Fintechs, being considered as a fusion of finance and technology, have seen a rapid growth in the recent years across the globe. According to the Financial Stability Board of the Bank for International Settlements, fintech is considered as a technologically enabled financial innovation that could result in new business models having a material effect on financial markets and institutions and the provision of financial services.
In view of the growing significance of fintech innovations in India, the Reserve Bank of India ("RBI") has recently taken several initiatives for re-orienting the regulatory framework to respond to the dynamics of rapidly evolving fintech industry. As innovation can create new risks for financial institutions, consumers of financial services as well as the financial system as a whole, it is important that the technology and innovation is used in the financial service sector with checks and balances.
The RBI had set up an inter-regulatory working group to examine the granular aspects of fintech. The report of the working group was issued in February 2018 ("WG Report") with one of the key recommendations to introduce an appropriate framework for 'regulatory sandbox' which would be an experiment space for the pilot testing of newly developed technologies. Regulatory sandbox is a commonly used term in the fintech industry now. Several countries such as United Kingdom, Australia, United States of America, Netherlands and Singapore have already introduced framework for regulatory sandbox. Further, in order to promote innovation in the securities market, the Securities and Exchange Board of India ("SEBI") has also proposed an 'innovation sandbox' to provide a testing environment to fintechs for offline testing of their proposed solutions in isolation from the live market subject to fulfillment of eligibility criteria.
Pursuant to the WG Report, the RBI has issued the draft framework for 'regulatory sandbox' on April 18, 2019 ("Framework"). This article focusses on the concept of regulatory sandbox, its pros and cons and its prospects in India if the proposed Framework is adopted as it is.
What is a regulatory sandbox?
As provided in the Framework, a 'regulatory sandbox' refers to live or virtual testing of new products or services in a controlled / test regulatory environment for which regulators may permit certain regulatory relaxations for the limited purpose of testing. The regulatory sandbox is a formal regulatory programme for market participants to test new products, services or business models with customers in a live environment.
The proposed financial service to be launched under the regulatory sandbox should include new or emerging technology, or use of existing technology in an innovative way and should address a problem or bring benefit to the consumers. The RBI may provide the appropriate regulatory support by relaxing specific legal and regulatory requirements on a case-to-case basis (with the exception to customer privacy and data protection, secure storage and access to payment data of stakeholders, security of transactions and statutory restrictions) for the duration of the sandbox which the sandbox entity will otherwise be required to comply.
Functioning of regulatory sandbox
The entire process for a regulatory sandbox including launch, theme of the sandbox, entry and exit conditions would be communicated by the RBI through its website.
The regulatory sandbox would conduct end-to-end processes with a limited number of participants having common interest in each sandbox for testing their products in a time bound manner. The entire process would be overseen by the fintech unit of the RBI. Further, the boundary conditions such as limit on number of customers, transaction ceilings and cap on customer losses would be clearly specified for a sandbox.
The sandbox participants would have to ensure that the test customers are informed, and their consent is obtained, regarding the potential risks and available compensation during the testing process. Further, before exiting or discontinuing the sandbox, the participants should ensure that the existing obligations to the customers under experimentation are fulfilled or addressed.
Eligible participants and criteria for using regulatory sandbox
The products / services / technology which could be considered for testing under regulatory sandbox include block chain technology, mobile technology applications, retail payments, money transfer services, smart contracts and artificial intelligence. However, products / services / technology such as crypto currency, credit registry, initial coin offerings and credit information would not be accepted for testing under regulatory sandbox.
The Framework provides for the following key conditions to be satisfied in order to participate in a regulatory sandbox:
Pros and cons of regulatory sandbox
As mentioned in the Framework, one of the key benefits of regulatory sandbox for fintechs is that they will get an opportunity to test the product's viability before rolling out their product / services in the market to public at large. Further, the advantage for regulator is that it will obtain evidence on the benefits and risks of emerging technologies enabling it to take a considered view on the requirement of regulatory changes or making new regulations required to support new innovation.
On the flipside, fintechs may still require RBI approval for launching the product / service in the market post sandbox testing. One of the key downsides for the regulator is that it may face legal issues such as claims from competitors who are outside the regulatory sandbox especially whose applications have been / may be rejected.
The proposed Framework is a step in the right direction to evolve technology innovation in the financial services sector, however, in our view, there may be following challenges if the proposed Framework is adopted as it is:
In order to have an effective utilization of the regulatory sandbox, the above aspects should be taken into account by the RBI while finalizing the Framework.
 The Framework can be accessed at https://rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=920.
 The eligibility conditions prescribed for start-ups can be accessed at: https://dipp.gov.in/sites/default/files/Startup_Notification11April2018_0.pdf.
For any clarification or further information, please contact
Lovejeet SinghSenior AssociateE: Lovejeet.email@example.com
About Clasis Law