Answer ... (a) Crowdfunding, peer-to-peer lending
Online lending in India is increasingly conducted on peer-to-peer (P2P) platforms. The Reserve Bank of India (RBI) regulates P2P lending under its Master Direction – Non-Banking Financial Company – Peer to Peer Lending Platforms (Reserve Bank). P2P platforms must be registered with the RBI as non-banking financial institutions (NBFC-P2Ps). An NBFC-P2P may connect borrowers with lenders and facilitate the granting of loans by providing services such as due diligence, credit assessment and risk profiling. NBFC–P2Ps must have a board-approved policy setting out, among other things, the eligibility criteria for participants. An NBFC–P2P is not permitted to lend on P2P platforms.
Other applicable conditions include the following:
- Only unsecured loans can be granted.
- While multiple loans may be given or taken, there are limits on the aggregate amount of loans that one lender may provide or one borrower may borrow.
- Certain maximum maturity periods are prescribed for the loans.
Crowd-funding platforms that facilitate P2P lending are regulated in the same manner as P2P platforms. Structures based on donations or rewards are generally permitted without any specific licensing or registration requirements. However, the regulatory status of equity-based crowdfunding platforms is not fully resolved. In 2014 the Securities and Exchange Board of India (SEBI) released a consultation paper seeking to establish an enabling framework for equity-based crowdfunding platforms. The proposal included conditions such as eligibility of participants/investors, the maximum capital that may be raised and other integrity and solvency requirements. However, this legal framework is yet to be formulated. The consequence is that today, equity-based crowdfunding may be considered prohibited under the existing SEBI rules and regulations.
(b) Online lending and other forms of alternative finance
Apart from NBFC-P2Ps, Indian banks and NBFCs also use their own online platforms to carry out lending activities. They may also use the services of independent service providers to facilitate the lending process by outsourcing activities such as the following, in accordance with the applicable regulations prescribed by the RBI in relation to the outsourcing of activities by banks and NBFCs:
- verification of the identity of borrowers;
- collection and preliminary processing of loan applications; and
- recovery of principal and/or interest.
India is also witnessing innovation in relation to the platforms through which payments are made. For example, there are proposals for blockchain-based information networks between financing entities to accelerate the processing of financing transactions.
The online lending activities of banks and NBFCs are generally regulated by the same rules and regulations imposed on these entities – that is, their respective credit policies and applicable regulations prescribed by the RBI, such as:
- in relation to banks, the Master Circular on Loans and Advances – Statutory and Other Restrictions issued by the RBI; and
in relation to NBFCs:
- the Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit Taking Company and Deposit taking Company (Reserve Bank) Direction, 2016; and
- the Master Direction – Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016.
(c) Payment services (including marketplaces that route payments from customers to suppliers (eg, Uber and AirBnb)
Payment services are primarily regulated under the Payment and Settlement Systems Act, 2007 (PSSA) (see questions 1.1 and 1.2). Marketplaces that route payments from customers to suppliers, such as Uber and Airbnb, may also be subject to the requirements under the PSSA and associated rules and regulations of the RBI. Additionally, the location of the customer and the supplier on such marketplaces may affect which requirements apply to payments made through such portals. If the customer and supplier are both Indian residents, an online card-not-present (CNP) payment for goods/services will ordinarily need to be authenticated using a two-factor authentication mechanism based on information not visible on the relevant cards. Further, such transactions must be effected through a bank in India and should be settled only in Indian currency. This mandate arises from the RBI’s notification of 22 August 2014 on Security Issues and Risk Mitigation Measures Relating to CNP Transactions. This necessitated a change in operational structure for marketplaces based outside India which connect customers and suppliers from India. Such marketplaces have now adopted structures through which CNP transactions involving domestic customers and suppliers are completed within India, and are not routed through the foreign marketplaces themselves.
Where a payment service involves a ‘cross-border money transfer’ element, it will be subject to certain restrictions and conditions under applicable laws.
Forex transactions are primarily governed by the Foreign Exchange Management Act, 1999 (FEMA). FEMA provides that only an entity which is authorised under the legislation (‘authorised person’) may deal in foreign exchange. An entity may operate as an authorised person only if it has obtained authorisation from the RBI under Section 10 of FEMA. There are essentially three types of authorised persons:
- Authorised Dealer Category I (typically, commercial banks);
- Authorised Dealer Category II (typically, upgraded full-fledged money changers, cooperative banks and regional rural banks); and
- full-fledged money changers.
Forex transactions are strictly regulated and multiple sets of rules and regulations instruct participants as to how they must be dealt with. In many instances, a forex transaction may require prior approval from the RBI.
