Self-Regulatory Organizations (SROs) and the RBI Omnibus Framework

In an era of rapid technological advancements and evolving financial ecosystems, effective regulation is critical to maintaining stability, fostering innovation, and protecting consumer interests. Traditional regulatory frameworks, while essential, often face challenges in keeping pace with the dynamic changes in the financial sector, particularly with the emergence of fintech companies and other innovative financial services. To bridge this gap, the concept of Self-Regulatory Organizations (SROs) has gained prominence globally as a complementary mechanism to enhance regulatory oversight and industry standards.

Self-Regulatory Organizations operate within a framework established by law or regulation and play a pivotal role in ensuring compliance, setting ethical standards, and resolving disputes within their respective sectors. The Reserve Bank of India (RBI), recognizing the need for a more nuanced and sector-specific approach to regulation, has introduced the Omnibus Framework for Recognizing Self-Regulatory Organizations for Regulated Entities (REs) under its purview. This framework, announced in the RBI’s Statement on Developmental and Regulatory Policies in October 2023 and finalized in March 2024, outlines the broad objectives, responsibilities, and governance standards for SROs, setting the stage for more effective self-regulation in India’s financial sector.

This alert explores the concept of SROs, their operation in major global jurisdictions, and their relevance in the contemporary financial landscape. It delves into the RBI’s guidelines on SROs, examining their role, functions, and membership criteria, with a particular focus on the burgeoning fintech sector. By providing a comprehensive overview of the SRO framework, this write-up aims to highlight the importance of self-regulation as a tool for enhancing compliance, fostering innovation, and safeguarding the integrity of the financial system.

Self-Regulatory Organizations (SROs) are non-governmental organizations or entities that are authorized by a regulatory body to regulate and oversee the activities of specific sectors or industries. SROs operate within a framework established by law or regulation, with the objective of ensuring compliance, maintaining industry standards, and protecting the interests of consumers, stakeholders, and the market as a whole.

The primary purpose of an SRO is to complement the regulatory framework by fostering a culture of compliance, setting industry standards, and resolving disputes within the sector. SROs are typically created to regulate sectors that require specialized expertise or where industry self-regulation is seen as a more efficient way to achieve compliance than direct governmental regulation.

Self-Regulatory Organizations (SROs) play a pivotal role in maintaining industry standards, especially in the financial services sector, across many jurisdictions worldwide. SROs work closely with regulatory bodies to oversee market practices, ensuring stability, transparency, and investor protection. Below are examples of how SROs operate in some major jurisdictions:

SROs operate by setting and enforcing rules that their members must follow. These rules often cover areas such as ethics, conduct, dispute resolution, and compliance with regulatory requirements. SROs are particularly relevant in industries where rapid technological advancements and complex operations make direct regulation challenging. They provide a platform for industry players to collaborate, share knowledge, and address common challenges, thereby contributing to the overall stability and growth of the sector.

RBI has recognized the need for SROs to enhance the effectiveness of regulations for its Regulated Entities (REs). The RBI’s “Omnibus Framework for Recognising Self-Regulatory Organisations for Regulated Entities” provides a structured approach to recognizing and operating SROs within the financial sector.

Key Features of the RBI Guidelines: Objectives and Responsibilities: SROs are expected to promote a culture of compliance, represent industry interests, share sectoral information with the RBI, and encourage research and innovation.

• Eligibility Criteria: SROs must be set up as not-for-profit entities, have diversified shareholding, and meet governance standards. They must also demonstrate professional competence and integrity.
• Governance Standards: SROs must have transparent governance processes, an independent board, and mechanisms to prevent conflicts of interest.
• Membership Criteria: Membership in SROs is voluntary, and the SRO must attain a minimum membership as prescribed by the RBI.
• Application Process: Entities seeking recognition as SROs must submit detailed applications, including their governance framework, roles, and responsibilities.

Eligibility and Composition of Self-Regulatory Organizations (SROs) in India

The RBI Omnibus Framework for Recognizing Self-Regulatory Organizations (SROs) sets forth specific eligibility criteria and governance requirements to ensure that SROs operate with independence, integrity, and professionalism. According to the framework, any entity aspiring to function as an SRO must be established as a not-for-profit company under Section 8 of the Companies Act, 2013.

Additionally, the SRO must demonstrate adequate net worth, sufficient to sustain its operations and fulfil its responsibilities on a continuous basis. The shareholding of the SRO is required to be diversified, with no single entity or group holding more than 10% of its paid-up share capital. This condition is crucial to maintaining the objectivity and impartiality of the SRO.

