Introduction
The Reserve Bank of India (‘RBI’) is India’s financial watchdog, ensuring the smooth operation of the economy by regulating interest rates, foreign exchange, and financial markets. Like a traffic cop for money, the RBI oversees financial market infrastructure, including benchmarks for these markets, under several legislative Acts: the RBI Act, 1934; the Government Securities Act, 2006; the Foreign Exchange Management Act, 1999; the Bilateral Netting of Qualified Financial Contracts Act, 2020, and the Payment and Settlement Systems Act, 2007. As financial markets expand and evolve, the RBI collaborates with the government to maintain safety and fairness.
Role of Self-Regulatory Organizations ('SROs')
The SROs act as the guardians of financial markets, working alongside the RBI to enforce rules and standards. They set the benchmarks for business conduct and ensure adherence, facilitating market growth and operational efficiency. The RBI has introduced a new Framework[i] for recognising SROs in financial markets, based on the Omnibus Framework issued by the RBI on 21.03.2024, with amendments specific to financial markets. The Framework outlines objectives, functions, eligibility criteria, governance standards, and membership criteria for SROs seeking RBI recognition. Recognised SROs are encouraged to develop best practices that exceed these minimum requirements.
Impact & Changes Compared to Previous Provisions
Unlike previous fragmented guidelines, this Framework establishes a detailed governance framework with specific requirements for Board composition, conflict of interest policies, and Director rotation, emphasising greater accountability and independence. The SROs’ expanded role in voicing member concerns and participating in policy development reflects a shift from mere self-regulation to active industry advocacy. Further, the Framework places a stronger emphasis on compliance monitoring, regular reporting, and direct engagement with the RBI, enhancing the regulatory oversight of SROs.
Key Aspects of the Framework
Characteristics of SROs: An SRO, like a club for professionals but with a strict dress code, functions like a referee, upholding fairness and adherence to regulations. To be effective, an SRO must meet several characteristics.
Authority & Governance: SROs should derive authority from membership agreements or articles of association (‘AoA’) to set and enforce ethical, professional, and governance standards.
Rulemaking & Oversight: SROs must have objective, well-defined, and consultative processes for framing rules and supervising member activities. Clear standards of conduct must be established, with non-monetary consequences such as counselling, reprimanding, or expelling members for rule violations.
Independence & Impartiality: SROs must operate independently and impartially, free from the influence of any single member or group of members.
Compliance & Dispute Resolution: SROs must develop standards to improve adherence to RBI circulars, directions, guidelines, rules, and regulations. They are also required to implement standardised procedures for resolving member disputes through transparent and consistent mechanisms, including arbitration.
Market Monitoring & Non-Substitutive Standards: SROs must effectively monitor market developments and ensure their standards comply with statutory and regulatory requirements. The standards set by SROs are meant to supplement, not replace, applicable laws, regulations, and RBI directives.
Objectives of the SRO: The general expectation from an SRO is to advance the sector it represents by promoting integrity, professionalism, compliance, innovation, and ethical conduct while operating in good faith and avoiding conflicts of interest. Specific objectives of an SRO include promoting a compliance culture by encouraging best practices among members, offering guidance, and implementing a code of conduct. SROs also act as a representative voice for their members in dealings with the RBI, government authorities, and other regulatory bodies, addressing industry concerns and ensuring equitable treatment. They aim to adopt global best practices by integrating international standards and practices, facilitate policymaking by providing sectoral information to the RBI, and foster innovation by supporting the introduction of new products within regulatory frameworks. Additionally, SROs encourage research and development to promote innovation while maintaining high compliance standards and ensuring fair practices by advocating for transparency and fair pricing, particularly for retail and smaller participants.
Responsibilities towards Members: SRO's primary function is to create a robust and ethical industry environment by developing a comprehensive code of conduct, developing a reasonable, non-discriminatory membership fee structure and avoiding conflicts of interest, disseminating sector-specific information through periodicals, bulletins, and other publications to raise awareness, efficient dispute resolution mechanisms, and educating members on statutory and regulatory provisions and the public about member operations.
Responsibilities towards the Regulator (RBI): SROs are expected to collaborate closely with the RBI, fulfilling several key responsibilities. They must regularly report sector developments and any member misconduct to the RBI, execute tasks assigned by the RBI, and provide required data or information. SROs are also required to submit an annual report to the RBI within 6 months of the end of the financial year and offer feedback on RBI consultations and draft circulars. Additionally, they must comply with inspections conducted by the RBI and report any changes in Board composition or adverse information about Directors.
Eligibility Criteria for SROs: The applicant must meet several eligibility criteria to qualify as an SRO. It must be a not-for-profit company registered under s. 8 of the Companies Act, 2013, with a minimum net worth of Rs. 10 crores. Membership in the SRO should be voluntary, and the SRO must adequately represent the sector, ensuring a diverse mix of members. If initial representation is insufficient, the SRO must provide a roadmap for achieving this diversity. The applicant and its directors must demonstrate professional competence and integrity and meet the fit and proper criteria determined by the RBI.
Governance Framework: SROs are required to adhere to high governance standards, ensuring transparency, professionalism, and independence. They must operate with professional management and have clear governance provisions outlined in their AoA or bye-laws. Additionally, SROs are mandated to maintain an independent Board, with at least one-third of the Board members being independent directors who have no active association with the entities represented by the SRO. Furthermore, SROs must ensure that they have skilled human resources and robust technical capabilities to monitor and oversee the sector effectively.
Application and Conditions for Grant of Recognition: Organizations aspiring to function as SROs must submit a detailed application to the RBI, along with relevant documents that include the memorandum and AoA, details of the Board and key managerial personnel, a roadmap for sector representation, and a declaration regarding criminal convictions or ongoing legal proceedings. The RBI reserves the right to reject incomplete applications but will provide a chance for the applicant to address objections within 30 days. Recognition is subject to periodic review, and the RBI may impose additional conditions or revoke recognition if necessary, ensuring alignment with public interest.
Our Analysis
Think of self-regulation as a gardener tending to a beautiful garden: with careful cultivation and pruning, the industry can flourish without the need for harsh pesticides or fertilisers. The new Framework for SROs represents a significant shift towards enhanced governance and accountability. It aims to foster a more robust and transparent financial market by setting clear standards and defining roles and responsibilities. While the Framework promises to strengthen market integrity and support innovation, its success will depend on effective implementation and ongoing compliance. However, the implementation and procedural aspects of this Framework remain to be seen. Nonetheless, this move of the RBI is welcome as it aims to contribute significantly to market stability, transparency, and fairness.
End Note
[i] Framework for Recognition of Self-Regulatory Organizations in Financial Markets regulated by the Reserve Bank – RBI; 19.08.2024.
Authored by Aayan Birla of Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.