For example, in terms of pre-paid forex cards, the Master Direction – Money Changing Activities, issued by the RBI on 1 January 2016, specifically permits entities with an Authorised Dealer Category I/II licence to issue forex pre-paid cards to residents for personal or business travel abroad. No other entities are permitted to issue these instruments.
Two types of trading platforms are permissible in India: recognised stock exchanges and electronic trading platforms.
Recognised stock exchanges are stock exchanges which are recognised by the central government and are governed by the Securities Contracts (Regulation) Act, 1956. The Securities Contracts Act prescribes requirements which a company must comply with before its shares can be listed on any recognised stock exchange in India. SEBI acts as the principal regulator of stock exchanges in India. Its primary functions include protecting investors’ interests and promoting and regulating the Indian securities markets. Fintech companies which perform financial intermediary functions may fall under SEBI’s regulatory scope. The Bombay Stock Exchange and the National Stock Exchange are the leading stock exchanges in India.
The RBI’s Electronic Trading Platform (Reserve Bank) Directions, 2018 regulate entities that operate electronic trading platforms (ETPs) – that is, any electronic system, other than a recognised stock exchange, on which transactions in eligible instruments (ie, securities, money market instruments, foreign exchange instruments, derivatives or other instruments of a similar nature, as may be notified by the RBI from time to time) are contracted. ETPs must be authorised by the RBI. However, ETPs operated by banks for their customers (acting as users) on a bilateral basis are exempt from registration with the RBI.
(f) Investment and asset management
Asset classes in India include equity, debt, commodities, real estate and cash. All asset classes (other than real estate) are ultimately regulated and monitored by the Ministry of Finance, SEBI and the RBI. Real estate comprising real property as an asset class is regulated by real estate regulatory authorities established in each state under the Real Estate (Regulation and Development) Act, 2016. However, real estate investment trusts, where money is pooled and invested in commercial properties to generate income, are regulated by SEBI in a similar way to mutual funds.
The rules and regulations applicable to asset classes extend to member registration, securities listing, transaction monitoring and investor protection, among other things.
In 2015 the regulatory body for commodities trading – the Forward Market Commission – merged with SEBI. Commodity trading on these exchanges requires standard agreements as per the instructions, so that trades can be executed without visual inspection.
Foreign exchange trading is generally restricted to the inter-bank segment, with participant banks holding authorised dealer (AD) licences granted by the RBI under FEMA. Retail customers buy and sell foreign exchange through AD banks. The RBI has proposed a framework for a foreign exchange platform (along the lines of the ‘FX-Clear’ interbank US dollar/Indian rupee spot trading platform of the Clearing Corporation of India Limited) for retail participants, to encourage transparent and fair pricing in the retail forex market. However, this framework has not yet come into effect.
(g) Risk management
Indian laws generally seek to regulate risk management activities such as underwriting. In the fintech context, the P2P Master Direction requires NBFC-P2Ps to conduct due diligence and undertake credit assessment and risk profiling of prospective borrowers on a P2P platform. The results must be disclosed to lenders on the P2P platform, effectively managing the lenders’ risk. The NBFC-P2P is not permitted to arrange any credit enhancement or provide any form of credit guarantee.
The P2P Master Direction does not restrict lenders from using their own underwriting processes; nor does it specify the underwriting activities which may be undertaken by such lenders. However, as the RBI governs the regulatory framework for P2P platforms in India, it is quite possible that the RBI may issue guidelines on underwriting by P2P lenders.
Roboadvisers are not specifically regulated in India, apart from general data protection rules. However, traditional financial services players have implemented various roboadvice solutions, which include:
- offering simple financial planning models on an intermediary’s website;
- generating lists of investment funds, securities and portfolios categorised on the basis of risk;
- helping customers to evaluate the probability of achieving their investment goals; and
- generating recommendations for customers to meet their investment goals.
In India, insurtech companies are registered with the Insurance Regulatory and Development Authority of India (IRDAI) as either an insurance company or an insurance web aggregator company. Underwriting processes are generally governed by an insurance company’s underwriting policy. However, insurtech companies must draft underwriting policies in accordance with the guidelines set out by the IRDAI. Further, an insurtech company must file its underwriting policy with the IRDAI once it has been approved by the insurtech company’s board.
As per the IRDAI guidelines, insurtech companies (registered as insurance companies) must ensure that certain details are included in their underwriting policies. Further, every insurtech company must establish a technical audit department to ensure that its underwriting complies with the guidelines. An audit must be conducted every six months and the report prepared by the technical audit department must be presented to the board of directors.