Recognizing Self-Regulatory Organisations: Charting the upcoming Odyssey in the Fintech Sector

The past few years have been eventful for the FinTech industry. While the pandemic brought conventional businesses to a halt, it was an inflection point for the FinTech industry.

Recognizing the value of the FinTech industry, the RBI has continued to consistently frame regulations in an attempt to balance concerns relating to customer protection, grievance handling, internal governance, data protection, cyber security, and financial system integrity, without restricting the industry’s growth potential.

However, keeping pace with the ever-evolving technology, nuanced business models, and intricate synthetic structures, while balancing the government’s mandate on financial inclusion and overall growth, has been somewhat challenging for the RBI.

As a result, the RBI did not attempt to promulgate any unified legislation governing multi-faceted business models. Rather, a discussion was initiated around self-regulation in March 2023 at a conference organised by the Department of Payment and Settlement Systems.

Soon after, the RBI published the ‘Draft Omnibus Framework for recognising SROs for REs’ acknowledging the need for self-regulation to complement existing formal regulations for effective sector-specific compliance.

With self-regulation being considered as a key approach to govern disruptive technologies in the financial services landscape, the RBI kickstarted 2024 by inviting comments on the ‘Draft Framework for recognising Self-Regulatory Organisations for FinTech sector.'

For a sector as progressive as the FinTech (FT) sector, a Self-Regulatory Organisation (SRO) allows RBI to have a semi-hands-off and adaptive approach towards the regulation of rapidly evolving technological advancements and innovations.

The draft framework in this regard, which was released by the RBI on January 15, is fractioned into four chapters which very broadly prescribe the characteristics, operations, eligibility criteria, functions, and governance standards for a FinTech self-regulatory organization (SRO-FT).

On a bare reading of the draft framework, it seems that the RBI intends to craft only an outline depicting the roles and functions of SRO-FTs without delving into firm constraints and criteria, to foster regulatory flexibility in the constantly evolving industry. In order to meet this end, SRO-FTs have been characterized as representatives of the FinTech sector and are envisaged to liaise with the RBI on behalf of its members. In addition to operating independently, the SRO-FT would function as a repository of information for industry research and policy making. In the eyes of the regulator, the SRO-FT would be a crucial body to assist not just in developing standards to be adopted across the industry, but also in cultivating a culture of compliance among its members.

Recognition of SRO-FTs will be dependent on RBI assessing, inter alia, the membership strength and diversity, net-worth, technological capabilities, grievance handling processes, independence, fee structure, and fit-and-proper status of the applicant SRO-FT. Further, RBI would also have the liberty to prescribe additional conditions or guidelines while issuing a ‘Letter of Recognition’ to an SRO-FT.

The essence of the draft framework is to empower the FinTech sector to come up with its own standards and ethical practices by means of a collaborative and market-sustainable approach. Simply put, the SRO-FT would perform all such functions that would be essential for the self-governance of the FinTech Industry, including, framing rules and codes of conduct, monitoring implementation across its members, standardising key documents, providing training and awareness, and arbitrating disputes and conflicts of interest between members.

While the advantages of an SRO-FT are indisputable, one cannot turn a blind eye to the potential challenges that may be encountered on a road paved with self-regulation.  A few of these challenges which may be required to be ironed out right at the outset for an SRO-FT to fulfill its purpose as an appropriate bridge between industry-led innovation and regulatory compliance, include:

Maintaining Objectivity and Independence: Impartial and influence-free operation of an SRO-FT would be crucial to bring overall credibility and inspire the trust of the industry in the framework. However, while the idea here may sound simple, prioritizing the needs of certain members without compromising the interests of the minority would need a system of objective checks and balances. Further, funding of the SRO-FT by its members must undoubtedly be transparent, and the RBI should consider prescribing certain formal guidance within the SRO-FT framework in this regard.

Holistic Representation and Incentivization: The draft framework requires an applicant SRO-FT to demonstrate the comprehensiveness of its membership. Essentially, an SRO-FT should represent entities of diverse size, nature, and activities within the FinTech space. In this context, while a broad contour has been set, more clarity is needed on how this purpose can be achieved practically viz-à-viz the relationship between each member and the SRO-FT, and the inter-se relationship between the members of the SRO-FT. This will especially be challenging considering that the membership of an SRO-FT is proposed to be entirely voluntary, and it is likely that the industry giants may choose to remain outside the ecosystem in the absence of any significant incentive.

Standard Setting: While recognition of SRO-FTs would instill confidence amongst consumers and investors, it will have to be ensured that SRO-FTs do not become the de-facto gatekeepers of the FinTech industry or bring in a layer of additional superfluous compliances. While RBI has categorically instructed stakeholders to deliberate further over the scope of the framework, it is likely that the industry would be inclined towards extending the scope of the framework to unregulated entities having some aspects of regulated business, only to avoid the possibility of ‘excessive’ regulation which may dis-incentivize membership. Further, while setting standards and monitoring compliance is crucial, self-regulation at the behest of a few must not stifle innovation.

Legal Authority: While an SRO-FT may receive the blessings of RBI, it would lack adequate legal authority which is typically enjoyed by a regulatory body. Though this challenge may be tackled depending on how accepting the FinTechs are of the self-regulatory ecosystem, standing today, where there is a possibility of multiple SRO-FTs co-existing in the industry, the apprehension of regulatory arbitrage which stifles the broader objective of the framework, i.e., to set unified standards across the sector, cannot be ignored.

RBI’s objective to adopt a framework-based approach seems to be ideal for an industry as dynamic as FinTech, and the adaptability of self-regulation to rapid changes allows the alignment of growth with self-imposed standards. However, going forward, a more structured outline focusing on the powers and composition of an SRO-FT may be required to be identified at this juncture to achieve the true intent of RBI, i.e., to harmonize innovation and regulatory compliance. Having said that, the promotion of self-regulation would not take away from RBI its authority as a sectoral regulator and the existence of SRO-FTs must be viewed as a step towards bringing forth standardization in the industry and not a complete handover by the RBI.

About the authors: Chirag Jain is an Associate Partner and Shreya Singh is a Senior Associate at DSK Legal.