dark clouds on digital gold

Reason: A Securities and Exchange Board of India (SEBI) Circular, Issued on October 21, Registered Barred investment advisor (RIA) by undertaking unregulated activities, such as providing a platform for the buying and selling of unregulated products – including digital gold. The common language leaves ample room for crackdown on many other alternative assets, such as cryptocurrencies.

With India unable to make up its mind about the legality of a variety of new, emerging financial instruments, SEBI’s move is, in fact, a form of shadow regulation (unless, more well-thought-out rules are implemented). place is considered). But since SEBI’s mandate is somewhat narrow, the new rules affect only those financial institutions that have registered themselves with the market regulator.

“We are in the stage of total regulatory arbitration. Entities regulated by reserve Bank of India (RBI) and other unregulated companies may continue to offer digital gold,” said the CEO cited above. We had no choice but to close, while others continue to make money.

Interoperability rules have started to cause a lot of outrage within the fintech industry. The new restrictions come soon after an advisory was issued by stock exchanges in August this year, barring stockbrokers from distributing digital gold on their platforms after September 10.

In fact, fintech companies like Paytm Or Grow, which holds SEBI RIA registration, could earlier offer crypto or digital gold to its customers as part of financial schemes. But now that is not possible. If found doing so, the market regulator can impose monetary penalties, ask firms to refund the invested money to clients with interest and, in the worst case, even their SEBI registration. can cancel. The threat to cancel the license has already had a manifold effect. On the one hand, a growing number of fintech companies are revamping their infrastructure and moving their digital gold business into a separate entity. On the other hand, some companies are planning to write to the regulator for more legal clarity.

In response to all this confusion, SEBI has recommended to the government that the offering of digital gold should be termed as securities in the upcoming Union Budget, according to two people aware of the matter.

“The only way out is if digital gold is called securities by amending the Securities Contract Regulation Act (SCRA) and the SEBI Act. Then, digital gold will be regulated and all RIAs, brokers and their linked entities will be able to offer digital gold,” said the first of the above two officials.

“Essentially, all gold trading on the exchanges is under us anyway. Therefore, digital gold is not much of a stretch,” said the second person quoted above. “Currently, digital gold is being offered in a regulatory void. If something goes wrong, the regulated environment will also be affected. Our circular is essentially aimed at ring-fencing regulated entities,” the official said. An email query sent to SEBI is yet to be replied to.

the Twilight Zone

Originally, digital gold was introduced only by Metals and Minerals Trading Corporation of India (MMTC), a public sector undertaking. MMTC’s offering was a joint venture with Swiss gold refiner PAMP. It was marketed as a new-age investment instrument that allowed an investor to invest in 24-karat gold, which is then stored in MMTC-PAMP’s secure vaults.

However, five years after MMTC’s initial moves, there are now dozens of private players in the digital gold market. The total number of digital gold accounts across various platforms has already crossed the 120 million mark this year.

Gold is also a particularly sensitive investment category in the Indian context. The country is the second largest consumer of gold globally and the tendency to convert household savings into gold is quite high. Currently, investors are trading in digital gold at the average ticket size 500-1,200, indicating the presence of small time retail investors.

“Here’s the question. What if Sona is not in their (fintech players’) custody? Who is monitoring these private players?” Chief Executive Officer of one of India’s largest fintech firms.

For investment apps like Upstox and Grow, digital gold was an opportunity to bring more users to their platforms. Compared to stocks, digital gold is fairly easy to understand and serves as a great attraction for investors at the bottom of the pyramid. These investors then gradually moved on to more complex products.

So far, so good. But the advent of private players also resulted in innovation, which added to the complexity.

For example, take Oropocket, a crypto firm founded in 2018 that allows Indians to invest in cryptocurrency tokens that are backed by gold and silver. Another company made a cryptocurrency Is issuing tokens backed by Digital Gold and against it without any regulatory oversight. Yet another is offering to store gold in Switzerland without regard to income tax laws or foreign exchange effects.

The regulator cannot help but take cognizance of the growing market for digital gold and these alternative unregulated assets that are often marketed as financial innovations.

Nitin Kamath, founder and CEO, fintech firm Zerodha Broking Ltd, said, “I think digital gold was barely being sold and I think SEBI had to step in because of it.” “Whenever it (Sebi) sees retail people taking risks, that’s when they usually jump in and issue a clarification,” he said.

