SEBI (Custodian) Regulations, 1996

What this chapter covers

This chapter carries 3 per cent of the III-A examination.

LEARNING OBJECTIVES: After studying this chapter, you should know about: Functions of a custodian and the services offered by them · Registration of a custodian with SEBI · Obligations and responsibilities of custodians · Code of conduct for custodians · Dispute Resolution

22.1 Custodian and custodial services

A "Custodian" is any person who carries on or proposes to carry on the business of providing custodial services.

Which is the first review question — the answer is simply custodian.

Custodial services in relation to securities or goods of a client or gold or gold-related instruments or silver or silver related instruments held by a mutual fund or title deeds of real estate assets held by a real estate mutual fund scheme in accordance with the SEBI (Mutual Funds) Regulations, 1996 means, the safekeeping of such securities or goods or gold or gold-related instruments or silver or silver related instruments or title deeds of real estate assets and providing services incidental thereto.

Note how wide the property is — securities, goods, gold and gold-related instruments, silver and silver related instruments, and title deeds of real estate assets held by a real estate mutual fund scheme.

And the six included activities:

i. maintaining accounts of securities or goods or gold or gold-related instruments or silver or silver related instruments or title deeds of real estate assets of a client;

ii. undertaking activities as a Domestic Depository in terms of the Companies (Issue of Indian Depository Receipts) Rules, 2004;

iii. collecting the benefits or rights accruing to the client in respect of securities or goods or gold or gold-related instruments or silver or silver related instruments or title deeds of real estate assets;

iv. keeping the client informed of the actions taken or to be taken by the issuer of securities, having a bearing on the benefits or rights accruing to the client;

v. keeping the client informed of the actions taken or to be taken with respect to the goods held on its behalf; and

vi. maintaining and reconciling records of the services as have been referred to in the above points (i) to (iv).

Custody is more than a strongroom. Limbs (iii) to (vi) are about collecting entitlements, informing the client and reconciling the record — the work that makes safekeeping useful.

22.2 Registration and eligibility

Any person proposing to act as a custodian needs to get himself registered with SEBI. Under Regulation 6, SEBI considers:

a. the applicant should fulfil the capital requirement in accordance with regulation 7;

b. the applicant should have the necessary infrastructure, including adequate office space, vaults for safe custody of physical securities and computer systems capability, required to effectively discharge his activities as custodian;

c. the applicant should have the requisite approvals under any law for the time being in force, in connection with providing custodial services in respect of goods of a client or gold or gold-related instruments or silver or silver related instruments of a mutual fund or the title deeds of a real estate assets held by a real estate mutual funds scheme, where applicable;

d. the applicant should have employed adequate and competent persons who have the experience, capacity and ability to manage the business of the custodian;

e. the applicant should have prepared a complete manual, setting out the systems and procedures to be followed by him for the effective and efficient discharge of his functions and the arms-length relationships to be maintained with the other businesses, if any, of the applicant;

f. whether the applicant is a person who has been refused a certificate by SEBI or whose certificate has been cancelled by SEBI;

g. whether the applicant, his director, his principal officer or any of his employees is involved in any litigation connected with the securities market;

h. the applicant, his director, his principal officer or any of his employees has at any time been convicted of any offence involving moral turpitude or of any economic offence;

i. the grant of the certificate should be in the interest of investors;

j. the applicant should be a fit and proper person as defined in the SEBI (Intermediaries) Regulations, 2008;

k. SEBI shall not consider an application under these Regulations unless the applicant is a body corporate.

Two criteria are distinctive to this intermediary. Limb (b) requires vaults for safe custody of physical securities — the only intermediary in this syllabus with a physical storage requirement. And limb (e) requires a complete manual covering both systems and the arms-length relationships to be maintained with the other businesses.

Capital adequacy

An applicant for the Custodian should have a net worth of a minimum of Rs. 75 crores, net worth meaning the paid-up capital and the free reserves as on the date of the application.

