Over the past few years, the Indian FinTech sector has grown significantly and has created many new opportunities for businesses as well as customers. According to a study on Innovate Finance, in 2019, India is ranked at third position in global FinTech investment.
Advancement in technology has forced the growth of several industries in India. FinTech is one such sector that has seen rapid growth in recent times. There is no denial of the fact that with increasing FinTech products bringing innovation in the investment sector to reach investors, there is a need to build a secure framework for the development of an efficient, fair, transparent, and inclusive securities market ecosystem.
The capital market of India has always been an early adapter of technology since, the use of technology is considered as a tool of advancement, and therefore, the Securities and Exchange Board of India (“SEBI”) have made efforts to create an ecosystem, which promotes the inclusion of FinTech Startups to introduce innovative financial products, which will help in the development of securities market in India.
SEBI believes that FinTech companies have the potential to accelerate the development and maintenance of a more efficient, fair, and transparent market environment and therefore, these FinTech companies should have access to market-related data, particularly trading and holding data, which is otherwise not readily available to them, in order to effectively test their innovations before introducing them in a live environment to develop innovative financial instruments or platforms for the securities market.
Therefore, SEBI in order to achieve the desired goal took a step in this direction and introduced the concept of ‘Innovation Sandbox’ vide circular SEBI/MRD/CSC/CIR/P/2019/64 dated 20.05.2019.
In this article, we attempt to discuss about the concept of SEBI Innovation Sandbox, its framework, and how it will help the FinTech Companies to bring much needed radical change in the Securities Market with its innovative products.
Innovation Sandbox will serve as a testing environment, wherein eligible FinTech companies and entities not regulated by SEBI including individuals (“Applicants”) will be able to conduct offline testing of their products and services in isolation from the live market based on market-related data made available by Stock Exchanges, Depositories, and Qualified Registrar and Share Transfer Agents (QRTAs) (“Enabling Organizations”).
The notion of an Innovation Sandbox is well-received by the FinTech companies as they consider it as a critical step towards the establishment and development of an efficient, fair, transparent, and inclusive securities market.
The Innovation Sandbox components and structure can be classified into three categories:
B. Legal; and
A. Design component
1. Data Sets
a.) It is one of the most crucial aspects of Innovation Sandbox, as access to Securities Market related data will help the FinTech companies to analyze, test, and improve its innovative product to achieve the desired goal.
Under this framework, FinTech companies are provided with access to the following data –
- Depositories Data (Holding Data and KYC);
- Stock Exchange Data (Transaction Data, Log Data); and
- RTA Data (Mutual Fund Transactions)
b.) The data sets to whom access have been granted shall be historical data, anonymized data, and episodic market events data instead of any live data.
c.) Phase-wise access to the datasets will be provided.
d.) The use of data sets will be governed based on a comprehensive confidentiality agreement including an ‘End User Agreement’ explicitly clarifying, that such data set is not available for sharing with the third party in any manner.
B. Legal components
Under this framework, SEBI will ensure the following –
a.) The Applicants are able to test their innovative products, without affecting the investor’s rights and violating any regulations, compliances, or any other rules stipulated under any of the Indian law including Intellectual Property Rights (“IPR”).
b.) The platform is completely secured, rights and obligations of stakeholders are clearly defined and Applicants comply with the agreed terms of contractually binding terms of participation.
c.) The platform will restrict misuse of data shared with the Applicants and will restrict the development of any product which can be used for any fraudulent activity.
C. Administrative components
a.) The application under this framework initially will be assessed based on the eligibility criteria and going forward self-assessment method will be used for automatic entry of the Applicants in the Innovation Sandbox.
b.) The governance body comprising of representatives from Enabling Organizations will be responsible to supervise the operations of the Innovation Sandbox in the interests of its contributors, users and Securities Market.
c.) An operational team will be constituted, which will be responsible for day-to-day activities of the Innovation Sandbox including processing applications, communicating with Applicants, assisting the governing body, maintaining the infrastructure of the Innovation Sandbox, supervising the testing in Innovation Sandbox, etc.
The Applicants intending to participate in the SEBI Innovation Sandbox shall fulfill the following eligibility criteria –
1. The Applicant shall establish the fact that there is a “genuine need to test” the product using the resources of the Innovation Sandbox, otherwise the Applicant will not be able to develop the product.
2. The Applicant has the necessary resources available to test the product in the Innovation Sandbox.
3. The Applicant has the testing plans with clear objectives, parameters, and success criteria available with them.
4. The innovative product developed by the Applicant shall have identifiable benefits for the consumer, capital market, and Indian economy.
5. The Applicant shall submit a cyber-security compliance certificate as per SEBI’s cyber security guidelines to prove that product is completely secured.
