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SEBI Regulatory Sandbox – A Boost to Fintech Innovation

Are you cautious to bring innovation to your sandwiches? What if there was a way to experiment without much spilling or reprimand? What if you had veteran chefs and tough critics to oversee your trials before reals? I suppose that would bring daring creativity much needed for an innovative yet appetizing sandwich. The rationale is no different for most other innovations.

Securities Exchange Board of India (SEBI) earlier this month issued a framework for regulatory sandbox. This framework provides entities registered with SEBI under Section 12 of SEBI Act, 1992, such as financial market participants and intermediaries, facilities and flexibilities to experiment financial technology (Fintech) solutions in a live and controlled environment on a limited set of real customers for a limited time frame. The object is to encourage and facilitate adoption and use of innovative Fintech solutions and promote the development of financial markets. To this end, SEBI may also provide appropriate regulatory relaxations to the applicant during sandbox testing phase. 

The Fintech solution for sandbox testing may be in retail payments space, money transfer services, marketplace lending, digital KYC, financial advisory services, wealth management services, digital identification services, smart contracts, financial inclusion products, cyber security products, mobile technology applications, data analytics, block chain technologies, artificial intelligence and machine learning applications etc.

Eligibility Criteria

The eligible entities may participate on their own or engage services of a Fintech firm, though the eligible entities will be treated as the principal applicant. The eligibility and evaluation criteria for the project will be based on several factors including profile of the applicant, novelty of solution, genuine need for live testing, benefits to users, no risks to financial system, testing preparedness, sound grievance redressal mechanism, adequate disclosure of potential risks to participating users, well defined testing boundary conditions, feasibility and scalability of the Fintech solution etc. The evaluation may be undertaken using a scoring process based on various parameters as considered relevant by SEBI including the foregoing.

Application and Approval Process

SEBI has prescribed a detailed step wise application and approval process. At the application stage, SEBI will review the application and inform of its potential suitability for a sandbox testing. SEBI may also issue guidance to the applicant per specific characteristics and risks associated with the proposed solution. At the evaluation stage, SEBI will work with the applicant to determine the specific regulatory requirements and conditions to be applied to the proposed solution in question. Subject to applicant being willing and able to meet these requirements, applicant will be granted permission to develop and test the proposed Fintech innovation in the sandbox.

Upon approval, the testing phase will begin wherein the applicant will need to disclose to its users that the solution will operate in a sandbox and the potential key risks association with the solution. The applicant would need to procure user’s acknowledgement that they have understood the associated risks involved. The sandbox testing stage shall be for a maximum of twelve months and may be extended upon request of the applicant and as determined by SEBI.

Regulatory Exemptions

To encourage innovation with minimal regulatory burden, SEBI will consider exemptions/relaxations which could be either in the form of comprehensive exemption from certain regulatory requirements or selective exemptions on a case by case basis, depending on the nature of Fintech solution being tested. SEBI may consider relaxation of requirements relating to net worth, track record, registration fees, financial soundness, SEBI guidelines such as technology risk management / outsourcing guidelines etc. The overarching principle is that no exemptions will be granted from the extant investor protection framework, know-your-customer (KYC) or Anti-Money Laundering (AML) Rules as these are cornerstone for market integrity and investor protection.

Cross-Domain Fintech Solution

The registration granted by SEBI to entities under Section 12 of SEBI Act, 1992 is activity based. Therefore, an entity which is registered with SEBI for a particular activity is authorised to carry out activity only in that domain. To enable cross domain testing of Fintech solutions, an existing registered entity can obtain a limited certificate of registration for the relevant domain where it wants to test a solution. This limited registration concept facilitates applicants to create and test Fintech solution in cross domain without being subject to the entire set of regulatory requirements to carry out that activity.

Benefits and Limitations

The benefits of a regulatory sandbox are manifold viz. availability of empirical data on the benefits and risks associated with the solution, allows regulators to understand regulatory changes needed to support such innovation, allows first hand customer experience and feedback, acts as pilot phase for testing product feasibility, risk mitigation to financial systems and aids in overall decision making process by all stakeholders concerned. Some limitations are effort and cost involved in the sandbox phase, limited empirical data for decision making process, non-availability of exemptions/relaxations post testing phase and its consequent implication on the applicant.

Overall, a sandbox provides a conducive and confined space to experiment with innovations at the edge and outside of the prevailing regulatory framework. This should go a long way in enticing market participants and intermediaries to innovate Fintech solutions which are bedrock to support a dynamic financial market.

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