SEBI’s regulatory framework must pave the way for a tech-balanced regime
Such requirements raise the question whether IA Regulations are tailored to new-age automated advisors, which often have no human interface.
By Sidharrth Shankar & Aman Bhatia In September 2020, SEBI introduced the first set of amendments to its regulatory framework for investment advisors. While the amendments are a step towards protecting retail investors, the technology neutrality of the regulations remains doubtful.
A predominantly younger Indian demographic has recently made a shift towards using investment distribution and advisory mobile applications for equity investments. Such apps are becoming popular as they provide faster, easier and less expensive approach to investments. Automated tools used typically do not have any human intervention, as investment advice is based on a predefined algorithm, which customises investment plans for each customer platform.
On the regulatory front, SEBI first covered the aspects of robo-advisors in its discussion paper released in 2016. However, SEBI took the view that such automated tools will have to comply with the existing provisions of SEBI (Investment Advisers) Regulations, 2013—or IA Regulations—which had been framed for individuals and entities offering investment advisory services (often referred to as RIAs). SEBI also proposed additional compliance requirements.
However, specific regulations for automated investment tools are yet to be framed. It is in this light that the recent amendments to IA Regulations become even more relevant.
A significant change introduced has been the separation of an IA’s distribution and advisory roles. Other key changes introduced by the amendments include net worth requirements of Rs 50 lakh for non-individual requirements and the diktat for all ‘persons associated with the advice’ to have NISM (National Institute of Securities Markets) certifications, and experience of two years in activities related to advice in financial products or asset management.
Such requirements raise the question whether IA Regulations are tailored to new-age automated advisors, which often have no human interface. A way to resolve this could be by granting a licence and imposing post-authorisation audit requirement. A similar approach has been followed by the Monetary Authority of Singapore (MAS)—the central bank of Singapore.
In late 2019, SEBI came up with another circular aimed at regulating RIAs by way of which a restriction was imposed on RIAs from providing free trials for any products and services. SEBI also restricted RIAs from accepting part payments for any products or services offered by them. It stipulated that advisers would be required to obtain prior consent and carry out risk profiling for all customers. Such requirements could have unintended consequences for mobile-based apps. In case SEBI’s concern is that such automated tools may not be suitable for everyone, it could consider requiring mobile apps to put controls in place (such as knock-out questions) to identify and eliminate clients who are unsuitable for using such tools for investment.
A separate but related perspective is fund-raising for such new-age start-ups. Under FDI norms, foreign investment is permitted for entities engaged in ‘financial services activities’. However, the FDI policy clarifies that the automatic route is available for only such investee companies whose activities are clearly regulated by a financial services regulator. In case where the activities are only partly regulated, exempted, or where a doubt exists with respect to regulatory oversight, foreign investment is permitted only under the government-approval route. Minimum capitalisation requirements have also been imposed by the Ministry of Finance for unregulated financial services activities. In contrast, no minimum capitalisation hurdles exist for regulated financial services activities.
This distinction imposes a conundrum for new-age businesses at the time of fund-raising. Often, such robo-advisors do not handle customer funds, providing only KYC services to the customers. A question for legal practitioners advising such fintech start-ups is whether the investee company should be treated as a provider of unregulated financial services vis-à-vis a mere technology company? The classification has far-reaching consequences, especially for fledgling companies seeking seed/VC stage funding where the minimum capitalisation requirement can play a disruptive role.
It is important for SEBI’s regulatory framework to pave the way for a technologically-balanced regime that encourages non-fund based financial services providers to use the latest technologies.
Shankar is partner and Bhatia is associate, J Sagar Associates. Views are personal