In its financial stability report dated December 27, 2019,1 the Reserve Bank of India (the "RBI") proposed the New Umbrella Entity (the "NUE") for retail payment systems, to offer alternative digital retail payment systems to the consumers, in a space which has been dominated by the National Payments Corporation of India (the "NPCI") since a decade now.
The RBI issued a Press Release on February 10, 2020, placing on its website a 'draft framework for authorization of a pan-India New Umbrella Entity (NUE) for Retail Payment Systems' (the "Draft Framework")2.
The Draft Framework is a welcome move by the RBI towards setting up an alternative to the NPCI in response to emerging issues of concentration risk and lack of fall back arrangements in times of operational downtime. It is also aimed at increasing competition and fostering innovation and upgradation in payments systems in India. However, there are concerns in the industry as to how it is structured. We have provided our observations and recommendations on different provisions of the Draft Framework below, for the benefit of the general public and different stakeholders.
2. PROVISIONS FOR A NEW UMBRELLA ENTITY
2.1. Objective (Ref: Section A)
To set up new pan-India umbrella entity / entities focussing on retail payment systems. Such an entity shall be a Company incorporated in India under the Companies Act, 2013. The Company may be a 'for-profit' or a Section 8 Company as may be decided by it.
2.2. Scope of Activities (Ref: Section H)
The scope of activities of the NUE shall be, inter alia, to:
- Set-up, manage and operate new payment system(s) especially in the retail space comprising of but not limited to ATMs, White Label PoS; Aadhaar based payments and remittance services; develop new payment methods, standards and technologies; monitor related issues in the country and internationally; take care of developmental objectives like enhancement of awareness about the payment systems.
- Operate clearing and settlement systems; identify and manage relevant risks such as settlement, credit, liquidity and operational and preserve the integrity of the system(s); monitor retail payment system developments and related issues in the country and internationally to avoid shocks, frauds and contagions that may adversely affect the system(s) and / or the economy in general.
- Fulfil its policy objectives and ensure that principles of fairness, equity and competitive neutrality are applied in determining participation in the system; frame necessary rules and the related processes to ensure that the system is safe and sound, and that payments are exchanged efficiently.
- Carry on any other business as suitable to further strengthen the retail payments ecosystem in the country.
2.3. INDUSLAW VIEW
- Concept of an 'umbrella' entity and
The title and objective of the Draft Framework indicates that a new pan-India 'umbrella' entity (NUE) is proposed to be set up or identified, for the management and operation of all retail payment systems. However, this vision somehow gets lost and diluted in the contents of the Draft Framework, which may create some ambiguity as to this intent and objective.
In particular, under section H of the Draft Framework, the scope of activities proposed to be carried out by the NUE primarily focuses on the setting up, management and operation of new payment systems (especially those in the retail space), and the development of new payment methods, standards and technologies. Considering that the Draft Framework does not clarify how this NUE may or is required to manage or operate existing payments systems. Contextually, the manner in which this new entity is required to act as an 'umbrella' entity lacks clarity. Further, the impact of this Draft Framework over existing payments systems or the control of this NUE over existing identified payments systems, is also unclear.
The scope under sub-clause (3) of section H mentions that the NUE is required to ensure that principles of fairness, equity and competitive neutrality are applied in determining participation in the system, and frame necessary rules and the related processes to ensure that the system is safe and sound. However, it is unclear whether the Draft Framework is referring to the overall system or the new payment systems proposed to be developed by this entity.
The Draft Framework also gives a broader purpose to the NUE by entrusting it with the responsibility of monitoring retail payment system developments and related issues in the country and internationally and taking care of developmental objectives in the larger scheme of things (like the enhancement of awareness about the payment systems). In this context, it has also been given the liberty to carry on any other business as suitable to further strengthen the retail payments ecosystem in the country.
- Entity/ Entities
The Draft Framework indicates to the setting up of new pan-India umbrella entity/ entities. It is ambiguous whether the RBI proposes to set up a single NUE or multiple NUEs.
- Where does the NPCI fit in?
It appears that this Draft Framework has been issued in the backdrop of RBI's Policy Paper on 'Authorisation of New Retail Payment Systems' in January 2019,3 wherein concerns regarding the concentration risk in the retail payments systems, from a financial stability perspective, operational downtime standpoint and to foster greater efficiency, innovation and competition, were raised. In RBI's Financial Stability Report of December 2019, it was further highlighted that the NPCI has emerged as a systematically important payment system entity and the availability of NUE would contribute to financial stability and as an alternative digital retail payment systems to the consumers, it would enhance the reach of digital payments to a larger number of people.