SEBI specifically mentioned digital gold as it was clearly visible across all platforms. But there are other offerings that could potentially fall under this broad umbrella of ‘unregulated products’ – such as international investments (allowing Indians to invest in US stocks), those offering investments in unlisted stocks platform, pre-IPO orders and even cryptocurrency for that matter. ,

Pre-IPO orders work like this. If, let’s say, Paytm’s public offering opens at 8 am on a particular day, some intermediaries start collecting orders from their customers much before that time, potentially leading to an initial public offering (IPO). Can manipulate the spirit of the surroundings. Technically, orders should be collected only during the IPO window. Again, everyone has the same information regarding the level of subscription.

“SEBI deliberately kept the term broad (in order) to ensure that all unregulated so-called financial products are kept away from the regulated ecosystem,” the first official quoted earlier in the story said.

“It is to be noted that while products like digital gold are unregulated and there are regulatory gaps as far as ensuring quality of checks and safety of storage is concerned, this can be addressed through appropriate standards. These can then be applied equally to all market participants,” said Sandeep Parekh, Managing Partner, Finsec Law Advisors.

price to be regulated

Parekh of Finsec Law believes that while the concerns over the unregulated nature of digital gold are legitimate, a complete ban is not really a solution. “This may reduce investor confidence in the product,” he said. Parekh also expressed doubts about the validity of the circulars.

For now, several fintech firms regulated by SEBI and offering digital gold have started restructuring their business. For example, Paytm Gold, which was part of SEBI-controlled brokerage firm Paytm Money, has now been transferred to the parent company. “The Company has immediately delisted Digital Gold from Paytm Money and brought it back under Paytm App of One97 Communications Limited, which is not regulated by SEBI. All non-regulated entities can continue to offer digital gold,” said the co-founder of a digital gold platform, who did not wish to be named.

A Paytm spokesperson said in response to an email: “No business transfer has taken place. Digital gold has always been a product of OCL (One97 Communications Limited). The company’s draft red herring prospectus also states that digital gold is offered by OCL in collaboration with partners. Digital gold was earlier accessible through Paytm and Paytm Money app. Currently, it is available only through Paytm app.”

Kuvera, an online platform offering financial products, in response to a tweet on November 8 responding to customer queries, said: “Yes, we are regulated by SEBI and are working towards compliance with the circular. Will issue a communication for a seamless transition.”

“If there is an unregulated entity, such entity can technically carry on the business of buying/selling and tracking of digital gold. However, ideally, such (a) company should be a separate legal entity and not under common control with the RIA company,” said Vatsal Gaur, partner, Peer Counsel, a law firm.

In other words, the general directorship would be a concern and regulatory action could be taken. Some other firms have completely stopped offering digital gold for the time being.

SEBI’s ban for unregulated digital gold platforms has become a boon and their trend has increased rapidly. But even he is being showered with questions as to how the circular affects him and his business.

“Two of our VCs (Venture Capital Funds) reached out to us and asked if we were affected by this circular,” said the co-founder of the Digital Gold platform quoted above. “These questions are coming from well aware and educated people and we had to explain to them that we were not affected.”

The likes of Zerodha are planning to write to the regulator for some sort of informal guidance. Zerodha’s Kamath said, “We are in the midst of making a request in terms of informal guidance on some of these products. Clearly there is regulatory arbitrage at some level. We have never sold digital gold because we thought it would.” Is not a good product. But assuming we want to sell it and someone else sold it and we didn’t because of regulations, then there is some (a) regulatory arbitrage,” he said.

“Similar scenario is going on in the crypto space as well. The crypto market is getting bigger but we have to sit and watch. So, on these 2-3 products, we are giving an informal guidance whether it should be allowed or not. Kamat said.

“Being one of the big players, if we start doing some unneeded things and if we are spotted doing that, the consequences for us are going to be much higher than some of the smaller players. Regulators today almost look at us like an MII (Market Infrastructure Institution or Exchange). So, we can’t really take these opportunities,” Kamat said.

what next?

It cannot be denied that the regulator has kept the circular wide enough to cover as many alternative unregulated assets as possible. Hence, confusion over what new innovative products the SEBI regulated entities can or cannot offer will continue for some time at least.

There is an ideology that says that investors will generally understand the risks before investing their money and, therefore, financial products should not be banned. However, the allure of owning gold in smaller denominations is affecting the gold-crazy Indian population.

The only way out is to bring digital gold under one umbrella in a well regulated environment and avoid regulatory arbitrage.

When a product is regulated by two regulators—RBI and SEBI, in this instance—the possibility of regulatory arbitration only increases. This rarely results in a good result.

Regulators and the government seem to be aware of this. This is the reason why digital gold can be brought under the SEBI Act in the next financial year. While this would correct some of the existing confusion, it would also inevitably increase the compliance requirements for entities that are currently unregistered. However, as India embarks on a slow, volatile path towards regulating new-age asset classes—from crypto to foreign stocks—some level of compliance and general rules may become a necessity.