How to Select an AIF Custodian — A Practical Evaluation Checklist

Choosing a custodian is one of the least glamorous decisions in setting up an AIF — and one of the ones most likely to cause quiet operational pain for years if it's rushed.

Why This Decision Deserves More Attention Than It Usually Gets

A custodian holds a fund's securities and settles its transactions, and for certain AIF categories and thresholds, SEBI's framework mandates custodian appointment rather than leaving it to Manager discretion. Because the relationship is meant to run for the fund's entire life and touches every transaction the fund executes, a poor custodian choice creates recurring friction — settlement delays, reconciliation headaches, reporting gaps — that compounds quietly across years rather than showing up as a single dramatic failure.

Regulatory Registration and Track Record — The Non-Negotiable Baseline

Start with the basics that shouldn't need debating: the custodian must be registered under the SEBI (Custodian) Regulations, 1996, in good standing with no material regulatory action pending. Beyond bare eligibility, check specifically for a track record servicing AIFs of comparable strategy and scale — a custodian with deep experience in listed-equity custody for mutual funds may have genuinely different operational muscle memory than one accustomed to the private-market instruments, unlisted securities, and structured-credit paper common in Category II and III AIF portfolios.

Operational Fit With the Fund's Actual Asset Mix

The evaluation should be built around what the fund actually holds, not a generic custody checklist. A Category III fund trading listed derivatives has different settlement-speed and margin-reconciliation needs than a Category II private credit fund holding unlisted debentures and security interests that rarely trade at all. Ask specifically how the custodian's systems and staff experience map to the fund's planned asset mix — including whether they can properly custody and value the more exotic instrument types the strategy may use (CCDs, CCPS, structured notes) rather than only conventional listed securities.

Technology and Reporting Integration

A custodian's reporting cadence and format need to integrate cleanly with the fund's own NAV computation and investor reporting cycle, not create a reconciliation project every quarter. Evaluate specifically: how quickly the custodian can produce holding statements after a transaction settles, whether their reporting format is compatible with the fund administrator's systems (avoiding manual data re-entry that introduces error risk), and whether they offer investor-facing portal access if the fund's structure calls for it.

Fee Structure — Beyond the Headline Rate

Custody fees are typically quoted as a basis-point rate on assets under custody, but the headline rate rarely captures the full cost picture. Ask specifically about transaction-based charges (settlement fees per trade), fees for handling non-standard instrument types, minimum fee floors that can make a smaller fund's effective rate much higher than the quoted basis-point number suggests, and charges for ad hoc reporting requests outside the standard reporting package.

Business Continuity and Operational Resilience

Given that custody failures — however rare — can be genuinely disruptive to a fund's operations and investor confidence, ask directly about the custodian's business continuity planning, data backup and recovery protocols, and whether they can provide evidence of periodic testing of these systems rather than a policy document that's never actually been exercised.

References From Comparable Existing Clients

The single most useful diligence step many Managers skip: speaking directly with existing clients of comparable size and strategy about their actual day-to-day experience — not the sales team's pitch, but the operations team's honest account of responsiveness, error rates, and how the custodian has handled genuine operational problems when they've arisen.

Getting This Decision Right at Fund Formation

Custodian selection is a decision made once at fund formation but lived with for the fund's entire life — worth the time to evaluate properly rather than defaulting to whoever a Manager's peer network happens to recommend. We help fund managers run this evaluation systematically as part of fund setup, matched specifically to the strategy's actual operational needs.

This article is for general informational purposes and does not constitute a recommendation of any specific custodian.

CA Anuj Desai