Introduction
Alternative Investment Funds (AIFs) today operate within a highly interconnected ecosystem. Fund administrators, custodians, cloud service providers, IT managed service providers, portfolio management systems, KYC platforms, legal tech tools, and analytics vendors all play a role in day-to-day fund operations. While outsourcing enables lean operating models and efficiency, it also introduces third-party and vendor risk—a risk category that has drawn increasing scrutiny from regulators.
The Securities and Exchange Board of India (SEBI) has made it clear through inspections, supervisory observations, and audit themes that outsourcing does not dilute fiduciary responsibility. When an AIF relies on third parties to process investor data, manage systems, or support critical operations, the fund remains fully accountable for the associated risks. Cyber incidents, data breaches, operational failures, or compliance lapses at a vendor are therefore treated as failures of oversight and governance, not merely vendor issues.
This article explains SEBI’s expectations around third-party and vendor cyber risk management for AIFs in a practical, regulator-aligned manner. It outlines why vendor risk matters, what SEBI looks for during inspections, common gaps observed across funds, and how AIFs can build effective vendor governance without excessive bureaucracy. The emphasis is on accountability, proportionality, and evidence—the core pillars of regulatory confidence.
Why Third-Party Risk Is a Critical Issue for AIFs
AIFs handle highly sensitive information and processes, including:
- Investor personal and financial data
- KYC and AML documentation
- Deal pipelines, valuations, and exit strategies
- Fund accounting, reporting, and compliance filings
When these activities are performed by third parties patch management software, any weakness in the vendor’s controls can directly expose the fund. From SEBI’s perspective, such risks are foreseeable and manageable, and therefore fall squarely within fiduciary responsibility.
In recent years, a significant proportion of cyber incidents and operational disruptions in the financial sector have originated from vendors rather than internal systems. This reality has elevated vendor risk management from a procurement concern to a core governance function.
SEBI’s Regulatory View on Outsourcing and Accountability
SEBI does not prohibit outsourcing. In fact, it recognises that outsourcing is essential for efficiency, especially for lean AIFs. However, SEBI’s position is unambiguous:
- Responsibility cannot be outsourced
- Accountability remains with the AIF
- Oversight must be demonstrable
During inspections, sebi cscrf checklist evaluates not only what has been outsourced, but how the fund governs those relationships. Funds that cannot demonstrate vendor oversight often receive adverse observations, even when vendors themselves are reputable.
Third-Party Risk as a Fiduciary Obligation
Fiduciary duty requires fund managers to act with due care, skill, and diligence in protecting investor interests. When third parties are involved, this duty extends to:
- Selecting appropriate vendors
- Assessing their risk posture
- Monitoring their performance and controls
- Responding to issues and incidents effectively
Failure to do so is increasingly interpreted by SEBI as a lapse in fiduciary oversight, particularly when investor data or fund operations are impacted.
What SEBI Means by “Third Parties” and “Vendors”
SEBI’s inspection lens typically covers a broad range of external entities, including:
- Fund administrators and registrars
- Custodians and depositories
- IT managed service providers
- Cloud and SaaS platform providers
- KYC, AML, and compliance vendors
- External consultants with system or data access
Any entity that processes fund data, supports critical systems, or influences regulatory compliance falls within vendor risk scope.
SEBI’s Practical Expectations for Vendor Risk Management
Although SEBI does not issue a prescriptive checklist, inspection patterns reveal consistent expectations. AIFs are generally expected to demonstrate:
- A structured approach to identifying key vendors
- Risk-based vendor classification (critical vs non-critical)
- Due diligence prior to onboarding
- Defined contractual responsibilities
- Ongoing oversight and review
- Incident escalation and accountability mechanisms
The absence of any of these elements often leads to inspection observations.
Vendor Identification and Risk Classification
The foundation of vendor risk management is knowing who your vendors are and how critical they are. SEBI expects cyber incident response for AIF to:
- Maintain a vendor inventory
- Identify vendors with access to sensitive data or systems
- Classify vendors based on criticality and risk
Treating all vendors equally is neither practical nor expected. Risk-based classification demonstrates judgment and proportionality.
Vendor Due Diligence Expectations
Before onboarding a vendor, AIFs are expected to perform reasonable due diligence. This does not require exhaustive audits but should cover:
- Nature of services provided
- Data and system access involved
- Basic cybersecurity and control posture
- Regulatory and compliance considerations
Due diligence should be documented and proportionate to vendor risk.
Contractual Controls and SLAs
SEBI inspections frequently examine whether vendor contracts clearly define:
- Scope of services
- Security and confidentiality obligations
- Incident notification requirements
- Audit and oversight rights
Contracts that lack clarity on cybersecurity responsibilities are a common inspection gap. From SEBI’s perspective, weak contracts reflect weak governance.
Ongoing Vendor Oversight and Monitoring
Vendor risk management does not end at onboarding. SEBI expects AIFs to demonstrate ongoing oversight, especially for critical vendors.
