INTRODUCTION
With the financial year ending in March 2023, there was a flurry of activity by financial services regulators. In particular, the Government of India has expressed its interest in the crypto ecosystem by expanding the Prevention of Money Laundering Act, 2002 ("PMLA") compliance to entities providing services in relation to Virtual Digital Assets ("VDA"). This, along with the Reserve Bank of India's ("RBI") consistent increase in scrutiny and investigations of businesses in the digital lending space constituted the key highlights in March 2023.
If the Union Budget, 2023, and the regulatory reforms announced over the past few months are any indication of the regulator's intent, it appears evident that we are likely to continue to witness several movements in both regulatory and market developments as we step into the new financial year. You can find our write-up on the key reforms affecting the fintech sector https://induslaw.com/publications/pdf/alerts-2023/Infolex_Article_Union_Budget_2023_Key_TechAways.pdf here. From an increase in embedded finance offerings to the launch of new-age technology and software services, several tech trends are set to shape the fintech industry in 2023.
RECENT LEGAL & REGULATORY DEVELOPMENTS
https://www.sebi.gov.in/legal/circulars/mar-2023/e-wallet-investments-in-mutual-funds_69254.html Mandatory Know Your Customer ("KYC") process for e-wallet investments in mutual funds
The Securities and Exchange Board of India ("SEBI") vide a circular dated March 23, 2023, has mandated that all e-wallets for investments in mutual funds must be fully compliant with KYC norms as prescribed by the RBI. The provisions of this circular will be applicable with effect from May 01, 2023.
Prepaid Payment Instrument ("PPI") charges for merchant transactions
The National Payments Corporation of India ("NPCI") vide a circular dated March 24, 2023, has levied an interchange fee of 1.1 percent on United Payments Interface ("UPI") transactions above INR 2,000, made to merchants (such as online merchants, large merchants and small offline merchants) using PPI such as online wallets. As per the circular, the changes will come into effect from April 1, 2023, and the aforesaid pricing will be reviewed on or before September 30, 2023. The circular clarifies that the interchange fee will have no impact on the end-customers and that UPI-to-UPI transactions will continue to remain free. Further, Peer2-Peer (P2P) and Peer-2-Merchant (P2PM) transactions between a bank account and a PPI will fall outside the purview of the interchange fee.
Accordingly, such interchange fee will only apply to digital wallet transactions made via merchant QR codes, which are likely to be paid by the merchant acquirer to the wallet issuer. Therefore, it remains to be seen if this charge will be absorbed by the merchant acquirer banks or will trickle down to the merchants as well.
NPCI has further stipulated that a PPI issuer will need to make a payment of 15 basis points as a wallet loading service charge to the remitter bank (account holder's bank) for loading amounts greater than INR 2,000 in the wallet.
Mandatory KYC and reporting requirements for cryptocurrency exchanges
The Ministry of Finance (Department of Revenue) vide a notification dated March 07, 2023, ("PMLA Notification"), has expanded the scope of the PMLA by bringing VDA transactions within its ambit. The PMLA Notification states that Section 2(1)(sa) of the PMLA, which defines the activities of a person carrying on 'designated business or profession' shall now include: (a) exchange between VDAs and fiat currencies; (b) exchange between one or more forms of VDAs; (c) transfer of VDAs; (d) safekeeping/administration over VDAs/instruments enabling control over VDAs; and (e) participating and providing financial services related to an issuer's offer and sale of VDA. Further, the PMLA Notification states that VDA shall have the same meaning assigned to it as provided under Section 2(47A) of the Income-tax Act, 1961 ("Tax Act").1
By virtue of the said notification, such persons who are engaged in the aforementioned 'designated business or profession' in relation to VDAs shall now be classified as 'reporting entities', as defined under Section 2(1) (wa) of the PMLA. Accordingly, such persons will now have to comply with the obligations set out under the PMLA and the rules made thereunder which inter alia, include verifying the identity of the client, reporting of KYC data to the central KYC registry, registration with and reporting to the financial intelligence unit of India, conducting on-going diligence, appointing principal officer, and maintaining records as per the PMLA.