Since the NPCI has been set up earlier to achieve a similar objective as provided for the NUE under the Draft Framework, it is unclear whether the NPCI and the NUE will operate side by side or whether this NUE will be managing the NPCI as an umbrella entity as well.
With regard to the above, the Draft Framework could potentially provide some more clarity on:
- the manner in which the NUE is intended to be an 'umbrella' entity for pan-India retail payment systems. This is because the scope of activities in the Draft Framework pertain only to new payment systems, methods and technologies, and there is ambiguity over the control of this NUE over existing payment systems;
- whether and how the NUE may or is required to exercise control over existing payment systems;
- whether the scope of the NUE to ensure principles of fairness, equity and competitive neutrality in the system, is limited to the new payment systems proposed to be developed by this entity or to the overall system.
- how the NUE is required to fulfil the responsibility of monitoring the retail payment system developments, in particular, whether for this purpose, the existing payment systems will be required to report or share data with the NUE. Further, given that the NUE may carry on similar business activities, a clarity is required on how it proposes to balance its monitoring responsibilities in the retail payments ecosystem whilst also being engaged in a similar business activity in the space, without disrupting a level playing field for other retail payment providers.
- whether the NUE is proposed to be a single entity or multiple entities, and in case of the latter, how will different NUEs co-exist with regard to distribution of scope of activities.
- the manner in which the NUE is intended to be an alternative to the NPCI, in particular, how the NUE will co-exist with the NPCI, and whether the NUE and NPCI will have any overlapping functions in the retail payment systems space.
3. ELIGIBILITY AND FOREIGN FUNDING
3.1. Eligible Promoters & Shareholding (Ref: Section C)
The entity eligible to apply as promoter / promoter group for the NUE shall be 'owned and controlled by residents' [as defined in FEMA Regulations, as amended from time to time] with 3 years' experience in the payments ecosystem as Payment System Operator (PSO) / Payment Service Provider (PSP) / Technology Service Provider (TSP). The shareholding pattern shall be diversified. Any entity holding more than 25% of the paid-up capital of the NUE shall be deemed to be a Promoter.
3.2. Foreign Investment (Ref: Section E)
In case of any Foreign Direct Investment (FDI) / Foreign Portfolio Investment (FPI) / Foreign Institutional Investment (FII) in the applicant entity, it shall:
- Fulfil, additionally, the capital requirements as applicable under the extant Consolidated FDI policy guidelines of the Government of India.
- Submit, with application of authorisation, necessary approval from the competent authority as required under the policy notified by the Department of Industrial Policy and Promotion (DIPP) under the consolidated policy on FDI and regulations framed under the Foreign Exchange Management Act (FEMA).
3.3. INDUSLAW VIEW
- While the NUE is required to be set up by promoters who is 'owned and controlled by residents', entities with foreign investment are also permitted to apply. However, for such an entity, necessary approval from the competent authority under the FDI policy is also required to be filed along with the application. While a reasonable ask, this condition may be problematic for promoters looking to utilise foreign funds for setting up an entity specifically for the purpose of setting up the NUE.
- Further, there appears to be a conflict. While the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 and the Consolidated FDI Policy, 2017 allow for 100% FDI under the automatic route for 'Other Financial Services' regulated by financial sector regulators, there is a requirement under this Draft Framework for the promoter to be owned and controlled by Indian residents.
A proviso or an explanation can be added to clarify the implications for promoters looking to utilise foreign funds specifically for the purpose of setting up the NUE.
4. FIT AND PROPER CRITERIA
4.1. Criteria (Ref: Section F)
The Entity / Promoter / Promoter Group shall conform to the Reserve Bank's 'fit and proper' criteria as under:
- Director of the Entity / Promoter Company / Group Company shall be deemed to be a "fit and proper" person if:
- Such person has a record of fairness and integrity, including but not limited to –
- financial integrity;
- good reputation and character; and
- Such person has not incurred any of the following disqualifications –
- Convicted by a court for any offence involving moral turpitude or any economic offence or any offence under the laws administered by the RBI;
- Declared insolvent and not discharged;
- An order, restraining, prohibiting or debarring the person from accessing / dealing in any financial system, passed by any regulatory authority, and the period specified in the order has not elapsed;
- Found to be of unsound mind by a court of competent jurisdiction and the finding is in force; and
- Is financially not sound.
- The entity shall have a past record of sound credentials and integrity.