The composition of the SRO’s governing body is equally important. The board of directors must include individuals with professional competence and a general reputation for fairness and integrity. To avoid conflicts of interest, at least one-third of the board members, including the chairperson, must be independent and should not have any active association with the regulated entities represented by the SRO. The framework also mandates that the directors fulfil ‘fit and proper‘ criteria on an ongoing basis, ensuring that the SRO is governed by individuals with relevant expertise and high ethical standards.

SROs play a critical role in maintaining industry standards, enforcing rules, and resolving disputes. They are also instrumental in:

• Setting Ethical and Professional Standards: SROs establish codes of conduct and best practices for their members.
• Monitoring Compliance: SROs oversee the activities of their members to ensure adherence to regulatory requirements and industry standards.
• Dispute Resolution: SROs provide mechanisms for resolving disputes between members, and between members and their customers.
• Industry Representation: SROs act as a collective voice for the industry, engaging with regulators and policymakers on behalf of their members.

Members of SROs typically include entities that operate within the regulated sector. In the context of the RBI’s framework, members would include Regulated Entities (REs) such as banks, non-banking financial companies (NBFCs), payment service providers, and fintech companies. Membership in an SRO is voluntary, but members are expected to comply with the standards and codes established by the SRO.

Fintech companies in India are subject to various regulations depending on their specific activities. Key regulatory bodies include:

• RBI: Regulates payment services, digital lending platforms, and peer-to-peer lending.
• SEBI: Regulates fintech companies involved in securities and investment management.
• IRDAI: Regulates fintech companies in the insurance sector.
• Ministry of Electronics and Information Technology (MeitY): Regulates data protection and cybersecurity for fintech companies.

The roles of SROs under RBI newly released framework and the Indian Banks’ Association (IBA) are distinct but complementary, with minimal risk of conflict or overlap. SROs, as envisioned by the RBI, are designed to enforce compliance, set industry standards, and ensure best practices among a broad range of regulated entities, including banks, non-banking financial companies (NBFCs), and other financial institutions.

In contrast, the IBA functions primarily as an advocacy group representing the interests of its member banks in policy discussions with the government and regulators. While the IBA focuses on lobbying for policy changes and addressing sector-specific issues, SROs will concentrate on regulatory oversight and compliance, ensuring that members adhere to the established standards within the RBI’s framework.

This distinction minimizes the potential for conflict, as SROs enforce regulations and the IBA advocates for policy change. However, care must be taken to ensure clear communication and delineation of responsibilities to avoid any overlap with other organizations involved with regulated entities, such as industry associations and advisory bodies, which may also have roles in standard-setting or advocacy. Effective coordination among these entities will be crucial to ensuring that SROs can operate effectively without encroaching on the roles of other organizations.

SROs are particularly relevant in the fintech sector due to the rapid pace of technological change and the emergence of new business models. SROs can help fintech companies comply with regulatory requirements, set industry standards, and address emerging risks. They also provide a platform for collaboration between fintech companies and regulators, facilitating innovation while ensuring consumer protection.

Role of SROs in India’s Fintech Sector: Learning from International Best Practices

Drawing from international best practices, Self-Regulatory Organizations (SROs) in India have the potential to play a transformative role in the burgeoning fintech sector. Globally, SROs in the financial and technological sectors have proven effective in creating an environment that balances innovation with regulatory compliance. In India, an SRO for the fintech sector could ensure the adoption of global standards while tailoring them to the unique challenges and opportunities of the Indian market.

Additionally, SROs could establish standardized procedures for risk management and fraud prevention, drawing on lessons from mature fintech markets such as the United States and the United Kingdom. SROs can act as a bridge between innovators and regulators, ensuring that new technologies are deployed in a manner that benefits consumers and the broader financial system.

In sum, SRO in India’s, informed by international best practices, could provide a robust framework for self-regulation that supports innovation while safeguarding consumer interests and maintaining regulatory compliance. The introduction of the RBI’s framework for Self-Regulatory Organizations represents a significant step towards enhancing regulatory oversight and promoting industry best practices among a wide range of regulated entities.

The RBI consultation paper can be accessed here.

We trust you will find this an interesting read. For any queries or comments on this update, please feel free to contact us at insights@elp-in.com or write to our authors:

Mukesh Chand, Senior Counsel – Email – mukeshchand@elp-in.com