Custodian
Also written Custody · SEBI-registered custodian · Custodial services
The SEBI-registered entity that holds a fund's securities in accounts of its own and settles its trades, so the assets sit somewhere other than with the manager who decides what to buy.
In plain language
A fund has two entirely different jobs inside it. One is deciding what to buy. The other is holding the thing that was bought.
If the same person does both, an investor has no independent evidence that the portfolio described in the quarterly report actually exists. The custodian is the separation: the manager instructs, the custodian holds and settles, and the securities account is the custodian's record, not the manager's spreadsheet.
That is the whole idea. Everything else — settlement, corporate actions, tax withholding, regulatory reporting — is work the custodian ends up doing because it is the one entity that can see every position at all times.
How it works
Custodians register with SEBI under the SEBI (Custodian) Regulations, 1996. Under the SEBI (AIF) Regulations the appointment is made by the sponsor or the manager, and since the SEBI (AIF) (Amendment) Regulations, 2024 (with effect from 5 January 2024) it is compulsory for every AIF, whatever the corpus and whatever the category.
Timing is specific: the custodian for a scheme must be appointed before the date of the scheme's first investment — not before first close, and not "sometime in year one". A custodial agreement is executed between the parties, and the custodian shall not be a related party to the sponsor or the designated partners unless specific conditions are met.
Because AIF securities are held in dematerialised form, the custodian is responsible for settlement and for ensuring the fund's demat accounts show the correct position at any time. It commonly also does tax withholding, proxy voting, and tracking of dividends, bonus and rights issues. For Category III AIFs it additionally keeps custody of goods received on physical settlement of commodity derivatives.
The custodian is also a reporting node for SEBI, not just a warehouse:
- Leverage breach (Category III): the AIF reports end-of-day leverage to the custodian by the end of the next working day and reports any intra-day breach. On a breach the AIF tells investors before 10:00 AM the next working day and squares off the excess by the end of that day; the custodian reports the fund's name, the extent of the breach and the reasons to SEBI before 10:00 AM the next working day, and confirms the square-off to SEBI the same day it happens.
- Credit default swaps: CDS exposures are reported to the custodian by the next working day; where earmarked securities fall below the CDS exposure and the AIF fails to rectify by the end of the next trading day, the custodian reports the breach to SEBI on the next working day.
- Specific due diligence: an investment taking a scheme to 10 percent or more of an investee company's equity on a fully diluted basis is reported to the custodian within 30 days, and the custodian compiles and reports to SEBI.
- FPI records: KYC records are kept in original for a minimum of 5 years from the cessation of transactions, longer if litigation is pending.
What the custodian does not do is protect the investor from the manager's judgement. Segregation protects against misappropriation and against the manager's own insolvency — the SEBI (AIF) Regulations separately require that the assets, liabilities, bank accounts and securities accounts of each scheme be segregated and ring-fenced from every other scheme. If the manager goes bankrupt or dissolves, the assets are identifiable and the fund is wound up through the liquidation route; they do not become part of the manager's estate. A portfolio that simply loses money is a different problem, and custody does nothing about it.
A worked example
Growth Fund I, a close-ended Category III AIF, declares first close on 15 November with a corpus of Rs 240 crore. Before it buys its first security the manager appoints a SEBI-registered custodian and signs the custodial agreement.
The cost. Take the workbook's own fee illustration — a fund with committed capital of Rs 98 crore paying annual custodian fees of Rs 51,10,000:
| Line | Rs |
|---|---|
| Custodian fees | 51,10,000 |
| GST at 18% | 9,19,800 |
| Total payable | 60,29,800 |
That is roughly 62 basis points of committed capital, and it sits inside transaction and operating expenses rather than inside the management fee. GST at 18% applies to the custodian, the administrator, the auditor, the legal adviser and the investment adviser alike.
The reporting. Growth Fund I runs leverage of 1.8 times NAV against a cap of 2 times NAV. On a Tuesday a derivative position moves and gross exposure closes at Rs 500 crore against an NAV of Rs 240 crore — a ratio of 2.08 times. The clock then runs:
| When | Who | What |
|---|---|---|
| By end of Wednesday | AIF | Reports the day's leverage, and the breach, to the custodian |
| Before 10:00 AM Wednesday | AIF | Reports the breach and its reasons to every investor |
| Before 10:00 AM Wednesday | Custodian | Reports the fund's name, the extent of the breach and the reasons to SEBI |
| By end of Wednesday | AIF | Squares off roughly Rs 20 crore of excess exposure and confirms to investors |
| End of the same day | Custodian | Confirms the square-off to SEBI |
The manager never reports the breach to SEBI itself. The custodian does, because the custodian is the only party that can see the positions without taking the manager's word for them.
