When Portfolio Managers Are Exempt from Appointing Custodians

Consider a scenario in a mid-sized wealth management firm where a Portfolio Manager (PM) is finalizing the operational structure for a new discretionary PMS scheme. The operations team is busy vetting the onboarding requirements, specifically the mandatory appointment of a SEBI-registered custodian to hold the clients’ assets. However, a junior associate raises a query regarding whether this mandate applies uniformly to all clients, especially those with very modest portfolio sizes or those opting for a purely cash-based arrangement.

This leads us to the specific regulatory relief provided by SEBI where the requirement to appoint a custodian is not absolute for every entity under every circumstance.

In the Indian regulatory landscape, the general rule remains that a Portfolio Manager must appoint a custodian to ensure asset safety and independent oversight of securities. However, a significant exemption exists for Portfolio Managers who manage portfolios with a corpus of less than ₹10 crore. In such cases, the burden of managing and safeguarding assets rests directly on the Portfolio Manager, provided they comply with specific internal controls that mirror custodial standards.

This exemption is designed to reduce the operational overhead for smaller, boutique PM firms that might find the fee structure of professional custodians prohibitive during their initial growth phase.

From an operational risk perspective, this relaxation requires extreme caution. When a firm acts as both the PM and the custodian for a small portfolio, the risk of asset co-mingling or unauthorized movement increases significantly. The firm must maintain scrupulous records, ensuring that every client’s securities remain in a dematerialized account specifically tagged to their name, and that cash is held in a distinct bank account separate from the firm’s own operating capital.

Any failure in this segregation, even for a portfolio under the ₹10 crore threshold, invites severe regulatory action, as it strikes at the heart of fiduciary responsibility.

If you are working in the back office of such a firm, your role involves validating the ‘corpus’ calculation regularly. If a client’s portfolio appreciation pushes the total assets under management (AUM) beyond the ₹10 crore threshold, the exemption immediately ceases to apply. You must be prepared to trigger the appointment of a custodian without delay. Understanding this threshold is crucial for risk management, as it dictates the legal boundary between a self-custodied operation and one requiring third-party institutional oversight.

Nuance

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This is a companion read for Section 8.4 — PORTFOLIO MANAGEMENT SERVICE from PASS Securities Operations and Risk Management Examination by Akhilesh Gururani, available on Amazon Kindle.

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