Registration Eligibility and Outsourced Risk Monitoring for a Category III Manager
Nexus Advisors LLP has applied to SEBI for registration as a Category III AIF manager. Its net worth is ₹6 crore, comprising ₹4 crore of tangible assets and ₹2 crore of a subordinated loan from a partner. The designated partners have 12 years of portfolio management experience, but the proposed compliance officer is a part-time consultant who also serves two other financial firms. Nexus plans to outsource real-time derivatives risk monitoring to the risk desk of its primary broker, arguing that the broker has better systems. One of Nexus's associates is subject to a pending SEBI show-cause notice for mis-selling in a previous distribution business. The application is otherwise complete, and Nexus expects to launch a ₹150 crore fund within three months. The compliance adviser must advise whether the application can proceed and what conditions should be built into the outsourcing arrangement.
1. Assess Nexus's eligibility for Category III manager registration, including net worth and fit-and-proper issues.
Read the worked answer
Eligibility assessment
- Net worth: A Category III manager must have minimum net worth of ₹10 crore. Nexus has only ₹6 crore. The ₹2 crore partner subordinated loan is not a substitute unless it meets the prescribed net-worth criteria; even if counted, ₹6 crore is short. SEBI registration cannot be granted on this balance sheet. Nexus must infuse at least ₹4 crore of qualifying net worth and maintain it.
- Fit and proper: The pending SEBI show-cause against an associate is a material disclosure. It is not an automatic rejection if isolated and disclosed, but SEBI will assess seriousness, relevance and remedial action. Nexus should submit full details, not let SEBI discover it.
- Experience: The designated partners' 12 years of PMS experience supports the fit-and-proper and competence assessment, but experience alone does not cure the net-worth shortfall.
Conclusion: the application should not be filed as ready until net worth is raised and the show-cause is disclosed. Filing with a known shortfall risks rejection and delay.
2. Can Nexus outsource derivatives risk monitoring to its broker? Set out the conditions that should apply.
Read the worked answer
Outsourcing conditions
Nexus may use a broker's risk systems for data, analytics or monitoring, but it cannot outsource its regulatory responsibility. The manager and its compliance officer remain accountable for leverage, exposure, margining and reporting. Conditions: (i) written agreement with service levels, audit rights and confidentiality; (ii) no delegation of investment decisions or compliance approval; (iii) independent reporting to Nexus, not filtered by the broker's sales desk; (iv) conflict management because the broker executes trades and may have its own inventory; (v) periodic vendor due diligence and business-continuity testing; (vi) disclosure to investors where material. The broker's risk desk can be a tool, not the fund's risk function. If the broker also provides prime brokerage, Nexus must ensure that risk limits are not relaxed to generate execution revenue.
3. Advise on the proposed part-time compliance officer arrangement.
Read the worked answer
Compliance officer
A part-time consultant serving two other financial firms creates capacity and conflict issues. SEBI expects a compliance officer with sufficient time, independence and knowledge of AIF regulations. Nexus should either appoint a dedicated compliance officer or document a robust part-time arrangement with clear hours, no conflicting regulated duties, and direct reporting to the designated partners. The compliance officer must be able to challenge the investment team on leverage and valuation. If the consultant cannot devote adequate time, the application should be deferred.