Much has been written about the recent Securities and Exchange Board of India press release dated October 21, 2021, which bars investment advisers from trading digital gold and “other unregulated commodities” to their clients. This press release was preceded by a missive from the National Stock Exchange earlier in August 2021 to stock brokers, asking them to stop selling digital gold on their platforms. In a market flooded with inventive products and services, these directions are no longer just about digital gold, but have rightly sparked a much-needed broader debate: how do Indian financial regulators plan to regulate innovation?
New asset classes are either a methodical product of politics, like real estate investment trusts or infrastructure investment trusts, or the wild child of technological disruption – digital gold, cryptocurrencies , even binary options and “contracts for differences” traded online are good examples. While the former typically involves a syncretic consultative process between industry and regulators to develop a framework into which these products are born, the nuts and bolts of the latter are often designed by the public and implemented by industry before that the authorities do not take over. About ten years ago, one would recall that a number of art funds on the market, which were created to invest the funds of high net worth individuals in art and collectibles, collided to a similar regulatory block. A number of these funds then even petitioned SEBI to ask for regulation, only asking that existing mutual fund laws not be retrofitted into a product that they felt deserved more nuanced regulatory treatment. However, that foray ended when SEBI initiated enforcement action for violating collective investment fund regulations, with the Supreme Court ultimately upholding SEBI’s view in 2018.
Gray areas in the twilight zone
The shadow of this regulatory twilight zone is not cast only on investment products – to this day, the framework for investing in foreign securities or even robo-advisory based investment services. artificial intelligence remains unexpressed. SEBI last month released informal guidelines that curiously prohibit portfolio managers from deploying their Indian clients’ funds overseas because SEBI has no jurisdiction over offshore securities. Transparent access to foreign markets is a service offered today on a number of online brokerage platforms and it is not known why the regulatory reflex on this service is negative. By the way, apart from an observation made years ago in a report by the SEBI Committee, which highlighted the need for marketing guidelines for offshore financial products, India today has no policy or literature on background on this.
Technology is changing the anatomy of financial markets, both in terms of creating new avenues for deploying liquidity and allowing better access; So what is it that drives government agencies to drop steep procedural barriers?
Problem when catching up
Investor protection is, and rightly so, the number one requirement that every regulator must tackle effectively. The innovative products on the market have a short lead time and quickly enter the mainstream retail imagination due to their online reach. Lack of product knowledge, coupled with enthusiastic advertising and easy click-through execution, distorts the risk appetite of retail investors. However, rapid but meaningful regulatory intervention during this phase is often limited by what is permitted by applicable laws and the powers of the regulator. The hybrid nature of the products also requires a division of territories to decide on the primary regulatory body in this area. What also takes time is to assess the scale of the product and the risks that accompany it, i.e. whether it presents a broader systemic threat from a money laundering perspective. money, exchange or leverage which then needs to be addressed through legislation or if these are largely localized pockets of activity that can be brought under control through an orderly set of marketing rules or solicitation.
And so while there are good reasons for agencies to wait for the dust to settle, the biggest short-term loser is unfortunately the very investor the regulator seeks to protect. Not only does such an approach hurt investor confidence, it is also not accommodating or encouraging for industry innovation.
One possible solution is to implement standardized marketing guidelines that cover all asset classes, borrowing from some relevant IOSCO guidance on distribution and marketing. This ensures that even when the service or asset is an unknown beast and regulatory soul-searching is underway, the impact on retail investors is tempered in the meantime.
To plan for the next steps, consider a risk prioritization framework that assesses both metrics:
For example, when the product clearly violates existing rules (such as over-the-counter contracts, contracts for difference or the operation of unlicensed order matching exchange platforms) and also has significant reach to detail, it must be reported immediate and urgent action must be taken to clip its wings. When the product is not yet regulated but only works within a certain subset of investors, for example by targeting sophisticated investors with a minimum ticket size, consider whether this requires market guidance, elaborate disclosures and nuanced regulations that will allow for some sort of beta testing control, rather than an outright ban. In fact, in such cases, regulators can also order parties to file claims under the regulatory sandbox and process them within a limited time frame, rather than monitoring their impact from the outside.
We should not only expect a technological disruption in financial services; it needs to be both welcomed and planned in a way that provides flexibility for more predictive and flexible market regulations and limits the latitude for reactionary market controls.
Shruti Rajan is a partner in the Mumbai office of Trilegal and an attorney specializing in financial services regulation and enforcement.
The opinions expressed here are those of the author and do not necessarily represent those of BloombergQuint or its editorial team.