BHIM UPI Brand Guidelines issued by NPCI
The NPCI vide a letter dated March 02, 2023, that was addressed to all UPI ecosystem participants (including banks), issued an addendum to the Mandatory Brand Guidelines2 for BHIM UPI. NPCI is of the opinion that owing to the increasing number of transactions on UPI per day, an awareness video will assist users to use the application safely, especially those with limited knowledge of smartphone usage. The use of the BHIM UPI brand mark by participants in the UPI ecosystem is subject to the participants complying with the Mandatory Brand Guidelines for BHIM UPI.
The letter mandated that all banks, payment service providers and third-party application providers comply with the following requirements by March 31, 2023:
- When a user installs and opens a UPI app, a video on 'How to use UPI safely' should be available on the first screen of the application in a prominent place. In case playing the video in the application is not feasible, a link to the video may be provided;
- There should be a provision to change the language of the said video; and
- The said video should be displayed to both existing and new users.
Extension of the last date to link Permanent Account Number ("PAN") with Aadhaar
To provide additional time to taxpayers to link their PAN with Aadhaar, the date for linking PAN and Aadhaar has been extended to June 30, 2023. One can now intimate their Aadhaar to the prescribed authority for AadhaarPAN linking without facing repercussions.
Under the provisions of the Tax Act, every person who has been allotted a PAN as on July 01, 2017, and is eligible to obtain Aadhaar, was required to intimate his Aadhaar to the prescribed authority on or before March 31, 2023, (erstwhile due date), on payment of a prescribed fee.
Now with the extension of the timeline, from July 01, 2023, the PAN of taxpayers who have failed to intimate their Aadhaar, as required, will be inoperative. It is imperative to note that the consequences during the period that PAN remains inoperative will be as follows: (i) no tax refunds will be made against such PANs; (ii) interest will not be payable on such refund for the period during which PAN remains inoperative; and (iii) TDS (tax deducted at source) and TCS (tax collected at source) shall be deducted /collected at a higher rate.
The PAN can be made operative again in 30 days, upon intimation of Aadhaar to the prescribed authority after payment of a fee of INR 1,000.
INDUSTRY DEVELOPMENTS
RBI summons Non-banking Financial Companies ("NBFCs") and seeks to review their contracts with fintech companies
The Digital Lending Guidelines3 issued by the RBI on September 02, 2022, ("DLG"), specifically directed regulated entities (being banks and NBFCs registered with the RBI) to adhere to RBI Master Directions on Securitisation of Standard Assets, 2021 ("Securitisation Directions"), specifically the provision on synthetic securitization, when accepting first loss default guarantees ("FLDG"). A coherent reading of the DLG with the Securitisation Directions suggests a prohibition of synthetic securitization measures such as FLDG.
In light of this development, owing to the lack of absolute clarity on the status of FLDG, some fintech companies have continued to operate on a model where some type of risksharing arrangement continues, while most others have migrated to a model that can be considered as prudent and conservative compliance with the DLG. However, the RBI having noticed instances of lending arrangements still structured basis a synthetic securitisation arrangement has written to regulated entities seeking details of their contractual arrangements with fintech companies to examine inter alia, details such as which entity has the ultimate ownership of the regulated entities, whether the full responsibility of assessing the customer credit worthiness lies with the regulated entities, the fintech, or split between the two, and who is ultimately bearing the credit risk of the contract. Based on industry reports, it appears that the objective is to ascertain whether the regulated entity has full control of the underwriting process before onboarding the customer and whether it would bear the credit risk in full, in case of defaults. Further, from RBI's perspective, FLDG arrangements are often seen as posing a transparency risk as fintech companies covering the credit risk of its partnered lenders/regulated entities are not regulated by the RBI and accordingly, are outside the scanner and purview of the RBI.