The innovative technologies have created a new path of innovation in the Securities market and the introduction of SEBI Innovation Sandbox has further helped the development of the securities market in India.
Therefore, SEBI on review of the existing framework of the Innovation Sandbox and considering its crucial benefits and huge potential, issued a revised framework for Innovation Sandbox vide circular SEBI/HO/ITD/ITD/CIR/P/2021/16 dated 02.02.2021, in order to encourage and make more companies participate; to develop new possibilities in the Securities Market; and to make existing services more efficient and investor-friendly.
The key amendments proposed by SEBI in the circular dated 02.02.2021, are as follows:
SEBI revised the objective of the Innovation Sandbox, which now states that Innovation Sandbox shall help in developing new products and services and new ways for delivering existing products and services –
- To create new opportunities in the Securities Market;
- To make existing services more efficient and investor-friendly.
B. Steering Committee and Enabling Organizations
The revised framework has introduced the concept of Steering Committee, which will comprise of members from Stock Exchanges, Depositories, Qualified Registrars, and Share Transfer Agents (“Enabling Organizations”) as well as SEBI.
The steering committee will be in charge of supervising the operations of the Innovation Sandbox and in charge of approving or rejecting applications based on the graded eligibility criteria and providing each Applicant a lead Enabling Organization.
C. Eligibility Criteria
The revised framework introduced will help Steering Committee to assess the Applicants in an easier manner, as the eligibility criteria has been bifurcated into two stages:
Stage I –
- The Applicant must be a citizen of India or an entity registered in India;
- The Applicant must have complied with Know Your Customers (“KYC”) norms provided by the Central KYC Registry and KYC Registration Agency;
- The Applicant must have a genuine need to test the solution in the Innovation Sandbox; and
- The Applicant must provide a justification for accessing the test data (depositories data, stock exchange data etc.,) and the test environment.
Stage II –
- The purpose of the Applicant’s project must be aligned with the objective of the Innovation Sandbox;
- The Applicant must have achieved adequate progress and must be on track with its testing plan;
- The Applicant must have postulated a post-testing plan;
- The project of the Applicant must offer identifiable direct/indirect benefits to investors, the capital market, and the financial sector as a whole.
In the revised framework, SEBI has bifurcated the Sandbox process into two stages for a more efficient approach :
Stage I –
In this stage, SEBI will provide limited access to the test environment and there will be a cap on utilization of resources as well to understand the genuine need of the Applicant to develop the product.
Stage II –
In this stage, the cap on resource utilization established during Stage I is eliminated in subject to resource availability.
Under this framework, after completing a minimum of sixty days in Stage-I of the Innovation Sandbox, a Sandbox Applicant becomes eligible for Stage-II of the Innovation Sandbox. The Applicant after completing the minimum term must present its project to the steering committee for review and entry to Stage II of the Innovation Sandbox.
Thereafter, after the completion of 90 days of testing in stage-II, the steering committee shall decide whether the applicant is suitable to continue the testing or not.
The entire duration of the Innovation Sandbox testing stage is a maximum of twelve months and extendable upon request of the applicant duly approved by the steering committee.
F. Intellectual Property Rights (“IPR”)
Although the prior framework allowed for the formulation of policies to safeguard Applicants’ IPR. However, the SEBI’s revised framework recognizes that Applicant’s submissions are likely to feature solutions that are based on similar ideas. As a result, SEBI will not consider any accusations of IPR infringement made by Applicants while testing their goods and services in the Innovation Sandbox.
SEBI with the introduction of Innovation Sandbox has paved the way for the creation of creative solutions to the challenges that the Indian securities market faces by enabling the Applicants to develop innovative products or services with constant regulatory support for the development of Capital Market, Investors, and Economy of the country as a whole.
The Innovation Sandbox provides an enabling platform that acts as a risk-mitigating factor for Applicants, which are not yet regulated, and that might cause harm to consumers.
Further, the enabling framework of the Innovation Sandbox helps bring the cost of innovation down; reduces barriers to entry; and allows regulators to collect important insights before deciding if further regulatory action is necessary or not.
Therefore, SEBI’s amended framework is a step in the right direction for the Indian Securities Market’s evolution. However, the lack of clarity regarding the graded eligibility criteria to be used by the steering committee while approving applications, as well as the failure to recognize the Applicants’ IPR in the Innovation Sandbox is likely to deter some FinTech start-ups and businesses from testing their innovative products and services in the Innovation Sandbox.
Despite the aforementioned limitations, SEBI’s circular is a ground-breaking move to stimulate the use of technology in the securities market, and the market regulator should be applauded for it.
– Team AMLEGALS, assisted by Ms. Kirti Dhoke (intern)
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