.png)
Ananya Dutta and Rahul Ranjan*
I. Introduction
Electronic Trading Platforms (‘ETPs’) are electronic platforms which enable trade in eligible instruments, including securities, derivatives etc., distinct from traditional stock exchanges. Such platforms are considered more flexible than traditional exchanges because of greater number of investment options and ease of accessibility.
On 29th April 2024, Draft Master Direction (‘Draft Directions’) for ETPs was released by the Reserve Bank of India (‘RBI’) which supersedes the Electronic Trading Platforms (Reserve Bank) Directions, 2018 (‘2018 Directions’). Through the newly proposed regulation, the RBI aims to address a very pertinent issue of unauthorised trading platforms which often promise exorbitant returns on Foreign Exchange (‘FX’) trading. Such platforms have been found to engage in frauds, leading many residents to lose large amounts of money. Further, with greater integration of onshore markets with offshore markets, it becomes imperative for the RBI to have more leverage in such financial markets in order to maintain exchange rate stability and enhance transparency to mitigate risks.
The Draft Directions have been able to address opacity in transactions through stringent security measures and extensive reporting mandates as well as expanded regulatory oversight, especially with the inclusion of off-shore ETPs. However, they have left out regulation of platforms that offer cryptocurrency trade execution, by virtue of their stipulated criterion for offshore and onshore ETPs. Furthermore, the absence of any emphasis on data localization in the Draft Directions is notable, considering its advantages in terms of data security and regulatory oversight. This becomes even more crucial, since earlier drafts of regulations provided for such measures.
In this two-part article, the authors assess the impact of the Draft Directions, facilitated by comparative analysis with the 2018 Directions. Subsequently, the authors explore the challenges created by the ambiguity surrounding cryptocurrency trade execution under the Draft Directions and suggest ways to tackle them. This is followed by the proposal of authors in respect to the potential for enhancing data localization through detailed discussion over its benefits and suggestions to imbibe it into the regulatory framework. Finally, we attempt to explore potential avenues for expanding the scope of electronic trading in Over-The-Counter (‘OTC’) derivatives as a way forward for the Indian trading market. Part One deals with a review of the Draft Proposal, and its deficiencies relating to cryptocurrency regulation. Part Two resumes the discussion on regulatory deficiencies, with the analysis of data localization approach by the RBI.
II. UNDERSTANDING THE PROPOSED FRAMEWORK
To effectively understand the deficiencies in the Draft Directions, a brief discussion on its provisions becomes imperative. Through this analysis, the intent behind introducing the provisions can be ascertained which will further aid to grasp the significance of regulatory deficiencies, proposed solutions as well as the potential scope for expanding RBI’s regulatory framework.
Upon bare perusal of the Draft Directions, it becomes clear that they retain certain key provisions of their predecessor relating to eligibility criteria, operating framework requirements, surveillance, and transparency mandates as well as directives regarding outsourcing of operations. In this light, they also require platform operators to maintain robust technological configurations that are capable of achieving high degrees of scalability and reliability while also meeting the requirements of efficiency, security, and transparency.
However, they expand their scope through the inclusion of ‘offshore’ ETPs “operated from outside India” by an entity “incorporated outside India”. The move to include offshore platforms can be seen as a response to the growth of foreign currency derivative markets dealing in non-deliverable forward (‘NDF’) contracts. Recently, a growth of offshore INR-NDF markets has been observed- allowing partakers to speculate on the Indian currency while avoiding capital account restrictions in India. These markets exert influence on the INR-USD exchange rate and volatility in the off-shore forward market has an influence on the domestic market. The RBI has in the past taken conflicting positions regarding the involvement of Indian banks in the rupee’s NDF markets. By including offshore ETPs under the ambit of the Draft Directions, the RBI appears to approve of the participation of Indian residents in derivative instruments involving the rupee and also provides itself with greater leverage in the market and greater influence over the rupee’s exchange rate.
Furthermore, the authorisation of ETPs under the 2018 Directions consisted only of a single-step procedure. On the other hand, the Draft Directions introduce a two-layered approval process to set up ETPs. Any ETP may, prior to its application for authorisation, apply for an “In-Principle Approval”, granted by the Central Bank if it deems that the platform has “demonstrated its ability” to fulfil the eligibility norms in the future which have been set out in paragraph 4 of the Draft Directions. This approval lasts for a period of six months, within which the ETP shall fulfil all eligibility criteria and apply for complete authorisation. Additionally, the RBI has clarified that grant of in-principle approval does not guarantee future authorisation and transactions shall be permitted to be undertaken by an entity with such approval only after obtaining complete authorisation from the RBI.
While the 2018 Directions enabled audits to be conducted by auditors accredited by any one of a range of professional bodies, the Draft Directions mandate ETPs to annually carry out information technology and information security audits by Indian Computer Emergency Response Team (‘CERT-In’) empanelled auditors only. This enhanced stringency demonstrates the Central Bank’s increased commitment to transparency. Along the same lines, the Draft Directions mandate quarterly reports on the functioning of the platforms in a prescribed format which diverts from the mandate stipulated under the 2018 Directions which required ETPs to provide data only if called to do so under any Indian law or by the RBI. ETPs must also annually report on its compliance status, along with details of any terms and conditions imposed at or after the time of authorisation. Thus, while the Draft Directions share the foundation laid by their 2018 predecessors by retaining critical provisions on eligibility, operational requirements, and oversight, they significantly advance the regulatory framework by incorporating offshore ETPs and introducing a more rigorous approval and compliance process. This increase in stringency is a direct response to the rise of various fraudulent trading platforms in India and the increased activity of Indian residents on off-shore platforms. The Draft Directions aim to cultivate a trading environment characterised by transparency and fairness, with necessary security measures at place in protect the interests of Indian investors.