As a result, regulated entities and/or their fintech partners having any arrangement that dampens the spirit of the DLG, are being questioned by RBI. If found to be in violation of the applicable law, in addition to being liable for heavy penalties, regulated entities may possibly be barred by the RBI from conducting business. It, however, remains to be seen whether and when the RBI will come out with more clarity on the final status of FLDG, which for the longest time, was typically issued by fintech partners to provide comfort to their partner lender (regulated entity) with respect to the borrowers originated by them; and what types of legally viable alternate options exist (including a more specialised and liberal digital lending license regime) for the fintech players going forward.
Effect of bringing cryptocurrency exchanges under the purview of PMLA
The RBI and the Government of India have for many years now been cautioning users of cryptocurrencies in relation to the associated potential economic, financial, operational, legal, customer protection and securityrelated risks associated with trading in cryptocurrencies. In the absence of regulations surrounding the governance of cryptocurrencies and VDAs, barring the Finance Act, 2022, which amended the Tax Act to include VDAs under the ambit of taxation in India. However, entities that were engaged in the business of operating platforms that dealt with the exchange of VDAs or the provision of any service in connection with VDAs, were unregulated.
Now, by virtue of the PMLA Notification, activities (as detailed above) undertaken by any entity operating or dealing with VDA will now fall under the classification of a 'reporting entity' as per the PMLA and come under the purview of the PMLA.
It is imperative to note that reporting entities (such as cryptocurrency exchanges) under the PMLA are subject to an onerous and granular set of obligations, including conducting customer due diligence and verification of client identity, registering with and reporting information to financial intelligence units of India and maintaining records. These entities are also required to register themselves with the central KYC registry. Additionally, the Indian Computer Emergency Response Team Directions dated April 28, 2022 (CERT-In Directions), issued by the Ministry of Electronics and Information Technology, already require virtual asset service providers, virtual asset exchange providers and custodian wallet providers to retain transaction and KYC records for a period of 5 years.
Accordingly, cryptocurrency exchanges and other VDA service providers have now gone from being completely unregulated to being heavily regulated, without the attendant reputational benefits in terms of marketing that a genuine recognition by either RBI or SEBI would bring. This move is bound to impose several initial challenges on VDA exchange and service providers in terms of processes and compliances to be met under PMLA.
Further, post the PMLA Notification, several foreign cryptocurrency exchanges operating in India would get affected by the PMLA Notification, and, accordingly, how such foreign entities will cope and comply with the stringent compliance requirements will need to be seen as further clarity on the extent of regulation applicable to such foreign entities is awaited from the regulator.
MARKET UPDATES AND MAJOR DEALS IN INDIAi
The Union Budget, 2023, which was announced by the Hon'ble Finance Minister on February 01, 2023, made references to the introduction of several key reforms and developments in the tech space. This validates that 'technology' is meant to play a key role in achieving the visions set out in Amrit Kaal4. Some of the key announcements made inter alia include framing a common business identifier and providing a one-stop KYC solution for companies, enabling an entity-level digi-locker system, establishing a national financial information registry, data embassies and a centre of excellence for artificial intelligence, amongst other activities towards simplifying business operations through the use of technology.
The regulators remained busy on the enforcement side with the RBI imposing penalties on Amazon Pay India Private Limited ("AmazonPay") 5 and Nuvama Wealth Finance Limited ("Nuvama") 6 due to non-compliance with RBI directives. In relation to AmazonPay, the RBI has clarified that such penalty was based on deficiencies in regulatory compliance with respect to KYC directives. Further, Nuvama had failed to implement a robust software capable of effectively identifying and reporting suspicious transactions.