And the net worth must not be double-counted: the custodian shall fulfill the net worth requirements under these regulations, separately and independently, of the capital adequacy requirements, if any, for each activity undertaken by it under the relevant regulations.

Existing custodians registered before the 2025 Amendment Regulations have three years from such commencement to reach not less than seventy-five crore rupees, separately and independently, of other activities' requirements.

And an older transitional rule allows a custodian approved under the Mutual Fund Regulations, 1993, the Foreign Institutional Investors Regulations, 1995 or the Government of India Guidelines for Foreign Institutional Investors to continue to function as a custodian and raise its net worth within a period of one year from the date of commencement of these regulations, extendable by SEBI upto a maximum of 5 years.

Validity and fees

Every certificate granted to the applicant as a Custodian shall be valid unless it is suspended or cancelled by SEBI.

Till suspended — the second review question.

Fees: the application fee of Rs.5 lakh, a registration fee of Rs. 50 lakhs to SEBI, and an annual fee of Rs. 10 lakh or 0.0005 per cent of the 'assets under custody' of the custodian, whichever is higher.

The annual fee shall be payable with reference to each financial year, within one month of completion of the financial year.

"Assets under custody" means the value of the assets held by the custodian of securities as disclosed by him.

Note the structure of the annual fee. It is the higher of a flat Rs. 10 lakh and a proportion of assets — so a large custodian pays with its size, and no custodian pays less than Rs. 10 lakh.

22.3 General obligations

Segregation

In cases where the custodian is carrying on any activity besides that of acting as a custodian, then, he should ensure that the activities relating to his business as custodian is separate and segregated from all other activities.

And people are segregated too: the officers and employees engaged in providing custodial services shall not be engaged in any other activity carried on by him.

Which is the third review question — True, and note that segregation runs to staff as well as to activity.

The code says the same in different words: the custodian shall ensure that an arms-length relationship is maintained, both in terms of staff and systems, from his other businesses.

Inspection of systems

Every custodian shall have in place adequate mechanisms for the purposes of reviewing, monitoring and evaluating the custodian's controls, systems, procedures and safeguards. The custodian shall have the mechanisms inspected annually by an expert and shall forward the inspection report to SEBI within three months from the date of inspection.

Reviewing, monitoring and evaluating — three verbs, as for a depository participant's internal accounting controls — plus an annual external inspection and a three month filing deadline.

No assignment

Custodian shall not assign or delegate its functions as a custodian to any other person unless such person is a custodian.

A narrow exception exists for physical goods: a custodian may engage the services of a person not being a custodian, for the purpose of physical safekeeping of goods or gold or silver belonging to its client including a mutual fund having a gold exchange-traded fund scheme or a silver exchange traded fund scheme.

Subject to three conditions:

the custodian shall remain responsible in all respects to its client for safekeeping of the goods or gold or silver kept with such other person, including any associated risks;

all books, documents and other records relating to the goods or gold or silver so kept with the other person shall be maintained in the premises of the custodian or if they are not so maintained, they shall be made available therein, if so, required by SEBI;

the custodian shall continue to fulfil all duties to the clients relating to the goods or gold or silver so kept with the other person, except for its physical safekeeping.

Only the physical act is outsourced. Responsibility, records and every other duty stay with the custodian.

Separate accounts, agreement and controls

Every custodian shall open a separate custody account for each client, in the name of the client whose securities are in its custody and the assets of one client shall not be mixed with those of another client.

The agreement with each client must provide for:

the circumstances under which the custodian will accept or release securities, goods, assets or documents from the custody account;

the circumstances under which the custodian will accept or release monies from the custody account;

the circumstances under which the custodian will receive rights or entitlements on the securities or goods of the client;

the circumstances and the manner of registration of securities in respect of each client; and

details of the insurance, if any, to be provided for by the custodian.

Internal controls: every custodian shall have adequate internal controls to prevent any manipulation of records and documents including audits for securities, goods and rights or entitlements arising from the securities and goods held by it on behalf of its client. Every custodian shall have appropriate safekeeping measures to ensure that such securities, goods, assets or documents are protected from theft and natural hazard.

