Obligation to appoint a custodian extended to all Alternative Investment Funds (AIFs)

Until now, not all AIFs were required to appoint a custodian. The AIFs required to appoint a custodian were:

• Category III AIFs;
• Category I and Category II AIFs with a corpus exceeding INR 500 crore; and
• Category I and Category II AIFs transacting in credit default swaps.

Mandate to appoint a custodian for all AIFs

Vide circular dated January 12, 2024 (“Circular”), SEBI has mandated that even schemes of Category I and Category II AIFs with a corpus of INR  500 crore or less should also appoint custodians. If a scheme of a Category I or Category II AIF with a corpus of INR 500 crore or less, is holding at least one investment as on date of the Circular (that is January 12, 2024), it should appoint a custodian on or before January 31, 2025. If a scheme of a Category I and Category II AIF with a corpus of INR 500 crore or less has not yet made any investment, it should appoint a custodian prior to first investment of the scheme.

Restrictions on associates acting as a custodian

Further, the Circular provides that if the custodian of an AIF is an associate of the manager or sponsor of the AIF, managers of such AIFs shall ensure compliance with Regulation 20(11A) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) on or before January 31, 2025.

Regulation 20(11A) has been newly introduced in the AIF Regulations very recently vide an amendment to the AIF Regulations dated January 5, 2024 (“Amendment”). The aforementioned Regulation 20(11A) states that a Custodian which is an associate of the Sponsor or Manager of an AIF may act as a Custodian for that AIF only when all of the following conditions are met:

• the Sponsor or Manager has a net worth of at least twenty thousand crore rupees at all points of time;
• fifty per cent or more of the directors of the Custodian do not represent the interest of the Sponsor or Manager or their associates;
• the Custodian and the Sponsor or Manager of the AIF are not subsidiaries of each other;
• the Custodian and the Sponsor or Manager of the AIF do not have common directors; and
• the Custodian and the Manager of the AIF sign an undertaking that they shall act independently of each other in their dealings of the schemes of the AIF.

Disclosures to SEBI by the Custodian

The Amendment has inserted a new sub-clause in Regulation 20(11) of the AIF to provide that the Custodian of an AIF shall report or disclose such information regarding investments of the AIF in such manner as may be specified by SEBI from time to time. The Circular states that, in this regard, the pilot Standard Setting Forum for AIFs (‘SFA’), in consultation with SEBI, shall formulate implementation standards for reporting data on investments of AIFs that are under custody with the Custodian. Such standards shall specify the format and modalities of reporting of data by the manager of AIF to the custodian and subsequently, by the custodian to SEBI.

ELP Comments

In our view, the net worth restrictions on the Custodian being an associate of the Sponsor or Manager of the AIF is meant to ensure that only very large financial institutions can install an associate as the custodian of an AIF of which the financial institution is a sponsor or manager. The additional restrictions are meant to ensure that the Custodian acts in the best interests of the investors. The Circular also states that the information necessary to ascertain compliance with the provisions of the Circular shall be incorporated in the format for quarterly reporting by AIFs in SEBI Intermediary Portal and the manager of AIF shall provide the requisite information accordingly while submitting the quarterly report to SEBI. From this, one gathers that SEBI proposes to collect information pertaining to AIFs from Custodians, which would be in addition to the quarterly reporting made by AIFs at present.

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
Paridhi Jain, Associate – Email – paridhijain@elp-in.com

Disclaimer: The information contained in this document is intended for informational purposes only and does not constitute legal opinion or advice. This document is not intended to address the circumstances of any individual or corporate body. Readers should not act on the information provided herein without appropriate professional advice after a thorough examination of the facts and circumstances of a situation. There can be no assurance that the judicial/quasi-judicial authorities may not take a position contrary to the views mentioned herein.