Saloni Rani
I. Introduction
Digital Gold allows an investor to purchase and sell gold online without any physical visits. It has gained prominence in a very short period because it does not create any blanket ban on the quantity of gold to be purchased and most importantly, it saves time and efforts of investors. The Securities and Exchange Board of India (hereinafter, SEBI) introduced the Electronic Gold Receipts (EGR) framework via notification in 2021 to regulate the digital gold. But its regulatory architecture remains asymmetrical. Although Section 2(h)(iia) in SEBI Act (hereinafter, the act) recognises EGRs as ‘security’, triggering the vault manager obligations, who will govern the audit and reports beyond conversion of physical to digital gold and investor protection mechanism. Yet there are some fintech platforms beyond the SEBI jurisdictional reach involved in creation of parallel grounds for the sale and purchase of digital gold and its products. This has created regulatory arbitrage based on differentiation in platforms rather than nature of the commodity. This platform-centric differentiation has undermined the objective of security regulation to regulate risk as an economic substance rather than institutional.
This is where the ‘regulatory gap’ emerges. This is not an incidental phenomenon but rather stem from structural defaults. It has three overlapping failures first, the narrow definition of EGR that exclude non-SEBI platforms, second, the jurisdictional silence in existing statues i.e. Consumer Protection Act, and IT frameworks which are devoid of SEBI mechanism, third, the absence of equivalence principle to capture digital gold irrespective of platform. These failures have caused the unregulated platforms to enjoy cost arbitrage avoiding their expense in fulfilling obligations and mandatory requirements of vault managers.
The author seeks to analyse the above failures and its implication by advancing this piece in three arguments. Firstly, examining the India’s current framework regulating the digital gold, secondly, by comparative analysis of UK’s Financial Conduct Authority Model, the piece seeks to analyse how functional approach for regulation of digital assets can eliminate platform-based loopholes. Lastly, it proposed certain recommendations to ensure investor protection.
II. Rethinking Digital Gold: Legal Gaps
Fintech platforms offer various schemes for purchase and sale of digital gold and related products. Majority of these platforms are not recognised by SEBI, which means that any transaction taking place under this category does not qualify as ‘EGR’ as it falls outside SEBI’s jurisdiction. This regulation and audit remain an insider process which lacks transparency unlike SEBI registered securities where vault managers have a significant role. This has three implications at large firstly, the manipulation in the pricing of digital gold on the websites which may not represent the real market values, but rather an internal discussion. Secondly, exposing investors to huge risk with no regulations and ultimately, liquidity in some cases and thirdly, the risk highlighting the regulatory arbitrage for example, platforms like Google Pay, Paytm Gold, etc allow investors to purchase the digital gold but falls outside the ambit of SEBI’s regulatory framework.
Although The SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 in regulation 4 prohibit the misleading statements interlinked with securities trading, still the subsisting jurisdictional limit exposes the gap in two-fold: SEBI recognise the investor risk on one hand but lacks the authority to regulate that transactions on other hand. This raises the fundamental question of whether the existing frameworks addresses this gap or not.
For example- The Consumer Protection Act (CPA) regulates the misleading advertisement which activate only when the harm has been caused. These provide the post-facto remedies but remains largely reactive unlike SEBI’s preventive approach. The latter works on an audit mechanism with proper risk management and Consumer laws cannot substitute this functionality as it will have a direct impact on investors. Furthermore, The Information Technology Act regulates electronic records ensuring validity of digital transactions. Its compliance will create an illusionary impact given that gold data is valid, but who will ensure if the risk and management was valid?
The implication of this regulatory bypass is misleading advertisement. The continuation of these practices may result in arbitrage. The SEBI has also, issued a cautionary notice to prevent investors from fraudulent investments. Thus, these regulatory arbitrage stem not only from legislative oversight but also, from structural design that’s the narrow definition of EGRs, the jurisdiction limitation of the statues as discussed, and absence of functional principle to regulate the digital gold uniformly. Thereby, the piece shall further engage in the comparative analysis with UK to analyse the learnings for India.
III. Functional Regulatory Contrast: The UK FCA Model
The United Kingdom (UK) has grappled with the same tension and today, it has set an exemplary category over governance of digital assets in the globe. The Financial Conduct Authority (hereinafter, FCA) of the UK adopted the functional approach. It interpreted the already existing statute, the Financial Service and Markets Act (hereinafter, the act), to gain regulatory oversight over the digital assets including gold. Section 19 of the act specifically asserts that no regulatory activity can be carried without the authorization. It helps FCA maintain an oversight over all the commercial activities of digital assets. This has led to elimination of unregulated markets to a large extent. It restricted advertisement to only those authorised and regulated by FCA, creating a safe market for investors free from misleading pricings. By mandating the disclosure obligations and adequate capital requirements, it has highly eliminated the anti-competitive environment. Thus, the same level playing field has been created after the functionality approach by FCA between different platforms. This showcased how a functional approach collapsed platform-based distinction.
Unlike UK with single regulatory authority, India has fragmented authorities e.g. SEBI only governs the digital gold listed on its platform, limiting the scope of Section 2(h)(iia). The regulatory framework governing digital gold in India further depends on platform-contingent rather than function-driven. Therefore, fundamental regulation in country first requires the change in determination of digital gold from institutional form to economic function. Function of digital gold on fintech is like vault manager’s EGR: both does not exist in physical forms. Here, the functionality equivalence will eliminate the platform-based arbitrage and establish the neutrality. Thus, the UK model provides India with framework for adoption rather than a blueprint for replication.
IV. Conclusion And Reform Recommendations
The fundamental reform must address the narrow definition of EGR under Section 2(h)(iia). It defines EGR as a security specified by the broad without catering to platforms outside the ambit of the board. SEBI must thereby first, broaden the ambit of EGR framework by proper regulations and compulsion to all the platforms dealing with digital gold to route their transactions from SEBI recognised exchange and vault managers. This will ensure their compliance with necessary pre-requisite conditions to facilitate the exchange of digital gold and ultimately, lead to the same level playing field.
Secondly, a clear legal authorization from SEBI should be issued evoking its power under Section 11A, whereby the registration of all the investors purchasing and selling the gold shall be mandated. This will help the board to supervise the actions of investors and prevent them from fraudulent investments. Further, there is a need for specific coordinated forum between RBI and SEBI. All the payment platforms i.e. Paytm, Google Pay shall obtain dual authorization, where RBI must approve the payment system operation and SEBI must account for digital gold investment products. This will eliminate the lacunae in these platforms whereby they are taking backdoor entries by categorizing them as a payment features.
Finally, SEBI should maintain structured stakeholder engagement backed by timely consultation and feedback mechanism. There shall be regular meetings with the digital gold platforms, vault managers and all other related bodies to highlight and understand the challenges. A period regulatory review shall be done by SEBI to critically analyse and fill the lacunae in governance of digital gold at root level. This will prevent the fraudulent investments by investors.
Saloni Rani is a B.A. LL.B. (Hons.) students at the Rajiv Gandhi National University of Law, Punjab
NUALS Law Journal 