SEBI Blockchain Circular: A Watershed Moment For Legal Technology In India

Blockchain technology has been one of the most important elements of the “digital revolution” for the past decade. It has number of benefits such as faster and automatic execution, lower transaction costs and non-ambiguity in performance of the contract by making the execution more objective¹. The technology was first applied in bitcoin (which is a form of digital currency created for use in peer-to-peer online transactions) and is well known globally for its use in cryptocurrency, which, as of now does not have a robust regulatory framework in India². Nevertheless, the Indian government has encouraged the use of blockchain by introducing the Ministry of Electronics and Information Technology (“MEITY”) National strategy on blockchain, published in January 2021 (“Strategy Paper”), which has been dealt with in detail in the later paragraphs of this article. In the same direction, Securities and Exchange Board of India (“SEBI”) has recently issued a circular for use of digital ledger technology for monitoring non-convertible debentures. SEBI’s move in this direction could lead to revolutionary change in the use of technology for legal and governance related issues.

Blockchain Technology:

Blockchain technology is a distributed ledger technology used for decentralized data sharing across a large network of untrusted entities.

Such distributed ledger confirms the authenticity of data and restricts any unauthenticated alteration or removal of data. Such blockchain can be used in permissioned or permissionless models. Permissioned model has applications in various domains such as healthcare, cyber security, governance, legal, smart cities etc.

The blockchain architecture options are as under:

Indian Blockchain background:

In India, the most renowned case of blockchain technology has been in relation to cryptocurrency and the Reserve Bank of India (“RBI”) stance on the same. Further, RBI in a recent notification4 has clarified that it’s earlier restriction⁵ on prohibiting all regulated entities in dealing with virtual currencies shall not be applicable anymore. This is in line with the Hon’ble Supreme Court’s judgement dated 4th March 2020, in the matter of “Internet and Mobile Association of India v. Reserve Bank of India⁶”.

Additionally, a high-level inter-ministerial committee constituted in November 2017 to study the issues related to virtual currencies published its report on 22nd July 2019 (“Report”). The Report recommended regulators such as RBI, SEBI and Insurance Regulatory and Development Authority of India etc to evolve appropriate regulations for development of distributed ledger technology, more commonly known as blockchain (“DLT”) in their respective areas⁷.

Thus, the Indian regulators are taking active steps to utilise blockchain to accelerate the creation of a digital economy. In this article, we have analysed the recent steps taken by SEBI which is in line with MEITY in this regard.

MEITY’s Strategy Paper:

MEITY’s Strategy Paper recognises the various benefits and challenges of blockchain in India. It has also made recommendations to realise India’s potential for the adoption of blockchain. The Strategy Paper identifies 17 different potential applications of blockchain that promote national interest which include property record management, supply chain management and e-voting etc.

It further emphasises on how blockchain can bring about a lot of value addition in e-Governance by improving transparency & accountability, building trust with citizens and improving efficiency.

Additionally, it emphasizes on the existing infrastructural and regulatory hurdles that can affect the adoption of blockchain, such as lack of storage infrastructure and skilled manpower, lack of data privacy as well as incompatibility with the Personal Data Protection Bill, 2019 and the Information Technology Act, 2000.

Lastly, the Strategy Paper makes certain recommendations such as:

(a) The formation of a national level framework (“Framework”) which includes the development of an indigenous blockchain platform, infrastructure for cross application and formation of specific use ledgers to ensure seamless hosting of multiple smart contracts and ledger, meeting the broad requirements of the country;

(b) Integration with electronic signatures and national level services such as e-sign, DigiLocker and ePramaan; and

(c) In order to plan and implement the Framework, a multi-institutional Centre of Excellence is proposed to be set-up in collaboration with organizations such as the National E-Governance Division of MEITY, the state governments of India, the National Informatics Centre and the National Informatics Centre Services Incorporated etc. The designated responsibilities of the proposed collaborating organisations have been mentioned in the Strategy Paper.

SEBI Circular on DLT:

In pursuance of the Report mentioned above, SEBI on 13th August 2021 published a notification8 (“DLT Circular”) whereby it has asked depositories to create and host a platform for security and covenant monitoring systems by leveraging DLT (“Blockchain System”). SEBI, as per the DLT Circular, intends to use the Blockchain System for capturing the process of creation of security, constantly monitor covenants by debenture trustees and monitor credit rating of the nonconvertible securities by the credit rating agencies (“CRAs”) among other things.

Some of the key highlights of the DLT Circular include:

(a) Depositories have to provide secure login credentials to issuers, CRAs, debenture trustees for recording and verifying requisite information on the Blockchain system;

(b) Depositories will also have to ensure adequate safeguards are put in place to ensure that data on the Blockchain System is protected, maintain a compatible Blockchain System with other depositories and develop an alert mechanism that needs to be shared to the stakeholders for submission, acceptance and rejection of information and alerts for periodic and event-based compliances etc.;

(c) Further, it also defines the roles and responsibilities of various stakeholders in the Blockchain System such as issuers, CRAs, debenture trustees etc.; and

(d) Lastly, it explains the information that is to be recorded and the protocol for periodic monitoring that is to be followed by issuers, debenture trustees and CRAs etc. in the Blockchain System.

The Blockchain System will come into effect from 1st April 2022, however, testing of the Blockchain System will start from 1st January 2022. Therefore, the DLT Circular has stated that Issuers, Debenture Trustees and CRAs etc. need to carry out necessary changes, if any, in order to be ready to execute such functions as may be required for the Blockchain System. The DLT used as per DLT Circular would be in the nature of permissioned architecture. The Blockchain System would provide authenticated details approved by debenture trustee and accessible by other stakeholders. The Blockchain System used can be put to multipurpose use and would also ease the diligence on issuers.

Conclusion:

MEITY’s Strategy Paper has recognised India’s potential to utilise blockchain to revolutionise the digital economy, e-governance and other sectors of national importance. It highlighted the existing and potential challenges of blockchain application. The Strategy Paper can be used as a guiding framework by regulators to aid application of blockchain.

After the DLT Circular, it can be safely said that SEBI is the first Indian regulator to explore and utilise legal technology. While this is a promising step, other regulators need to follow suit. Regardless, it appears to be a step in the right direction for the use of legal technology in India. This would be the watershed moment for use of technology in the regulatory and legal industry in India.