As India gradually reopens its economy post a complete national lockdown, the Securities and Exchange Board of India (SEBI) on June 5 released its regulatory sandbox testing framework (SEBI RS Circular). While the ongoing pandemic has disrupted the way we interact and conduct business, it has also accentuated the role of financial technology (fintech).

Regulatory sandboxes (sandbox) can play an important role in promoting fintech innovations to meet new consumer needs. Such sandboxes are often viewed as a signal to the market about the regulator’s openness to technological innovation — a message that is critical to encourage businesses to innovate and create solutions fit for the new reality. While SEBI’s announcement is a welcome move, the existing Indian regulatory framework is not well equipped to harness the full potential of regulatory sandboxes.

A regulatory sandbox refers to live testing of technological innovation under supervisory oversight. It enables regulators to design regulations that can leverage the potential of innovations while mitigating its risk. In India, the Reserve Bank of India (RBI), Insurance Regulatory and Development Authority of India (IRDAI) and now SEBI, separately operate their regulatory sandboxes.

New fintech solutions can enable consumers to adapt to a new social order marked by physical distancing, without losing access to financial systems. This also heightens the need to strike a balance between regulatory priorities that promotes innovation and efficiency, reduce economic vulnerabilities, while keeping risks in check. A sandbox is an important tool to achieve such a balance.

Key challenges

However, a review of the sandbox framework of the financial sector regulators indicates two primary challenges in the regulatory approach.

First, the present framework for fintech sandbox testing is scattered across four financial regulators, with each regulator working in a silo. This fails to account for the disruptive nature of fintech innovations that will blur sectoral demarcations of payments, banking, insurance, securities and pension. The existing framework will only encourage innovations that best fit the circumscribed limits of each regulator, but not those that best serve consumer needs.

Second, there is no uniformity in the approach adopted by each regulator. For instance, while the RBI and IRDAI permit non-regulated entities to apply on its own for sandbox testing, SEBI allows participation of non-regulated entities only through partnership with a regulated intermediary.

Similarly, there is variation in eligibility criteria, duration of the sandbox, consumer protection measures, etc. Unlike the RBI and IRDAI, SEBI requires that in case a registered intermediary seeks to test for an activity for which it is not registered, it has to obtain a limited registration for the activity it seeks to perform. Since innovations may pertain to activities that may not currently require any registration, clarity in this regard should have been provided. Under the existing framework, a cross-sectoral fintech innovation developer will be required to approach different regulators and will be subject to different conditions and timelines for testing the same innovation.

Standalone law

To deal with the existing challenges, the Vidhi Centre for Legal Policy in its report on “Blueprint of a Fintech Regulatory Sandbox Law” recommends the enactment of a standalone law that will facilitate testing of cross-sectoral fintech innovations that fall within the regulatory ambit of more than one financial regulator.

Among other things, the proposed law envisages the creation of a formal inter-regulatory co-ordination committee consisting of representatives from the four financial regulators for facilitating cross-sectoral fintech sandbox testing and prescribes common minimum standards for sandbox participants to adhere.

Such a framework will cause least disruption to the financial system as it will still enable each regulator to continue operating its own sandbox. At the same time it will provide regulatory certainty to fintech innovators.

The role of fintech to meet the financial needs in this new social order presents a huge opportunity for countries. Recognising this, regulators across the globe are focussing on developing systems that will promote fintech innovations, such as UK’s announcement to develop a digital sandbox. India should also leverage this opportunity to build a regulatory system that encourages the development of robust, secure, low-cost and contactless financial products and services.

The writer is a Team Lead and Senior Resident Fellow (Fintech) at Vidhi Centre for Legal Policy