Amidst the perceived funding winter and dynamic regulatory environment, fintech companies have emerged as the top sector in the first quarter of 2023 and have accounted for almost 45 percent of the funding raised by Indian technology startups during this period. The funding raised by Indian startups dropped by 75 percent to US$ 3 billion during the first quarter of 2023 from US$ 12 billion in the corresponding quarter of 2022. Overall, with over 4,000 startups, the fintech sector raised US$ 1.28 billion in funding during the first quarter of 2023.7
Fintech deals concluded during the month of March 2023 include:
GrayQuest, an online lending platform for school and college fees, raised US$ 7 million in the Series A funding round led by Pravega Ventures. The round also saw participation from the Weizmann Group, Telama Family Office and Apurva Parekh. The startup plans to utilize the proceeds towards product development and scale its distribution.8
StashFin, a neo-banking startup, raised US$ 100 million in a debt funding round from venture debt firms InnoVen Capital and Trifecta Capital as well as a host of domestic lenders. The fresh proceeds will be deployed to optimize the entity's portfolio for potential securitization as it looks to scale up its business.9
Nimbbl, a fintech startup raised US$ 3.5 million in funding from Groww, Sequoia Capital India and Global Founders Capital. The round also saw participation from Palo Alto-based angel collective Amara VC along with angel investors such as Kunal Shah of Cred, Amrish Rau of Pine Labs, and Jitendra Gupta of Jupiter. The focus of Nimbbl will be on acquiring a merchant base.10
LoanTap, the digital lending platform, acquired the healthcare-focused fintech firm Unofin in an effort to ramp up its exposure in the healthcare financing space. LoanTap plans to expand its reach in the rapidly growing healthcare sector in India by leveraging the fintech healthcare expertise of Unofin, which has serviced over 12,000 customers.11
BharatPe, has picked a majority stake in Trillion Loans Fintech, an NBFC. Besides, BharatPe has already secured all necessary approvals from the RBI to acquire a 51 percent stake in the said NBFC. The move will enable BharatPe to make major inroads into the lending space.12
Acko, the Bengaluru-based insurance-tech unicorn, acquired the digital health platform Parentlane. The acquisition will help Acko in building a digital healthcare ecosystem focused on solving core problems in healthcare access for its customers.13
PhonePe, raised an additional US$ 200 million in primary capital from Walmart, at a pre-money valuation of US$ 12 billion. This new funding comes as a part of PhonePe's ongoing US$ 1 billion fundraise, having shifted its domicile to India last year. PhonePe will deploy the new funding to scale new businesses such as insurance, wealth management, lending and stockbroking. IndusLaw advised PhonePe on this transaction.14
Footnotes
1 Section 2(47A) of Tax Act defines VDA to mean: '
(a) any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme; and can be transferred, stored or traded electronically; (b) a non-fungible token or any other token of similar nature, by whatever name called; (c) any other digital asset, as the Central Government may, by notification in the Official Gazette specify:
Provided that the Central Government may, by notification in the Official Gazette, exclude any digital asset from the definition of virtual digital asset subject to such conditions as may be specified therein.
Explanation-For the purposes of this clause, - (a) "non-fungible token" means such digital asset as the Central Government may, by notification in the Official Gazette, specify; (b) the expressions "currency", "foreign currency" and "Indian currency" shall have the same meanings as respectively assigned to them in clauses (h), (m) and (q) of section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999).'
2. https://www.bhimupi.org.in/sites/default/files/BHIM%20UPI%20Guidelines.pdf
4. The Finance Minister of India, Ms. Nirmala Sitharaman while presenting the Union Budget 2023, outlined her vision of Amrit Kaal, which envisages a technology-driven and knowledge-based economy for India for the next 25 years.
5. https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=55322
6. https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=55354
7. https://inc42.com/buzz/fintech-startups-steal-the-show-in-q1-2023-raise-45-of-total-funding/
9. https://www.vccircle.com/stashfinraises-100-mn-debt-co-led-by-innoven-trifecta-capital
11. https://www.vccircle.com/kaecapital-backed-loantap-snaps-up-unofin-to-boost-healthcare-lending-play
12. https://www.livemint.com/companies/news/bharatpe-acquires-nbfc-trillionloans-11679423583867.html
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