Spice Route Legal
Introduction
Dealing in foreign exchange by entities is tightly regulated in India. To deal in foreign exchange in India, a person must be specifically permitted by the Reserve Bank of India (“RBI”) under the Foreign Exchange Management Act (FEMA), 1999 (“FEMA”). The RBI, for the first time in 2006, had rationalised the regulatory framework governing such entities and specified the various licences for entities that may deal in forex exchange and undertake money-changing activities:
a) Authorised dealers (Authorised Dealer Category – I, Authorised Dealer Category – II, Authorised Dealer Category – III) (“Authorised Dealers”); and b) Full-fledged money changers (“FFMCs”).
Since then, the RBI has not made any significant changes to the overall categorisation, except the introduction of a special licencing regime for NBFCs as Authorised Dealer Category – II.
On 26th December 2023, the RBI issued the “Draft Licensing Framework for Authorised Persons (APs) under FEMA” (“Draft Framework”), which proposes to significantly rehaul the existing regulatory regime governing Authorised Dealers. It intends to expand the permissible scope of activities for Authorised Dealers, extend the eligibility criteria for an Authorised Dealer licence to be inclusive for more entities, and introduce a formal registration process in this regard.
Additionally, the Draft Framework intends to introduce a new concept of “Forex Correspondent” scheme based on the contours of various distribution channels prevalent across financial sectors.
Scope of Activities of a Forex Correspondent
As per the proposed scheme, a Forex Correspondent would be a money changer that enters into an agency agreement with an entity that possesses an Authorised Dealer Category – I (“AD Cat – I”) or Authorised Dealer Category – II (“AD Cat – II”) licence, in a manner similar to the business correspondent arrangement with banks. Unlike an FFMC, forex transactions carried out by a Forex Correspondent will be reflected on the books of the principal Authorised Dealer. The scope of activities of a Forex Correspondent may include:
Purchase of foreign currency notes/travellers’ cheques and sale of foreign currency notes/travellers’ cheques for foreign private and business travel
Purchase of foreign currency notes/travellers’ cheques and sale of foreign currency notes/travellers’ cheques for foreign private and business travel
Purchase of foreign currency notes/travellers’ cheques and sale of foreign currency notes/travellers’ cheques for foreign private and business travel
However, while the RBI intends to streamline the activities by introducing this scheme, as per the draft framework, an entity cannot act as a Forex Correspondent for more than one Authorised Dealer, and can deal in foreign exchange only with the public or its principal Authorised Dealer.
Eligibility Criteria
The eligibility criteria laid out for Forex Correspondents is as follows
- An existing FFMC or AD Cat – II on surrender or after expiry of its authorisation
- An NBFC or a bank after obtaining necessary permission from the Department of Regulation, RBI
- A company as defined under the Companies Act, 2013.
Additionally, the principal Authorised Dealers are required to formulate a board-approved policy to engage Forex Correspondents and prescribe their eligibility criteria. This policy shall additionally include provisions that govern the following:
- Net worth requirements
- Due diligence requirements
- System requirements
- Reporting requirements
- Grievance redressal mechanism
Presently, the minimum net-owned fund requirement for FFMCs is INR 25 Lakh for single-branch FFMCs and INR 50 Lakh for multiple-branch FFMCs. We suspect that the principal Authorised Dealers would expect a Forex Correspondent to maintain a similar net-worth.
