FinTechSelf-Regulation in the FinTech Industry: A possibility

BRIEF OVERVIEW OF THE FINTECH SECTOR’S RAPID GROWTH AND INNOVATION 

Technological advancement and modern innovation have rapidly helped the FinTech sector towards exponential growth. The growth was beyond imagination in financial services which led to the change of customer preference due to its ease.

The Covid-19 pandemic triggered the growth of FinTech and digitalization. The funding in the FinTech was unimaginative. A research report predicts that the revenues of the FinTech companies will increase threefold faster than the traditional banking sector between 2023 and 2028.

The radical growth in the banking sector, e-commerce, and rapid digital adoption around the world will continue to benefit the countries. At present, FinTech companies are working along with large and traditional financial institutions in the market and expanding their base through emerging technology.

Despite its potential, the rapid proliferation and popularization of FinTech alternatives to regular offline institutions for banking, lending, investing etc. raises concerns about customer protection, data privacy, and cyber security.

It is crucial to recognize the rapid advancements in such SaaS technologies. Although they need to be regulated, excessive regulation could also hinder FinTech’s development.

Regulatory measures should be balanced, flexible, and proportionate to manage these risks without stifling growth. Finding this balance is essential to harness the creative potential of FinTechs while mitigating risks to the financial system.

ESTABLISHMENT OF SELF-REGULATORY ORGANIZATION FOR THE FINTECH INDUSTRY 

On January 15, 2024, the Reserve Bank of India (hereinafter referred to as “RBI”) released a draft Framework for Self-Regulatory Organisation(s) (hereinafter referred to as “Framework/FSRO“) in the FinTech Sector to promote self-regulation amongst FinTech companies and potentially create distinct self-regulatory body governing FinTech companies (hereinafter referred to as “SRO-FT”).

The FSRO would ideally consist of FinTech companies that come together to define ethical and professional conduct, consumer protection practices and technological standards for their members.

Subsequently, the SRO-FT is imagined as a bridge by promoting responsible innovation and adherence to industry best practices while enabling faster adaptation to the dynamic nature of the FinTech landscape. The approach of the Government is to empower the sector to demonstrate its commitment in the absence of any formal regulations

OBJECTIVE OF THE DRAFT FRAMEWORK FOR SELF-REGULATORY ORGANIZATION(S)

The basic objective of the Government is to make FinTech companies choose their own set of standards that align with the growth and is answerable to peer demands. These self-regulations may foster self-discipline and conducive environment in the FinTech sector. The draft seeks to present a basic structure which can be followed for the structure of the SRO-FT.

IMPORTANT FACTORS IN THE SRO DRAFT

All kinds of FinTech companies whose working are fundamentally different are included in the draft stating that “restricting to one SRO-FT could dilute some industry concerns”. This raises concerns about the consensus of different FinTech companies whose fundamental work is different and is governed by different laws.

The SROs cannot be the true representative of the FinTech sector as it derives its strength from its membership. There would be times when a particular FinTech company would not join the SRO and would remain as it is. Does it mean that a FinTech company is not representing the FinTech sector?

Also, the concern may arise on the membership agreement, if the SROs are large enough to dominate the market according to its will then the new entrants would be fearful to enter the market also it may be the case that the SRO would not let them enter.

Functions of the SROs may include that the members need to mandatorily adhere to the regulatory compliances. Failing to do so would lead to outset from SRO with fine as such.

FUNCTIONS AND RESPONDIBILITES OF SROS

As per the draft, the major function of the SRO-FT would be setting up specialized guidelines for data security, data privacy and consumer protection. The SRO-FT is left on its own discretion to frame standardized documents for the FinTech sector for specific requirements which would be detrimental in the long run for new FinTech companies which are in their nascent stage of establishment.

Also, the accreditation system in SRO-FT would definitely lead to exploitation by the hands of top FinTech companies. The Government officials will typically consider whether self-regulation is a proper alternative to public regulation, or whether costs can be covered in a public framework.

The framework has suggested the members of the SRO-FT to pay for its sustenance and impartiality of the same. The members should support collective arrangements and ensure that their autonomy is not threatened. There should be self-auditing in evaluation of the performance of individual companies. The value of individual members in the SRO-FT arrangement may be increased by enhancing the reputation of that arrangement.

ROADMAP AHED FOR IMPLEMENTATION OF SRO-FT

The setting up of an SRO-FT in future would face a dilemma in regards to compliance, whether compliance should rely on peer pressure among the individual members companies or on market pressure. There is also uncertainty about the role of the Government and whether departments or courts should be put in charge of enforcing the mandate of the SRO-FT.

SRO promulgations of the SRO-FT should not be advisory and its members should be bound to follow its rules. The implementation of this would not have an easy way as it is not formally recognised under any law or act. It may be recognized under Reserve Bank of India Act 1934 (hereinafter referred to as “RBI Act”) or the Payment and Settlements Act, 2007 (hereinafter referred to as the “PSA Act”).

The recognition of the SRO-FT by the in RBI Act or the PSA Act would give teeth to the body to act upon its members and would bring transparency and responsibleness.

An alternative suggestion is for the Department of Consumer Affairs (Central Consumer Protection Authority) to bring guidelines under the Consumer protection Act, 2019 preventing the interest of the public at large and necessary actions in case of data leaks or any mishappening by the members of SRO-FT.

CHECK AND BALANCES FOR SRO

According to the draft, the SRO-FT have to structure framework that would guide its own oversight and enforcement. This would contradict in future. What if there are two SROs and both of them set up different rules and regulation for overseeing their works and its enforcement. No uniformity will exist.

To solve this problem, the Government should prepare a basic draft on the working of SROs which would be followed by the SROs. For surveillance mechanisms on industry participants, the draft does not speak about who are industry participants. It would apply only to members or to the whole FinTech sector.

AMLEGALS REMAKRS

The concept of a self-regulation industry body is not new in India. The best example of this is the Advertising Standards Council of India (hereinafter referred to as the ”ASCI”). However, on taking a closer look at the work and effectiveness of the advertising industry, it becomes clear that the ASCI  has struggled to maintain ethics and professionalism in the Industry mainly due to the absence of formal regulations.

Despite the ASCI’s existence, there are offensive and problematic advertisements which have to be taken to court at the end of the day. Since the FinTech sector is not regulated as of now, an SRO-FT might be used as a scapegoat by the Government in case of a debacle.

Thus, to ensure power to the body and also to ensure accountability, the SRO-FT should have stakeholders from the FinTech industry as well as the Government from each regulating department that would help the SRO-FT to work within the framework of that department or law.

As the volume of digital transaction increase, the Government may eventually set-up a designated FinTech tribunal along the lines of the traditional tribunals working in India with people employed being both judicial and non-judicial experts in the digital transaction.

-Team AMLEGALS assisted by Mr. Pritam Kumar (Intern)

For any query or feedback, please feel free to get in touch with tanmay@amlegals.com or jason.james@amlegals.com