Mutual funds are slowly becoming the go-to investment choice to get access to a diverse range of asset classes.
However, there is a financial institution working behind the scenes to keep the invested securities safe, known as a custodian in mutual funds.
In this article, we’ll understand custodian meaning in mutual funds and learn about their duties and responsibilities.
What is a Custodian in Mutual Funds?
A custodian is a financial institution that safeguards securities held by a mutual fund house. Trusts, banks, and other financial institutions can be a mutual fund’s custodian and they’re not limited to protecting a particular asset.
They can safeguard stocks, gold, silver, real estate documents, or others. You must be wondering why custodians exist in the first place.
The reason is simple – to prevent fraud and malpractices. Custodians are typically neutral parties put in place to protect investor interests.
However, they’re not mere caretakers. Mutual fund custodians can also extend other financial services compliance and admin support to the fund.
How a Custodian in Mutual Fund Works
Think of a custodian as the safe keeper of a box with valuables. You’ve invested in the valuables, the box is owned by the AMC, but the keys are with the custodian.
The following points will show you how a mutual fund custodian works in the real world.
- You invest money in mutual fund schemes offered by an Asset Management Company (AMC)
- The AMC invests your money in multiple securities
- These securities are kept with different custodians like HDFC Bank Limited, SBI-SG Global Securities Services Private Limited, and Orbis Financial Corporation Limited
Custodians are fully trusted by the fund houses because these custodians are registered with SEBI and work accordingly.
SEBI regulations for Mutual Fund Custodians
- Appointment of Custodian: Mutual funds must appoint a custodian who is registered with SEBI to safeguard their securities.
- Asset Valuation: Based on SEBI’s guidelines for ensuring transparency and fair pricing.
- Segregation of Duties: There is a clear segregation of duties between the custodian and other entities involved in the mutual fund operations to avoid conflicts of interest.
- Risk Management: Custodians are required by regulation to implement risk management practices to protect mutual fund assets.
- Compliance and Reporting: Custodians must comply with SEBI regulations and regularly report to SEBI on various aspects of their operations.
Mutual Fund Custodian’s Responsibilities and Duties
The responsibilities and duties of a custodian are laid out by SEBI wherein a custodian has to enter into a proper legal agreement with the AMC in which all the terms and conditions have to be mentioned beforehand.
Following is the list of duties and responsibilities that are undertaken by custodians:
1. Holds the Securities in Custody
Custodians have to keep the securities of a fund house in their custody and have to collect and pay them any dividend, interest income, bonus issue, or any capital gains received on these securities. They have to open a separate custody account for each mutual fund house.
2. Documentation of Securities
Custodians have to maintain proper documents of securities as per fund house expectations and SEBI regulations. They have to keep the copy of documents so that they can be accessed if the original one gets lost or destroyed.
3. Making Payments
Custodians have to pay on behalf of a mutual fund house whenever they invest in any security. But, they can not recommend any security to the fund house.
4. Conducting Due Diligence
They have to conduct thorough due diligence on the securities held by them for which the report is submitted to the board having full discrepancy.
Who Appoints a Custodian in a Mutual Fund?
Custodians are SEBI-registered entities that operate under the strict rules put forth by the regulatory body.
The list of SEBI registered custodians includes the likes of Axis Bank, BNP Paribas, Citi Bank, and others.
As mutual funds are offered by AMCs, they appoint a Board of Directors that is responsible for safeguarding the interests of the AMC, investors, and stakeholders. The same Board of Directors appoints the mutual fund custodian.
Importance of Custodians for Investors
Custodians are very important to protect the investors who are putting their savings in a mutual fund.
They have their in-house compliance officer which addresses issues relating to a mutual fund scheme.
Custodians reduce the risk of holding securities or the investor’s records held by a fund house because they will keep them in their safe online lockers.
Though they are not managing your money directly, they indirectly keep track of the securities in which money is being invested.
Custodian’s Role in Settlement and Clearing
There is a role of custodian in mutual fund scheme’s settlement and clearing process as well.
The custodians have to be in touch with the clearing houses and have to oversee the securities that are being added/discarded by the fund house.
Whenever the fund house is purchasing any security, custodians have to transfer the amount.
Also, while selling, custodians collect all the gains and transfer them to the fund house.
Regulations Governing Custodians in Mutual Funds
Custodians have to abide by the rules mentioned in the Securities and Exchange Board of India (Custodian of Securities) Regulations, 1996.
They have to be inspected once a year and the report for the same has to be submitted to the SEBI Board.
Custodians are supposed to inform the Board about where they are keeping the records of securities.
Custodians also have to appoint a compliance officer that monitors their activities.
If in any case, any of the rules are not followed, he informs the Board about it. The Board can conduct an audit by themselves in which they can check all the books of accounts of the custodian.
Future of Mutual Fund Custodians
The future of custodians in the mutual fund industry is pivotal because every fund house has to appoint them.
The fund house also hires two or three custodians to manage their different schemes.
According to Association of Mutual Funds in India (AMFI), the total Assets Under Management (AUM) held by all the Indian mutual fund houses has multiplied by two times between 2018 and 2023.
It means that there is a sharp rise in securities held by fund houses, and thus the demand for custodians will also increase.
A custodian in mutual fund is like a bank locker that keeps all the securities held by a fund house safely with them and maintains their records.
Custodians make the payment for purchasing the security and collect the gains on behalf of a fund house.
They are fully regulated by the SEBI and therefore investor interest is also protected.
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