The due diligence requirements of a Forex Correspondent are similar to those of a business correspondent, except that in the case of a Forex Correspondent, there are additional requirements of a bankers’ report and a ‘no objection certificate’ from the Directorate of Enforcement (if applicable). It appears that the RBI intends to impose slightly stricter due diligence requirements on the engagement of Forex Correspondents given the regulatory and AML risks that forex transactions entail. To summarise the changes proposed under the Draft Framework, due diligence of a Forex Correspondent shall include an evaluation of
- Its reputation/market standing
- Its ability to implement technology
- Its financial soundness
- No objection Certificate’ from the Directorate of Enforcement in case the applicant is under investigation
- Its management and corporate governance
- Satisfactory bankers’ report
- Its cash handling ability
There is a shift in regulatory governance from direct regulation to self-regulation. For instance, the Securities and Exchange Board of India has allowed the Association of Mutual Funds to govern the activities of mutual fund distributors since the early 2000s. More recently, the Insurance Regulatory and Development Authority of India required the Life Insurance Council and the General Insurance Council to jointly issue standards that govern “Bima Vahaks” (an insurance distribution channel), discussed in greater detail here. Similar to other financial sector regulators, the RBI has recommended that the Foreign Exchange Dealers’ Association of India bring out standard baseline eligibility criteria based on the above requirements
As per the existing regulatory framework, an AD Cat – II licence is initially granted for 1 year and subsequently renewed for 1-5 years. The Draft Framework proposes to renew existing AD Cat – II licences on a perpetual basis. Additionally, the Draft Framework intends to do away with an FFMC licence.
Entities that have an AD Cat – II licence or FFMC licence, with INR 50 crores or more as the average “annual forex turnover” for the last 2 financial years, will have two options:
- Apply for a new or permanent AD Cat – II licence, as the case may be; or
- Become a Forex Correspondent and surrender existing licence.
AD Cat – II or FFMC licence holders that do not meet the average “annual forex turnover” criterion of INR 50 crore will have to become a Forex Correspondent.
The Draft Framework has provided an expansive definition of “annual forex turnover” to mean the aggregate of foreign currency notes, coins and travellers’ cheques purchased from or sold to public including those purchased from or sold to public by its agents/franchisees, and the value of remittances facilitated, during the financial year. It appears that considering the impact of COVID-19, the RBI intends to permit the exclusion of turnover figures of FY 20-21 and FY 21-22 to compute the average turnover.
The Draft Framework does not clearly specify the timelines within which such entities need to apply to the RBI. The Draft Framework specifies that an existing FFMC may approach the RBI for upgradation to an AD Cat – II licence, or an existing AD Cat – II may approach the RBI for permanent authorisation, at two separate instances:
- 2 (Two) months prior to the date of expiry of the existing authorisation; and
- By the date of the expiry of its existing authorisation or within a period of 2 (Two) years from the date when the new framework comes into force, whichever is later.
However, we suspect that the RBI would align the timelines once the new regulatory framework comes into effect, and such entities would be given adequate time to make an application to the RBI or give up their licences and become a Forex Correspondent.
Compliance Requirements
Given that Forex Correspondents would be agents of an AD Cat – I or an AD Cat – II, the Draft Framework shifts the onus of ensuring compliance with the regulatory framework to principal Authorised Dealers. The Draft Framework requires Authorised Dealers to be liable for the acts and omissions of their Forex Correspondents and ensure that the Forex Correspondents adhere to the applicable FEMA regulations.
Additionally, the principal Authorised Dealer must ensure compliance with the following
01
That it issues the necessary permission to each outlet of the Forex Correspondent under the Forex Correspondent agreement
02
That the Forex Correspondent agreement shall inter alia include provisions that govern the following
- The tenor of the arrangement;
- Authorised places of business of the Forex Correspondent;
- The permissible activities of the Forex Correspondent;
- The commission or fee for the exchange services;
- Suitable limits on cash holding by the Forex Correspondent;
- The duration for which the Forex Correspondent shall maintain a record of its transactions; and
- Provisions that ensure the preservation, protection, security, and confidentiality of customer information in the custody or possession of the Forex Correspondent.
03
In the event the principal Authorised Dealer is a bank or an NBFC, it shall follow the applicable guidelines on the outsourcing of financial services;
04
Report the transactions undertaken by its Forex Correspondents including those under the Liberalised Remittance Scheme; and
05
Ensure that information regarding its Forex Correspondents is placed on its website and the AP Connect portal.
Conclusion
By introducing business correspondents and business facilitators in 2006, the RBI was one of the first regulators that permitted the distribution of regulated services and products through unlicensed agency channels. Given that Indian foreign exchange laws are quite restrictive, the RBI’s proactive stance in introducing the new policy is a bold move. We will soon circulate part 2 of this article that will detail out the other changes proposed under the regulatory framework for Authorised Dealers. Stay tuned!