Theft and natural hazard — the two risks a vault is built against.

Records

Every custodian shall maintain the following records and documents for a minimum period of five years:

a. records containing details of securities, goods, assets or documents received and released on behalf of each client;

b. records containing details of monies received and released on behalf of each client;

c. records containing details of rights or entitlements of each client arising from the securities held on behalf of the client;

d. records containing details of registration of securities in respect of each client;

e. ledger for each client;

f. records containing details of instructions received from and sent to clients; and

g. records of all reports submitted to Board.

Five years — the fourth review question. And the custodian shall also inform Board of the place where the records and documents as mentioned above are maintained.

22.4 Compliance officer

Every custodian shall appoint a compliance officer who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions, etc., issued by the Board or the Central Government and for redressal of investors' grievances. The compliance officer shall immediately and independently report to the Board any non-compliance observed by him.

22.5 Obligations and responsibilities

The custodian shall be required to meet obligations and discharge responsibilities, in the manner specified by the Board from time to time, to ensure:

(1) appropriate governance structure and processes;

(2) appropriate risk management policy and processes;

(3) scalable infrastructure and appropriate technical capacity;

(4) framework for orderly winding down; and

(5) any other measure as may be specified by the Board from time to time.

These four heads will look familiar. They are the same obligations imposed on a qualified stock broker and, in substance, on a QRTA — the standard package for market infrastructure. Framework for orderly winding down is again the striking one: it assumes failure is possible and asks how client assets would be handed on.

22.6 Code of conduct

The Custodian shall:

Maintain the highest standard of integrity, fairness and professionalism in the discharge of his duties.

Be prompt in distributing dividends, interest or any such accruals of income received or collected by him on behalf of his clients on the securities held in custody.

Be continuously accountable for the movement of securities or goods in and out of the custody account, deposit, and withdrawal of cash from the client's account and shall provide a complete audit trail, whenever called for by the client or SEBI.

A complete audit trail, on demand by the client or the regulator — the essence of custody.

Establish and maintain an adequate infrastructural facility to be able to discharge custodial services to the satisfaction of clients, and the operating procedures and systems of the custodian shall be well documented and backed by operations manuals.

Maintain client confidentiality in respect of the client's affairs.

Where custodian records are kept electronically, the custodian has to take necessary precautions to ensure that continuity in record-keeping is not lost or destroyed and that sufficient backup of records is available.

Create and maintain the records of securities held in custody in such a manner that the tracing of securities or obtaining duplicate title documents is facilitated, in the event of loss of original records for any reason.

Records designed for reconstruction — so that a lost original does not mean a lost holding.

Extend to other custodial entities, depositories and clearing organizations all such co-operation that is necessary for the conduct of business in the areas of inter custodial settlements, transfer of securities and transfer of funds.

Ensure that an arms-length relationship is maintained, both in terms of staff and systems, from his other businesses.

Exercise due diligence in safe-keeping and administration of the assets of his clients in his custody for which he is acting as custodian of securities.

And on public advice: the custodian shall not render, directly or indirectly any investment advice about any security in the publicly accessible media, whether real-time or non-real-time, unless a disclosure of his interest including a long or short position in the said security has been made while rendering such advice, an employee also disclosing the interest of his dependent family members and employer including their long or short position.

22.7 and 22.8 Disputes and the Investor Charter

All claims, differences or disputes between a custodian and its client arising out of or in relation to the activities of the custodian in the securities market shall be submitted to a dispute resolution mechanism that includes mediation and/or conciliation and/or arbitration, in accordance with the procedure specified by SEBI.

**And: the Custodian shall ensure compliance with the Investor Charter specified by the Board from time to time.

The chapter's review questions confirm that a person carrying on or proposing to carry on the business of providing custodial services is a custodian; that the certificate of registration is valid till suspended; that it is True that custodial activities must be segregated from other activities; and that records are maintained for a minimum of 5 years.