SEBI Innovation Sandbox for FinTech Startups
- 19 August 2019 | 2051 Views | By Abhinav Mishra
The Securities and Exchange Board of India (SEBI) is the regulator and the supreme authority for regulating the securities market in India. SEBI was founded in 1988 and given statutory powers on 30 January 1992 through the SEBI Act 1992.
The primary functions of the Securities and Exchange Board of India include the protection of the interests of investors in securities and to promote the development of, and to regulate the securities market and matters connected and incidental therewith. SEBI has to be reactive to the requirements of three different groups, which constitute the market:
- Issuers of securities
- Investors and;
- Market intermediaries
SEBI has been appreciated hugely as a regulator as it has initiated many systematic reforms aggressively and successively in the past. SEBI is recognized for its quick measures towards making the markets electronic and paperless by introducing the T+5 rolling cycle from July 2001 and T+3 in April 2002 and further to T+2 in April 2003.
Introduction to Innovation Sandbox for Indian Fintech Startups
Amidst the fast-paced growth of the FinTech industry in India, financial regulators in the country have been swift to recognize each such development and keep pace with the market. One particularly interesting development is the global adoption of regulatory sandboxes. SEBI also believes in the ideology of encouraging, adoption and usage of financial technology (‘FinTech’). It strongly believes that it would have a profound impact on the development of the securities market. FinTech can act as a catalyst to further foster and maintain an efficient, unbiased and transparent securities market ecosystem. SEBI has also felt that FinTech firms should have access to market-related data, particularly, trading and holding data, which is otherwise not readily available to them, to enable them to test their innovations well before the introduction of such innovations in a live environment, to further create an ecosystem which fosters innovation in the securities market.
With a vision to operationalizing the abovementioned endeavor, The Securities and Exchange Board of India on May 20th 2019, proposed a framework on “Innovation Sandbox” – a testing environment where FinTech firms and entities not regulated by SEBI including individuals can experiment innovations in a closed environment. This creates exciting opportunities for all FinTech firms to revolutionize with a long-term outlook and construct business models that will renovate the financial services and investments industry. IRDAI came up with a similar initiative to ensure flexibility in the insurtech market.
What is Sandbox?
A Sandbox, as defined in the Oxford English Dictionary, “is synonymous with software development and refers to a virtual space in which new or untested software or coding can be run securely”. A regulatory sandbox will allow FinTech startups to test their products before going live and analyze and improve upon the gaps in their present services.
Eligibility criteria to be a participant of Innovation Sandbox
The circular released by SEBI lays down the broad framework concerning the design, legality, administration, and eligibility of the participants of the sandbox. The circular issued provides just a basic framework for outlining of the concept of Innovation Sandbox for FinTechs by SEBI. For becoming eligible for testing in the Innovation Sandbox, the applicants would have to fulfill all the criteria’s as stated below:
- An entity which intends to innovate products/services/solutions in commodities or securities market in India;
- An entity with a genuine need to test the proposed solution in Innovation Sandbox resources;
- An entity with the necessary resources to support testing in Innovation Sandbox;
- An entity with a post-testing plan;
- An entity with solution offering (direct/indirect) identifiable benefits to consumers and Indian capital markets at large; and
- An entity whose solution is validated for cyber security parameters.
Components of SEBI Innovation Sandbox
One of the most important constituents of an Innovation Sandbox is access to securitIes market-related data, which will allow the participants to test and improve their FinTech solutions. The datasets shall be historical and anonymized data and shall also contain data related to episodic market events. Live data shall not be made available to these participants. More so, access to such datasets will be provided in a phased manner starting with a limited amount of data and based on validations, more exhaustive data would be provided to participants. Such data sets will be shared through APIs (application program interface. The use of datasets would be governed by comprehensive confidentiality agreement clearly stating that the datasets should not be sold or shared with anyone in any manner or with any other entity.
The legal framework of the Innovation Sandbox would provide adequate flexibility to boost the adaptability of Innovation Sandbox to incorporate changes. There would be a provision for setting up the Innovation Sandbox as a separate not-for-profit entity for reinforcing impartiality in the process. The Innovation Sandbox would confirm that no regulatory barriers and compliances, including know-your-clients (KYC) norms, are broken while the participants test their products or services. The rights and obligation of all the participants would be clearly defined according to the SEBI Framework. The Innovation Sandbox would also target at preventing data misuse and prevent cyber threats.
The circular stating the framework for Innovation Sandbox provides for a governance body would be formed comprising of representatives from the stock exchanges, depositories, and qualified RTAs. This body would be responsible for the supervision of operations of the Innovation Sandbox and ensuring that the Innovation Sandbox fulfills its objectives. A grievance redressal system would be formulated to deal with grievances of Innovation Sandbox applicants. The entire process would eventually be made digital to ensure transparency.
Benefits of Innovation Sandbox
The proposed sandbox would provide numerous benefits to all, be it the stakeholders including investors, FinTech firms, capital market institutions as well as the regulator.
- Cost-benefit: The sandbox framework would help FinTech companies reduce the cost and eliminate entry barriers. As test data would be provided to them (which otherwise is inaccessible), the participants could test their programs in a better manner reducing the cost of testing which they would incur with test data, more so they can even compare results with actual results, as it will be based on historical data.
- Better regulatory framework: Innovation Sandbox will also allow SEBI to get a better understanding of the functioning of a FinTech service/product holistically. This will enable SEBI to decide and make necessary modifications in the existing laws or make new ones. Thus ensuring a level-playing field for all financial companies.
- Close to real testing environment: The framework would allow FinTech firms to test the viability of their product prior to live market launch. Thus, they can test and work on all their shortcomings using the test dataset provided in Innovation Sandbox. FinTech firms would be able to test their solutions beforehand in order to test their compliance with SEBI’s regulations before venturing out in the open market, thereby promoting readiness in meeting statutory requirements.
- Better opportunities: This sandbox would promote innovation, which would only lead to an increased range of products and services and thus, in turn, develop better opportunities for more firms to develop and exhibit their products, thus leading to increased employment. It would provide a platform for the firms to showcase their solutions to the stakeholders in a protected environment. This would especially give a boost to start-ups, which would be able to secure more funding due to this feature.
The SEBI’s Framework for setting up Innovation Sandbox appears to be a promising step towards encouraging innovation in the securities and exchange market along with bringing twin-benefits to consumers in the form of improved ease of services and facilitating a wider range of services to choose from. A secured platform would facilitate testing of interoperability of new solutions and reinforce innovation among the developers, who would not only be able to test the viability of their solutions but also explore the industry and prepare for challenges ahead.
The need of the hour is to clearly define the objectives and challenges that should be addressed and conclude whether the innovations being tested in a sandbox have the potential to enhance the working of the capital market at large. Overall, this indeed is a very welcome move by the capital markets regulator and will only lead to the betterment of the Indian securities market, keeping it on par with other developed economies. It would also go a long way in the development of the emerging FinTech sector in India. But, the success will depend on proper implementation.