Foreign Investment in Indian Fintechs - New Challenges

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In late July, India’s Enforcement Directorate (ED) filed a formal complaint under the Foreign Exchange Management Act against Simpl, a Buy Now Pay Later (BNPL) service provider, for alleged violations of foreign direct investment (FDI) norms. The ED’s press release asserts that Simpl is carrying on business activities (allowing customers to buy products from partner merchants and pay for them later in instalments) which fall under financial service activities and that Simpl did not obtain government approval for foreign direct investments (FDI) over INR 900 crores, as required under a 2016 circular of the Reserve Bank of India (RBI).

The relevant RBI circular (which is also reflected in the extant FDI policy) states that FDI is allowed up to 100% under the Government approval route in financial services activities which are not regulated or partly regulated by any financial sector regulator or where there is lack of clarity regarding regulatory oversight. I will refer to this category as Approval Route FSA henceforth.

What constitutes a "financial services activity"?

Neither the RBI circular nor Press Note 6 of 2016 dated October 25, 2016 (PN6) which incorporated it into the FDI policy, provides a definition for “financial services activities”. However, PN 6 had replaced the paragraph on “Non-Banking Finance Companies” in the erstwhile FDI policy, which listed 18 specific activities which were eligible for 100% FDI under the automatic route, subject to certain minimum capitalisation requirements - (1) merchant banking (2) under writing, (3) portfolio management services, (4) investment advisory services, (5) financial consultancy, (6) stock broking, (7) asset management, (8) venture capital, (9) custodian services, (10) factoring, (11) credit rating agencies, (12) leasing & finance, (13) housing finance, (14) forex broking, (15) credit card business, (15) money changing business, (17) micro credit, (18) rural credit (collectively, the NBFC activities).

Further, a press release issued by the Ministry of Finance in 2018, titled “Minimum Capital Requirements for ‘Other Financial Services’ activities which are unregulated by any Financial Sector Regulator and FDI is allowed under Government Route” sets out minimum capitalisation requirements for FDI in Approval Route FSA, listing the same 18 NBFC activities. Though this list is non-exhaustive, it suggests that the government intended to cover the NBFC activities and similar services under Approval Route FSA requiring government approval for 100% FDI (there is a separate debate regarding the sensibility of including these activities under Approval Route FSA for government approval as most are already regulated).

BNPL - financial service or technology-enabled platform?

While BNPL is not explicitly included as an NBFC activity, the category of “credit card business” was previously defined under the FDI policy preceding PN 6 of 2016 to include issuance, sales, marketing and design of various payment products such as credit cards, charge cards, debit cards, stored value cards, smart card, value added cards etc. That said, while BNPL is presented as a payment method at checkout, it is fundamentally a lending product and does not involve the issuance of any card or payment instrument. Hence, BNPL does not fit within the scope of “credit card business”.

Nor does a typical BNPL model align with any of the other 17 NBFC activities. Even setting aside the NBFC activities, it is difficult to see how BNPL fits within the scope of “financial service activities”.

Most BNPL providers operate primarily as technology platforms that integrate with merchants and offer the user interface and ancillary services that enable the transaction. The actual financial activity of disbursing the loan and bearing the credit risk is carried on by a third-party lender (bank or NBFC). While BNPL providers enable a financial service, they may not themselves be carrying on a financial service activity in the traditional sense.

Implications for fintechs

As things stand, the lack of a clear definition for “financial services activities” in the FDI framework means that any fintech company with foreign capital, especially those enabling credit or payments under models not explicitly regulated by the RBI could find itself unexpectedly categorized under Approval Route FSA, with huge financial consequences, as the penalty can be up to three times the amount involved in the contravention (i.e., the investment amount).