Wealth-Tech Companies: Operation and Regulation in India
The first ‘FinTech’ companies started with provided services involving one or more financial assets. A financial asset is a non-physical asset whose value is derived from a contractual claim/demand/ utility or equity shares. Financial assets are often called securities.
General Mode of Operation of Wealth-Tech Companies
Wealth-Tech companies in India are all registered as brokers with SEBI. These companies are also registered as depository participants (with NSDL or CDSL). Their platforms also provide direct access to top mutual funds
Their services are provided directly through applications and not in the traditional sense of stock broking. These apps are filled with information, market data, analyst reports and almost everything else that an investor needs to make an informed decision whether to buy or sell shares on the platform.
These companies also provide a one-stop portal for opening dematerialized (DEMAT) accounts at nominal costs and far secure KYC methods. Moreover, funds can be added to these apps via a multitude of payment systems like UPI and Bank Transfer (IMPS/NEFT/RTGS), making it convenient for small investors.
These platforms charge a percentage or a nominal fixed amount per trade, as commission. They also make profits through their advisory and portfolio management services.
Before we delve in, let us understand what comes under "securities’:
Securities are those financial assets which can be traded on the financial markets. According to the Securities Contracts (regulation) Act 1956 under Section 2(h), the definition of “security” includes shares, bonds, debentures, derivatives, mutual fund units etc.
Further, there are four types of securities:
Debt Securities
Assets are bought or products are made by leveraging debt. The Borrowing Company is required to repay the principal amount and attach a percentage of interest on the same. Since there is no tax on debt, companies put their other assets as collateral for the debt and, eventually pay-off the same with cash-flows generated by debt-funded asset itself.
Equity Securities
The investor buys the equity/shares of a company by trading in the secondary market (Stock market). The price of equity is determined by the market and is backed by intrinsic value of the same. However, shares of a company may be overvalued or undervalued based on the uptrend or downtrend of the market.
Hybrid Securities
These securities include a combination of equity and debt securities. The percentage of capital in debt or equity depends from companies to comapnies and, from industry to industry. This is generally done to balance risk (by managing volatility) in the face of uncertainty in the market.
Derivatives
These securities derive their value from an underlying asset or the aforementioned securities. This includes Options, Futures, commodities, market indexes etc.
Now, these securities are relevant and accessible to the retail investors and financial institutions only due to the existence of stock brokers. There are six types of brokers recognised by SEBI (as of June 20, 2022):
Stock Brokers in equity segment
Stock Brokers in Currency derivative segment
Stock Brokers in interest rate derivative segment
Stock Brokers in commodity derivative segment
Stock Brokers in Equity derivative segment
Stock Brokers in debt segment
The Legal Framework governing Wealth-Tech Companies
WealthTech companies have to comply with provisions of:
Companies Act 2013 (for corporate governance),
IT Act 2000 (to maintain data privacy unless customer consents otherwise) and
SEBI - Act 1992- regulations, circulars and guidelines or informal guidances
Since most of these companies are registered as brokers (they have other SEBI intermediary registrations as well) they have to comply with the---
SEBI (Stock Brokers) Regulations 1992 [last amended in February 2022]
Some important Definitions
Regulation 2 (ae) defines a "clearing member" as a person having clearing and settlement rights in any recognised clearing corporation and shall include any person having clearing and settlement rights on a commodity derivatives exchange
Regulation 2 (gb) defines a “stock broker” to be “a person having trading rights in any recognised stock exchange and includes a trading member”. The recent amendments have axed out the definition of sub-brokers. It was earlier under clause (gc).
“Regulation 2(fa) defines a "self-clearing member” as a member of a clearing corporation who is also a stock broker and clears and settles trades on its own account or on account of its clients only and, it includes any person having clearing and settlement rights on a commodity derivatives exchange.
----------------------------"Provided that such person who clears and settles trades in commodity derivatives, shall be required to become a member of a recognised clearing corporation, from such date as may be specified by the Board"
Regulation 2(g) defines a "Small Investor" as an investor that is involved in buying or selling of securities primarily through cash the market value of which does not exceed Rs. 50,000 aggregate on a given trading day (as shown in contract note produced by the stock broker)
Application for registration
Regulation 3(1) provides that no one shall act as a stock broker till they obtain a certificate of registration from the Board. Also, No separate registration is required for a clearing member already registered with the Board.
Regulation 10A provides that no person shall act as a clearing member (those who clear and settle trades made on the market), unless a certificate of registration is obtained from the Board.
#Most FinTech Companies in this space have opted to be self-clearing members so as to make transactions cheaper and, their service, more marketable.
Factors to be considered in an application for registration as a stock broker {Regulation 5}:
The Board shall consider all matters relation to trading , dealing or settling and also:
Whether the applicants are eligible under the law to be a member of a stock exchange
Whether the applicants have the necessary infrastructure to handle the activities
Whether the applicants have any past experience in trading or dealing with securities
Whether the applicants have been subjected to disciplinary proceedings in matters contravening Securities laws
Whether the applicant is a “fit and proper person” as in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008
Under Regulation 6, the Board after consideration, shall grant a Certificate of Registration in Form D and inform the stock exchange of which the applicant is a member.
Conditions for Registration [Regulation 9]
Any registration under Reg. 6 shall be subject to the following conditions:
The stock broker holds the membership of any stock exchange;
He is subjected to the rules, regulations and bye-laws of the stock exchange which are applicable to him;
Where the stock broker proposes a change in control of management, he has to obtain prior approval of the Board (SEBI) for continuing to act as stock broker after the said change.
He shall pay fees charged by the Board in the manner provided under these regulations;
He shall take adequate steps for redressal of grievances, of the investors within one month of the date of receipt of the complaint and inform the Board as and when required by the Board;
He shall at all times abide by the Code of Conduct as specified in Schedule II; and
He shall at all times maintain the minimum net worth as specified in Schedule VI.
Every stock broker who act as an underwriter shall enter into a valid agreement with the body corporate on whose behalf it is acting as underwriter and shall abide by the regulations made under the Act in respect of the activities carried on by it as underwriter.
Every Stock Broker shall be entitled to act as an underwriter only out of its own net worth/funds as may be prescribed from time to time.
Further regulations
Regulation 17
It mandates that every stock broker to maintain register of transactions (Saudabook), General and Client specific ledgers, Cash Books, Journals, Bank pass book, contracts, and details of securities physically received and other statement of accounts.
It is the duty of every stock broker to intimate the Board regarding the place where the aforementioned documents are maintained.These records shall be preserved for a maximum period of 5 years (under Reg.18)
Regulation 19
Gives complete authority to the Board to inspect whether the stock broker has been compliant with Securities Laws. Under Regulation 20, the Board is bound to send a reasonable notice before initiating such inspection.
Under Regulation 25,
If a stock broker contravenes the Securities Laws in force, it can face:
“Monetary penalty under Chapter VIA of the Act.
Penalties as specified under Chapter V of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008] including suspension or cancellation of certificate of registration as a stock broker.
Prosecution under Section 24 of the Act{SEBI ACT}”
Regulations 26, 27 and 28
Set out the list of offences that are punishable by monetary penalty, penalty under SEBI (Intermediaries) Regulations 2008 and prosecution under Section 24 of SEBI Act, respectively.
Some of the these offences include:
Furnishing false information, documents, accounts or records.
Failure in filing return or report with the Board.
Failure to maintain books of account or records in the manner specified by the SEBI Act 1992 or any of the regulation(s) to which a registered stockbroker may be subjected to (based on the extent of its services).