management platforms.

VDAs include crypto-assets such as bitcoin, stablecoins, non-fungible tokens, etc. India has a mature VDA industry with millions of investors. Even after the advent of India’s web 3.0 market the VDA industry in India does not have a comprehensive regulation or a dedicated regulator yet.

SECTORAL REGULATORS

The key regulatory bodies that regulate fintechs in India are Reserve Bank of India (RBI), Insurance Regulatory and Development Authority of India (IRDAI) and Securities Exchange Board of India (SEBI).

Digital payments and digital lending

RBI,India’s central banking authority,regulates financial services such as payments and lending.Itregulates Payment Service Providers (PSPs), for example, Payment Aggregators(PA)and Pre Paid Instrument(PPI)issuers. In order to advance the digital payments in the Country, RBI has introduced lightweight payment systems like UPI Lite making the ecosystem ready for catastrophic events. Furthermore, it has released Digital Lending Guidelines, 2022 to regulate the Banks, Non-BankingFinancial Companies (NBFCs), Lending Services Providers (LSPs) and Digital Lending Platforms/Applications (DLAs). After detailed consultation with the industry stakeholders it has allowed First Loan Default Guarantee (FLDG) which is a prevalent market practice in the  digital lending ecosystem of other jurisdictions. It has also constituted specialised departments and institutions to support fintech’s growth such as RBI Fintech Department; RBI Innovation Hub and National Payment Corporation of India (NPCI).

Wealthtech

SEBI, India’s securities regulator, regulates the wealthtech sector, either on its own or through its regulated entities.It requires fintechs to ensure their business models are transparent and auditable. SEBI has constituted an Advisory Committee on Leveraging Regulatory and Technology Solutions (AleRTS) to ascertain the adequacy of Supervisory Technology (Suptech) and Regulatory Technology (Regtech) tools that it intends to use. Furthermore, it has developed an Artificial Intelligence (AI) based monitoring tool named Picture Based Information News Accumulator and Key Information Analyser (Pinaka) to scan through various videos displaying stock tips and identify violations of securities market regulations. It has also published various consultation papers wherein concerns with respect to regulation of fractional ownership platforms, fantasy stocks games and unregistered financial influencers were posed.

Insurtech

The insurtechservices fall under the purview of IRDAI, India’s insurance regulator that  regulates insurers, corporate agents, web aggregators for insurance and third-party agents for insurance, etc.To achieve its goal of insurance for all by 2047, IRDAI has shifted from the rule based approach to a principal based approach of regulation reducing the regulatory burden, facilitating ease of doing business and encouraging use of technology. It has constituted a committee to explore latest developments in Artificial Intelligence (AI) and Machine Learning (ML). It has also announced to host fortnightly open house discussions for fintech entities to collect suggestions on making insurance related activities more efficient and delivery of insurance services more seamless.

VDA/ Crypto Industry

The Indian Government has classified cryptocurrency or VDA service providers as reporting entitiesunder the Prevention of Money Laundering Act(PMLA), 2000; and its rules. PML Laws obligate reporting entities to comply with obligations includingverifying the identity of customers as per the processes specified under the PML Laws; reporting suspicious transactions to authoritiesand maintaining records of transactions.India, however, does not have a comprehensive law or a dedicated regulator to regulate crypto-assets yet but India is keen to adopt common global standards.In February 2023, India proposed that the International Monetary Fund (IMF) and the Financial Stability Board (FSB) must suggest a global regulatory approach that India and other countries can adopt.

LEGAL AND REGULATORY FRAMEWORK

This is an overview of key laws, directions, guidelines, circulars, and regulations that govern fintechs in India.

Payment and Settlement Systems Act(PSS Act),2007

The PSS Act governs the operation of Payment System Providers (PSPs)in India and empowers the RBI to regulate them.A payment systemenables payment to be made between a payer and a beneficiary.To operate a PSP, an entity must obtain prior RBI authorisation.

Master direction on Pre Paid Instruments (PPI Directions), 2021

The PPI directions govern the issuance and operation of PPIs.It classifies them into three categories namely closed PPIs; small PPIs; and Full-KYC (Know Your Customer)PPIs. Closed PPIs are not regulated by the RBI. However, to issue small and full-KYC PPIs, a non-bank PPI issuer must obtain prior RBI authorisation.