Why NISM asks about it
Chapter 7 (Alternative Investment Funds Ecosystem), section 7.1.4.3 introduces the custodian among the service providers, and Chapter 17 (Regulatory Framework) carries the obligations — appointment, leverage-breach reporting, CDS reporting and the specific due-diligence reporting. Expect questions on who appoints the custodian (sponsor or manager), by when (before the scheme's first investment), whether it is optional (it is not, for any AIF), and the leverage-breach sequence, where the examinable point is that the custodian reports to SEBI while the AIF reports to investors.
Common exam traps
- The custodian is appointed by the sponsor or the manager — not by the trustee. The trustee appoints nobody here; it executes the trust deed and signs the Investment Management Agreement.
- There is no corpus threshold any more. Since the 2024 amendment every AIF must appoint a custodian. An answer of the form "only if the corpus exceeds X crore" is the trap, not the rule.
- The deadline is the scheme's first investment, not its first close. A fund can hold a first close without a custodian; it cannot invest without one.
- Custodian is not fund administrator. The administrator keeps the books, computes NAV, allocates income and expense accruals and produces investor statements. The custodian holds securities and settles. Custodians usually sell administration too, which is why candidates merge them.
- The custodian cannot be a related party to the sponsor or designated partners unless specific conditions are fulfilled — the segregation is pointless otherwise.
- Segregation is not a guarantee against loss. Deposits of securities or cash with a custodian still carry counterparty risk, and custody does nothing about a portfolio that simply performs badly.
Where this is taught
- Series XIX-E · Chapter 1: Investments Landscapeintroduced here
- Series V-B · Chapter 3: Legal Structure of mutual fundsintroduced here
- Series IX · Chapter 1: Introduction to the Capital Marketintroduced here
- Series XIX-D · Chapter 1: Investments Landscapeintroduced here
- Series III-A · Chapter 22: SEBI (Custodian) Regulations, 1996introduced here
- Series XIX-C · Chapter 1: Investments Landscapeintroduced here
- Series V-D · Chapter 3: Legal Structure of Mutual Funds in Indiaintroduced here
- Series XIX-B · Chapter 4: Category III AIF: Fund Structures and Service Providersintroduced here
- Series II-B · Chapter 9: Structure and Constituents of Mutual Fundsintroduced here
- Series V-A · Chapter 3: Legal Structure of Mutual Funds in Indiaintroduced here
- Series X-A · Chapter 5: Introduction to Indian Financial Marketsintroduced here
- Series XIX-D · Chapter 8: Legal Documents and Negotiations
- Series XIX-C · Chapter 7: Alternative Investment Funds Ecosystem
Related terms
- Net Asset ValueThe net assets of a mutual fund scheme divided by the number of units outstanding — what one unit of the scheme is worth on a given day, after every liability except the unitholders' own.
- DematerialisationConverting securities held as physical certificates into book-entry holdings: the certificates are defaced, mutilated and surrendered to the issuer, and an equivalent quantity is credited to the holder's demat account.
- Beneficial ownerThe investor who owns dematerialised securities for every practical purpose — the depository is the registered owner on the company's books, but the dividends, bonus, rights and votes are the investor's.
- Alternative Investment FundA privately pooled investment vehicle registered with SEBI that raises money from select Indian or foreign investors under a defined investment policy — never from the public at large.
- DepositoryAn institution that holds investors' securities in electronic form and provides the services needed to transact in them — the securities equivalent of a bank holding money rather than cash.
- Depository participantThe SEBI-registered agent through whom an investor reaches a depository — NSDL and CDSL cannot open investor accounts themselves, so every demat account is opened and operated through a DP.
- ISINThe 12-character code (ISO 6166) that identifies one specific security in the depository system — country prefix, nine-character basic number and a check digit, as in INE475C01012.
- Compliance Test ReportThe annual self-certification an AIF manager prepares in SEBI's prescribed format, testing the fund against the AIF Regulations and routed through the sponsor and trustee for comment.
- First CloseThe date an AIF scheme declares it has raised enough commitments to proceed — the point from which tenure, management fees and set-up cost amortisation all start running.
- ADR, GDR and IDRDepository receipts represent shares of a company in one country but trade on an exchange in another — American inside the US, Global outside it, Indian for foreign shares listed here.
- Vault ManagerThe SEBI-registered intermediary that stores and safekeeps gold deposited for trading in Electronic Gold Receipts, and coordinates their creation, transfer and extinguishment with the depository.
- Investment Management AgreementThe agreement between the trustee, acting for the AIF, and the investment manager, by which the trustee delegates its entire investment management power — and by which the manager can later be removed.
- Accredited InvestorAn investor certified by an accreditation agency as meeting SEBI's income or net-worth tests, and therefore allowed into products on relaxed terms — including below the Rs 1 crore AIF floor.
- SettlorThe party who brings an AIF trust into existence — executing the trust deed with the trustee and conveying the initial sum that becomes the trust's first asset.
- Stewardship codeSEBI's mandatory code requiring all AIFs and mutual funds to monitor, engage with and vote in the listed companies they invest in — and to publish the policies by which they do it.