Rethinking Compliance: SEBI Reverses its Hiving-Off Mandate for Custodians

Custodians occupy a crucial position in India’s financial ecosystem. Regulated and licensed by the SEBI (Custodian) Regulations, 1996, a custodian provides safekeeping services for securities and related instruments, maintaining custody accounts, collecting entitlements, and ensuring compliance with regulatory requirements. For Alternative Investment Funds (“AIF”), custodians are essential intermediaries ensuring proper asset segregation, accurate recordkeeping, and timely settlements, particularly under Regulation 20 of the SEBI (AIF) Regulations, 2012, which mandates the appointment of a custodian for all categories of AIFs.

In December 2024, the Board of the Securities and Exchange Board of India (“SEBI”) proposed a structural overhaul of the regulatory regime for custodians, with potentially wide-ranging consequences, suggesting that custodians who are also involved in business activities which are not  regulated by SEBI or any other financial sector regulator, should hive off such operations into a separate legal entity. However, over the subsequent six months, SEBI’s Board has reconsidered its stance and has ultimately rolled back this hiving-off requirement.

In its Board Meeting held on December 18, 2024, SEBI called on custodians to “hive-off activities that are not under the purview of any financial sector regulator to a separate legal entity within two years”. Custodians were however permitted to undertake “activities incidental to regulated activities” (such as fund accounting) within the same legal entity. This move aimed to mitigate conflicts of interest and regulatory overlap risks, especially where entities involved in diverse financial services were not directly overseen by SEBI.

To operationalize the abovementioned decision, SEBI tasked the Custodians and Depositories Standard Setting Forum (CDSSF) with preparing a definitive list distinguishing core and non-core functions. This was aimed at bringing consistency to outsourcing norms and clarifying permissible lines of business.

In response to stakeholder feedback and internal deliberations, SEBI, during its Board Meeting in March 2025, decided to defer the implementation of the new rule. The regulator acknowledged the need to evaluate alternate approaches that could better balance ease of doing business with regulatory safeguards.

Finally, in a reversal of its December 2024 stance, SEBI’s Board, in its meeting on 18 June, 2025, resolved that custodians “shall not be required to set up a separate legal entity” for undertaking financial services activities. This reversal was unequivocally driven by the objective of ease of doing business. Custodians may continue undertaking non-SEBI-regulated activities as well as unregulated activities within the same entity, subject to the following conditions:

• They must implement robust internal mechanisms to manage potential risks and have adequate mechanisms to address issues of conflicts of interest.
• The unregulated activities must be fee-based, non-fund based activities and pertain to financial services sector.
• Custodians that are not banks or bank-associated entities and choose to offer unregulated services, must disclose clearly to all relevant stakeholders that such activities are outside the purview of, and without recourse to SEBI and must set up distinct and separate Strategic Business Units for undertaking activities outside the purview of SEBI.

The decision by SEBI’s Board on June 18, 2025 represents a fundamental shift in SEBI’s regulatory philosophy. Instead of imposing a rigid structural separation, the regulator is now mandating a more flexible yet robust functional separation through internal controls and clear operational boundaries. The emphasis is on the effectiveness of internal governance, transparency, and clear demarcation of responsibilities within a single legal entity, rather than relying solely on a distinct corporate structure. This revised framework offers substantial operational flexibility and potential cost savings for custodians, particularly those integrated within larger financial groups, by eliminating the need for complex and costly corporate restructuring. However, it simultaneously places a significantly higher burden on custodians to establish and maintain impeccable internal compliance, robust conflict of interest management policies, and transparent disclosure practices.

Further, the emphasis on segregation of functions and arm’s length dealings remains intact under the SEBI (Custodian) Regulations, 1996. Specifically, Regulation 13 mandates custodians to maintain segregation between custodial and other activities, while Regulation 14 requires robust internal monitoring systems.

Therefore, while SEBI has softened structural mandates, custodians must remain vigilant in operational compliance to avoid regulatory scrutiny, particularly as cross-functional services grow.

The minutes of the 210^th meeting of SEBI’s Board held in Mumbai on June 18, 2025 can be found here

The minutes of the 209^th meeting of SEBI’s Board held in Mumbai on March 24, 2025 can be found here

The minutes of the 208^th meeting of SEBI’s Board held in Mumbai on December 18, 2024 can be found here

We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com  or write to our authors:

Vinod Joseph, Partner – Email – vinodjoseph@elp-in.com

Saloni Khaitan, Advocate, Email – salonikhaitan@elp-in.com