Guidelines on regulation of Payment Aggregators(PAGuidelines), 2020

Non-BankingPAs require RBI authorisation to operate.The PA Guidelines prescribe authorisation process and eligibility criteria for Non-Banking PAs. PAs must have a minimum net-worth of Rs. 15 Crores when they apply for the authorisation.

Master direction on Digital Payment Security Controls (Security Directions), 2021

The Security directions prescribe that RBI regulated entities such as banks, and credit-card issuing NBFCs musthave a robust governance framework for digital payment products and services,implement minimum security control standards, and conduct risk assessments.

Master direction on Know Your Customer (KYCDirection), 2016

The KYC master direction mandated thatRBIregulated entities must conduct KYC of their customers in order to prevent these entities from being used, by criminal elements for money laundering activities.

Stock Brokers Regulations, 1992; Investment Advisers Regulations, 2013; and Research Analysts Regulations, 2014

The wealthtechs that offers stock broking services are regulated under the SEBI (Stockbrokers) Regulations, 1992. Other wealthtech services depending on the nature of services, are regulated under the SEBI (Investment Advisers) Regulations, 2013 and SEBI (Research Analysts) Regulations, 2014.

Registration of Corporate Agents Regulations, 2015; and Insurance Web Aggregators Regulations, 2017

The regulations that regulate and govern the insurtech industry comprising of  corporate agents andweb-aggregators are the IRDAI (Registration of Corporate Agents) Regulations, 2015; and IRDAI (Insurance Web Aggregators) Regulations, 2017.

CROSS-BORDER FINTECH BUSINESS

One of RBI’s key priorities, with respect to cross-border fintech business, is making cross-border payments (especially inward remittances) more efficient.For this, it plans to leverage home-grown fintech products, for instance, as UPI, RuPay card network,and Bharat Bill Payment System (BBPS).Some keys steps that the Indian Government, RBI and NPCI have taken in this respect include:

1. India is exploring the possibility of linking India’s payment systems like UPI with similar systems in other countries. For instance, in February, 2023, RBI and the Monetary Authority of Singapore (MAS) launched cross-border linkage between India’s UPI and Singapore’s Pay Now (a fast payment system). RBI is also in talks with countries like Indonesia, Mauritius, and the UAE, to implement similar linkages.
2. The NPCI and Canara Bank have reportedly launched a service to enable Indians residing in Oman to make payments for their bills in India. The service will be enabled through NPCI’s BBPS, which facilitates bill payment services for electricity, water, gas, phone, etc.
3. In January 2023, NPCI permitted Non-Resident Indians (NRI) residing in 10 countries (including US and Singapore) to pay through UPI, even if their bank accounts are linked to their foreign phone numbers. So far, in order to use UPI, NRIs have had to maintain an active Indian number and link it to their accounts.
4. In February 2023, RBI extended the UPI facility to foreigners travelling to India from G20 countries.
5. India has signed an agreement with Russia to enable payments through RuPay cards and UPI in Russia.
6. In April 2023, NPCI International Payments Limited (NIPL), NPCI’s international arm announced that it has partnered with PPRO, a global digital payments infrastructure provider. Through the partnership, NIPL will leverage PPRO’s vast network of PSPs and merchants to enable acceptance of RuPay cards and UPI globally.

CONCLUSION

The regulatory regime for fintech in India exhibits dynamism and continuous evolution, attuned to the rapid advancements within the industry. This article provides an inexhaustive list of mandates for India’s most successful industry. It is evident that government bodies and regulatory authorities display an unwavering dedication to nurturing innovation whilst concurrently safeguarding consumer interests, data privacy and overall financial stability. For fintech entities, proactive comprehension and adherence to pertinent laws and guidelines are imperative to prosper within this burgeoning sector. As the fintech ecosystem further expands, it becomes indispensable for all stakeholders,encompassing startups, investors, and consumers, to possess a comprehensive understanding of regulatory mandates.

Authored by-

Adv. Somesh Pandey,

Legal Associate, SUO Law Offices, Noida.