SEBI's Dual Mandate: Streamlining Custody and Fortifying Pledge Mechanisms for India's Capital Markets



Reinforcing Market Integrity: SEBI's Strategic Overhaul of Custody and Pledge Frameworks

The Securities and Exchange Board of India (SEBI), in its continuous endeavour to bolster market integrity and enhance investor protection, has recently introduced a significant two-pronged regulatory update. These measures, encompassing a new framework for custodians and enhanced compliance for pledge creation and invocation, underscore the regulator's commitment to fostering a robust, transparent, and efficient capital market ecosystem. As a Chartered Accountant navigating India's dynamic financial landscape, these developments warrant close examination for their profound implications across financial institutions, intermediaries, and investors.

Unpacking the Custodian Framework: A Differentiated Approach

Effective March 24, 2026, SEBI has unveiled a revised framework specifically for custodians not sponsored by banks, allowing them to offer financial services beyond the direct purview of the market regulator. This strategic move aims to facilitate diversification while ring-fencing regulated custody operations. Under the new guidelines, such non-bank-backed custodians must conduct these additional services through a separate strategic business unit (SBU).

The key tenets of this differentiated approach include:

  • Operational Segregation: The SBU must maintain distinct books of accounts, operating on an arm's-length basis from the core regulated custody services. This ensures that any risks associated with the non-regulated activities do not spill over into the critical custody function.
  • Net Worth Calculations: Crucially, the custodian's minimum net worth requirements must be met after excluding the financial position of the SBU. This provision safeguards the financial stability of the regulated entity, preventing capital erosion from potentially riskier ventures.
  • Industry Standardisation: The Custodians and DDPs Standards Setting Forum (CDSSF) is tasked with defining the list of financial services permissible under this framework and classifying core and non-core activities in consultation with SEBI. This collaborative approach aims to bring clarity and consistency to the scope of permissible activities.
  • Governance and Compliance: The circular further mandates robust governance structures, including board-level committees for audit and risk management, alongside systems for reporting suspicious transactions.

This nuanced regulatory stance acknowledges the evolving business models within the financial services sector while prioritising the foundational role of custodians in safeguarding investor assets. For financial institutions considering expanding their service offerings, this framework provides a clear roadmap, albeit with stringent compliance and governance prerequisites.

Fortifying Pledge Mechanisms: Enhanced Transparency and Investor Protection

In a parallel and equally critical development, SEBI has introduced enhanced compliance requirements for the creation and invocation of pledges of securities through the depository system. This move, articulated through a circular dated February 5, 2026, and discussed prominently on March 5, 2026, directly addresses concerns around investor rights and operational transparency in secured transactions. The changes aim to bring the process of pledging securities closer in line with the provisions of Sections 176 and 177 of the Indian Contract Act, 1872.

Key revisions include:

  • Pledgee Undertakings: Pledge Request Forms (PRFs) for depositories will now incorporate a provision where the pledgee explicitly undertakes to provide reasonable notice to the pledger(s) before invocation, thereby complying with Sections 176 and 177 of the Contract Act.
  • Mutual Agreement on Adherence: Both the pledger and pledgee must undertake to abide by the Contract Act, the Depositories Act, 1996, SEBI Regulations, circulars, and bye-laws. This reinforces the legal sanctity and enforceability of the pledge agreement.
  • Standardised Forms and Intimations: Depositories are now required to maintain a standardised format for PRFs and send immediate intimation/notification to both parties upon invocation, confirming the recording of the pledgee as the beneficial owner.

These measures are a direct response to potential ambiguities and challenges faced by investors in the past regarding the invocation of pledged securities. By mandating clear communication and legal adherence, SEBI is significantly enhancing investor protection and reducing the scope for arbitrary actions. This is particularly relevant given the increasing participation of retail investors in the market and the complexities sometimes associated with derivatives, as hinted by SEBI chief Tuhin Kanta Pandey's recent comments on monitoring speculative activity in short-dated options.

Implications for the Indian Financial Ecosystem

These regulatory refinements by SEBI collectively signal a mature approach to capital market development. For financial intermediaries, especially custodians and depositories, the immediate impact will be an increased focus on compliance infrastructure and operational adjustments. The segregation of non-regulated activities into SBUs will necessitate careful strategic planning and robust internal controls to manage potential conflicts of interest and maintain regulatory fidelity.

From an investor's perspective, these changes are largely positive, offering greater transparency and protection. The clearer rules around pledged securities provide a stronger legal recourse and ensure fair treatment. Furthermore, by strengthening the foundational elements of market infrastructure, SEBI is paving the way for sustained investor confidence and broader participation in India's capital markets.

In essence, SEBI's recent directives are not merely procedural updates but strategic interventions designed to future-proof India's financial architecture. They aim to balance innovation with prudential oversight, ensuring that as the market expands, its underlying mechanisms remain resilient, fair, and globally competitive.

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