III. REGULATORY DEFICIENCIES
A) Taking Crypto Trade into Account
With the release of the Draft Directions, it is evident that the RBI aims to foster a transparent and fair electronic trading environment. Though this objective governs the entirety of the directions, one crucial aspect that has been left out in the process pertains to regulation of ETPs offering cryptocurrency trade execution. This can be construed through a joint reading of few paragraphs of the Draft Directions. As per paragraph 3(b) of the regulations outlining general conditions, it is specified that ETP operators registered with the RBI must ensure that only transactions involving instruments approved by the RBI are conducted. The RBI has consistently maintained that cryptocurrencies are not approved as instruments for trading. In a circular dated 24th December 2013, the RBI clarified that trading of cryptocurrency is not authorised by it. The position of the bank was reaffirmed in 2021 when the RBI governor reiterated the warnings associated with cryptocurrencies. Given this context, it is clear that ETP operators registered with the RBI will not be allowed to carry out transactions involving cryptocurrencies.
When it comes to offshore ETPs, it has been stipulated under paragraph 15(b) that operators and the transactions in such ETPs are to be governed by the financial market regulator of the respective country of incorporation. Further, only those dealings in eligible derivative instruments between residents and non-residents have been permitted, as recognised by the Foreign Exchange Management Act 1999. Since cryptocurrency is a decentralized virtual currency (‘VC’) and falls outside the governance of financial regulators, it is evident that it does not meet the criteria stipulated under the Draft Directions. This resultantly bars trade execution of cryptocurrencies through offshore ETPs between residents and non-residents.
As cryptocurrency is not recognized as legal tender and operates without RBI’s authorisation, it is apparent that the RBI does not intend to develop policies that would grant legitimacy to such VCs. However, this apprehension may be unwarranted. In 2022, the government introduced a 30% tax on crypto profits and subsequently, broadened the scope of Prevention of Money Laundering Act, 2002 (PMLA) to encompass the crypto sector. With such development, there was hope that cryptocurrency would gain the recognition of legal tender- but this did not materialize. As clarified by the finance minister, the government introduced certain measures solely with the intent to regulate the significant volume of crypto-transactions while also navigating the possibility of outrightly banning such transactions. Thus, it can be inferred that regulations can be brought in without the need to grant a formal recognition.
Further, the Central Bank possesses the statutory authority to regulate VCs. In Internet and Mobile Association of India v. Reserve Bank of India, the Apex Court rejected the submission of the petitioner that RBI is devoid of any power to regulate VCs as they lack the recognition as legal tender. Rather, the court went on to observe that crypto users and traders undertake such activities that squarely comes within the purview of the RBI. The bank’s statutory authority encompasses the oversight of any intangible property that, under certain conditions, can function as money, thereby confirming its legal jurisdiction over cryptocurrency trading.
In light of the same, we propose that the RBI should issue specific regulations for platforms offering crypto trading to Indian residents. Undoubtedly, with the expansion of the ambit of PMLA to include regulation of cryptocurrencies, certain obligations have been imposed upon crypto-oriented platforms themselves, by virtue of them being Reporting Entities (‘REs’). However, a major lacuna observed herein is the lack of clarity regarding the identification of the specific regulator with respect to Virtual Digital Assets (‘VDAs’). Rule 2 (fa) of the PML (Maintenance of Records) Rules 2005 provide that guidelines may be issued by a regulator: however, no such regulator has been specified for these platforms. This has led to questions over the binding power of the guidelines that have been issued so far. For instance, the guidelines of the Financial Intelligence Unit (‘FIU’) for REs that provide services related to VDAs are essentially ineffectual because the director of the FIU has not yet been notified as the regulator and consequently, the guidelines do not have a binding effect.
The collapse of major financial exchanges, such as the FTX collapse, underscores the urgent need for at least some degree of regulatory oversight. The issue becomes more pressing with recent cyber-attack on India’s one of the largest crypto exchanges, WazirX, resulting in a heist of over 230 million dollars. With the exchange undergoing conditional moratorium, investors have pointed out several lapses in terms of transparency, especially discrepancies in reporting specific figures of assets and liabilities. Had the exchange been under a set of guidelines such as the Draft Directions, several mechanisms for security and reporting as required under Paragraph 11 and Paragraph 13 would have been in place which could have protected the interests of 4 million Indian investors.
Given that under the existing Draft Directions, the operator of such platforms cannot register with the RBI because they cannot meet the requisites of the definition of ETP stipulated therein, a specific regulatory framework for such platforms must be formulated which will address the existing gap. More importantly, the regulation of such platforms would not translate to regulation of cryptocurrencies themselves and instead be concerned with the mechanisms, governance, and compliance of the platforms. This approach aligns with the current position of the Government of India regarding cryptocurrencies, which avoids direct endorsement or prohibition of digital assets while still ensuring that the supporting infrastructure operates transparently and responsibly.
This new framework, inspired from the Draft Directions, should establish separate criteria for registration, compliance, and auditing tailored specifically for these platforms with the RBI acting in a supervisory capacity overseeing the operational aspects of the platforms. This approach would ensure that such platforms operate within a structured environment, enhancing oversight and protecting Indian investors.
Therefore, Part One has comprehensively dealt with the Draft Directions and its shortfalls in the regulation of cryptocurrency. In Part Two, we continue the critique by assessing the stance on data localization , arguing that data localization should form an integral part of the eligibility criteria, being assessed at every layer of compliance. Further, we argue that preservation of data should be regulated more dynamically, to secure India’s data sovereignty.
*Ananya Dutta is a 3rd Year BA LLB (Hons.) student at National Law University, Odisha. Rahul Ranjan is a 3rd Year BBA LLB (Hons.) student at National Law University, Odisha
Comments