Outsourcing is a common practice in many industries, but for portfolio managers, there are strict limits on what can be delegated. This article explains what you can and cannot outsource under SEBI regulations.
The Regulatory Framework
Core Principles
SEBI has released comprehensive guidelines on outsourcing for intermediaries, ensuring high service standards and risk management. The key principles are:
- Maintain a robust outsourcing policy
- Prohibit outsourcing core business and compliance functions
- Conduct self-assessments and report suspicious activities
Recent Enforcement
SEBI has penalised a portfolio manager for outsourcing core investment functions to a technology company under the guise of "technology consulting". SEBI held that the prohibition on outsourcing core functions applies regardless of how such arrangements are contractually described.
What You Cannot Outsource
Core Business Activities
Core business activities that define the portfolio manager's role cannot be outsourced. These include:
- Investment decisions
- Portfolio management
- Client relationship management
- Risk management
Compliance Functions
Compliance functions must remain with the registered intermediary. These include:
- Regulatory compliance monitoring
- Investor grievance redressal
- Reporting to SEBI
- Compliance with SEBI and government regulations
Core Investment Functions
SEBI has reiterated that portfolio managers cannot outsource core investment functions, regardless of how such arrangements are contractually described. In a recent order, SEBI penalised a portfolio manager ₹42 lakh for outsourcing core investment functions.
What You Can Outsource
Administrative Functions
Portfolio managers may outsource administrative functions such as:
- Back-office operations
- Technology infrastructure
- IT support
- HR and payroll
Non-Core Functions
Portfolio managers may outsource non-core functions that do not affect investment decisions or compliance.
The First Global Finance Case
The Violation
SEBI alleged that First Global allowed external entity Algo One and its representative Achin Agarwal to participate in portfolio investment decisions and execution processes in a manner that violated regulations.
The Penalty
SEBI imposed a total penalty of ₹42 lakh on the company, Ms Mehra, and Mr Khanna. SEBI also restrained First Global Finance from onboarding new PMS clients for 21 days.
Key Lesson
The case reinforces that portfolio managers cannot outsource core investment functions, regardless of contractual descriptions.
Compliance Considerations
Outsourcing Policy
Portfolio managers must maintain a robust outsourcing policy that:
- Identifies permissible outsourcing activities
- Sets criteria for selecting third parties
- Establishes monitoring mechanisms
- Addresses risk management
Due Diligence
Before outsourcing, portfolio managers must conduct due diligence on third parties to ensure they meet required standards.
Monitoring
Portfolio managers must continuously monitor outsourced activities to ensure compliance.
Practical Guidance
What to Check Before Outsourcing
- Is it a core function? If yes, cannot outsource
- Is it a compliance function? If yes, cannot outsource
- Does it affect investment decisions? If yes, cannot outsource
- Are there regulatory requirements? Check relevant regulations
What to Include in Outsourcing Agreements
- Scope: Clearly define what is being outsourced
- Compliance: Third party must comply with regulations
- Monitoring: Portfolio manager retains monitoring rights
- Audit: Right to audit third party
- Termination: Clear termination provisions
Expert Legal Guidance
Anuj Desai & Associates provides expert legal advisory services on outsourcing compliance for portfolio managers. Our securities law experts help firms understand what can and cannot be outsourced, develop compliant outsourcing policies, and ensure regulatory compliance. Contact us for guidance on outsourcing and other regulatory matters.