- In case of any dispute on fulfilment of fit and proper criteria, Reserve Bank's decision shall be final.
4.2. INDUSLAW VIEW
- The qualifying criteria for directors of not just the NUE but also of each promoter and promoter group company, which is that they must have good reputation, character, and honesty, is inherently subjective, open to interpretative ambiguity and is left to the discretion of the RBI. This brings about an element of subjectivity and arbitrariness in the process. Further, there is lack of transparency in the fit and proper criteria which may be followed by the External Advisory Committee (EAC), the Board for Regulation and Supervision of Payment and Settlement Systems and the RBI in the process which will be followed for selecting the NUE.
Draft Framework can provide a more objective fit and proper criteria for directors, in order to remove the element of subjectivity and any arbitrariness in the process of selection of the NUE.
5. PROVISIONS FOR MINIMUM CAPITAL REQUIREMENTS
5.1. Capital (Ref: Section G)
The NUE shall have a minimum paid-up capital of Rs.500 crore (to support / address the need of capital for managing risks, invest in technological infrastructure, for business operations, etc.). No single promoter / promoter group shall have more than 40% investment in the capital of the NUE. The promoters shall upfront demonstrate capital contribution of not less than 10% i.e. Rs.50 crore at the time of making an application for setting up of the NUE. The promoter / promoter group shareholding shall be diluted to a minimum of 25% after 5 years of the commencement of business of the NUE. A minimum net-worth of Rs.300 crore shall be maintained at all times.
5.2. INDUSLAW VIEW
- Minimum capital thresholds
The minimum paid-up capital threshold for the NUE has been set at INR 500 crores, which is subject to a minimum contribution of at least 10% i.e. INR 50 crore at the time of making an application itself. Moreover, a minimum net-worth of INR 300 crores is required to be maintained at all times. While the purpose of this requirement is understandable (which is to support or address the need of capital for managing risks, invest in technological infrastructure, for business operations, among other things), the target group for such applicants may result in excluding upcoming and promising players in the market that are conducive to innovation and development in the retail payments system space, but who cannot meet the minimum capital requirements under the Draft Framework.
- Further, the language of the Draft Framework is framed in a manner which can be interpreted to mean that promotor or promoter group is not permitted to dilute its shareholding below 25% even after 5 years of the commencement of the business.
- A proviso can be added, carving out an exception to the minimum capital threshold requirement to widen the target group for applicants, to include start-ups and upcoming and promising entities in this space.
- The Draft Framework should clarify whether the promoter or promoter group is entitled to dilute its shareholding below 25% after 5 years of the commencement of the business.
6. PROVISIONS FOR SUBMITTING A BUSINESS PLAN
6.1. Business Plan (Ref: Section J)
The application for setting up the NUE shall contain a detailed business plan covering the payment system/s proposed to be set-up and / or operated along with other documents to duly establish its experience in the payments ecosystem.
Such plan shall, inter alia, include technology, security features, market analysis / research, benefit if any of such payment systems, operational structure of the payment systems, time- period for setting up the payment systems and proposed scale of operations, etc. A proposed organisational strategy in terms of fulfilling its responsibility as an umbrella entity shall also be given in the business plan.
6.1.1. INDUSLAW VIEW
- Requirement of a business plan in the absence of clarity on the
scope of the 'umbrella' entity
While its role as an 'umbrella entity' for retail payment systems remains ambiguous, this NUE is however required to provide a proposed organisational strategy in terms of fulfilling its responsibility as an umbrella entity in the detailed business plan it has to submit along with the application for authorisation to the RBI. In the absence of clarity with regard to the NUE's role as an umbrella entity in this space, it may prove difficult for the proposed promoters to detail an effective business plan that conforms with the intention of the RBI under this Draft Framework. This may also lead to filing of incorrect or frivolous applications that are not in line with the objectives of the Draft Framework.
The Draft Framework should provide some clarity on how the proposed NUE is intended to be an 'umbrella' entity for pan-India retail payment systems in relation to new and existing payment systems in India. Further, given that the NPCI has been set up earlier to achieve a similar purpose as the NUE, the Draft Framework should clarify how the NUE will be an alternative to and co-exist with the NPCI, and whether each of their functions will be distinct or overlapping.
The above would enable eligible entities to better understand the scope of responsibilities to be assumed by the NUE as an umbrella entity, and accordingly, more effectively design the detailed business plan to be submitted along with the application, as well as draft the Memorandum of Association.
We have also submitted the above recommendations to the RBI in response to the press release inviting public comments on the Draft Framework
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