Informist, Wednesday, Nov. 13, 2024

MUMBAI – The Securities and Exchange Board of India has proposed in a consultation paper issued Wednesday that custodians should have a minimum net worth of INR 1 billion, twice the current requirement of INR 500 million, due to the exponential growth in the volume of business provided by them to their institutional investor clients.

The paper on review of custodian regulations and operational circulars pertaining to them also proposed that custodians should bear a similar framework of enhanced obligation and responsibilities as qualified stock brokers. "Custodians, due to the quantum of client assets and amount of clients' funds and securities handled by them, on behalf of foreign investors and domestic investors, etc., have come to occupy a significant position in the Indian securities market," it said.

Under SEBI's framework, stock brokers who are large sized in terms of clients' trading volume and fulfil other specified criteria are subject to monitoring and surveillance by the market regulator and stock exchanges much higher than that on all stock brokers. These brokers are also subject to higher compliance requirements. There are currently 14 qualified stock brokers as per the list issued jointly by the stock exchanges in March this year.

There are 17 custodians registered with SEBI whose services can be availed by institutional clients such as foreign portfolio investors, mutual funds, portfolio managers, alternative investment funds, and non-institutional clients such as family offices and high net worth investors. The value of the securities held by the clients, or assets under custody, of custodians was INR 278.50 trillion as of Sept. 30, up from INR 2.70 trillion in March 2002, data from the SEBI paper showed.

According to SEBI, custodians are critical to its investor protection mandate in the context of securities they safe-keep for the SEBI-registered funds catering to retail investors and other third-parties.

The SEBI paper also proposed that a framework must be prescribed to seek prior approval from the market regulator for any change in control of a custodian, similar to that applicable for other intermediaries. The regulations and circulars on custodians are currently silent on this requirement.

It also proposed that custodians should be compulsorily required to have a policy on business continuity planning and a disaster recovery system. Such a policy will require covering standard operating procedures that are to be followed in the event of a disaster and an escalation hierarchy within the custodian to handle the disaster.

It will also require custodians to be prepared to handle any issue which may arise due to trading halts in stock exchanges. According to the market regulator, trades by custodians to institutional investor clients currently make up for a significant proportion of the cash market turnover. SEBI said in the paper that foreign portfolio investors, who are clients of custodians, contributed 14.8% of NSE's cash market turnover and 13% of BSE's turnover, in 2023-24 (Apr-Mar). "Considering that custodian is a key constituent of the institutional investors ecosystem, any disruption in custodian services may significantly impact the orderly functioning of securities market and severely impact investor confidence."

The market regulator had set up a working group to give recommendations on updating the custodian regulations. But in the consultation paper, while SEBI has laid down the recommendations made by the working group, it has also rejected some of them.

For instance, the working group noted that custodians, particularly those for FPIs and who are mandated to act as designated depository participants for FPIs, currently insist on receiving an executed power of attorney from clients which empowers them to open and operate the accounts, and sign documents and deeds, on behalf of the clients. The working group proposed that the custodian agreement itself should permit the client to provide authority to the custodian to open and operate the accounts, and sign documents and deeds.

"If the authority is provided in the agreement, the POA (power of attorney) is not required to operate the accounts," the working group had told SEBI. But the market regulator dissented to this proposal and said that the custodian agreement already provided flexibility for receipt and release of funds and securities of FPIs by the custodian. SEBI said that the power of attorney "is intended to be a choice at the hands of clients rather than a mandatory document, which may give unfettered rights to custodians to act on behalf of clients."

SEBI has invited comments from investors, market participants, and the public on the consultation paper by Nov. 28. End

Reported by Rajesh Gajra

Edited by Tanima Banerjee

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