This may include:
- Periodic performance and risk reviews
- Compliance confirmations
- Review of incident reports or control changes
Oversight does not need to be continuous, but it must be structured and repeatable.
Cybersecurity and Data Protection Expectations
For vendors handling fund or investor data, SEBI expects AIFs to:
- Understand where data is stored and processed
- Ensure access is limited and controlled
- Seek assurance on security controls
Blind trust in vendor assurances without oversight is increasingly viewed as inadequate.
Incident Management and Vendor Breaches
A frequent inspection question is: What happens if a vendor suffers a breach?
SEBI expects AIFs to have:
- Defined incident escalation procedures
- Clear internal accountability
- Awareness of regulatory and investor notification obligations
Vendor incidents must be treated as fund incidents, not external problems.
Documentation and Evidence: The Inspection Differentiator
Even where vendor risk practices exist, many AIFs fail inspections due to lack of evidence. SEBI, auditors, and trustees typically look for:
- Vendor lists and classifications
- Due diligence records
- Contracts and SLAs
- Review notes and communications
Evidence demonstrates that oversight is real, not assumed.
Common Vendor Risk Gaps Observed During SEBI Inspections
Across inspections, recurring gaps include:
- No formal vendor inventory
- No risk-based classification
- Over-reliance on brand reputation
- Contracts without cybersecurity clauses
- No evidence of ongoing oversight
Most of these gaps arise from governance weaknesses rather than intent.
Balancing Vendor Risk Management With Lean Operations
SEBI does not expect AIFs to build large procurement or risk teams. What it expects is discipline and proportionality.
Lean funds can achieve effective vendor risk management by:
- Focusing on critical vendors
- Standardising due diligence templates
- Leveraging managed service providers responsibly
- Maintaining simple but consistent documentation
Simplicity executed well is preferable to complexity executed poorly.
Vendor Risk and Trustee Oversight
Trustees play a critical role in vendor risk governance. SEBI expects trustees to:
- Seek assurance on key outsourcing risks
- Review reports on critical vendors
- Ensure remediation of material gaps
Lack of trustee visibility into vendor risk is often highlighted during inspections.
Integration With Enterprise Risk Management
Vendor risk should not exist in isolation. SEBI increasingly expects:
- Inclusion of vendor risk in risk registers
- Alignment with cybersecurity and operational risk
- Escalation of significant vendor issues
This integration reinforces the fiduciary nature of outsourcing decisions.
Why Vendor Risk Management Is a High-Impact Control
Among all cybersecurity and IT controls, vendor risk management delivers outsized impact because:
- Many breaches originate at vendors
- Funds often lack direct visibility otherwise
- Governance failures are easily identifiable
Strong vendor risk management significantly improves regulatory confidence.
How Infodot Helps AIFs Meet SEBI Vendor Risk Expectations
Infodot Technology helps AIFs design and operate SEBI-aligned third-party and vendor risk management frameworks. Infodot’s approach focuses on governance, practicality, and inspection readiness rather than excessive paperwork.
Infodot supports AIFs by:
- Creating vendor inventories and risk classifications
- Designing due diligence and review frameworks
- Supporting contract and SLA alignment
- Monitoring vendor cybersecurity posture
- Preparing audit- and trustee-ready evidence
This enables AIF leadership to demonstrate effective oversight and fiduciary diligence without operational burden.
Conclusion
Third-party and vendor risk management has become a critical regulatory focus area for AIFs. SEBI’s expectations are clear: while outsourcing is permitted and often necessary, accountability cannot be outsourced. Funds must demonstrate that they understand, govern, and oversee the risks introduced by vendors—especially those handling sensitive data or critical operations.
SEBI does not expect exhaustive audits or complex frameworks. It expects awareness, proportionality, documentation, and evidence of oversight. AIFs that treat vendor risk as a governance discipline rather than an administrative task are far better positioned to pass inspections, maintain investor trust, and operate resiliently in an increasingly outsourced ecosystem.
FAQs
- Does SEBI allow outsourcing for AIFs?
Yes, outsourcing is allowed, but accountability and oversight remain with the AIF. - Is vendor risk management mandatory for AIFs?
Yes, it is treated as part of fiduciary responsibility and governance. - Who is accountable for vendor failures?
The fund manager remains accountable, even if services are outsourced. - Are all vendors considered high risk?
No, vendors should be classified based on criticality and risk. - Does SEBI prescribe vendor risk frameworks?
No, SEBI focuses on outcomes, not specific frameworks. - Is vendor due diligence required?
Yes, reasonable due diligence is expected before onboarding. - Are SaaS providers included as vendors?
Yes, all third parties handling fund data are included. - Do trustees oversee vendor risk?
Yes, trustees are expected to seek assurance on critical vendors. - Is documentation necessary for vendor oversight?
Yes, undocumented oversight is treated as non-existent. - Can vendor brand reputation replace due diligence?
No, reliance on reputation alone is insufficient. - Are contracts reviewed during inspections?
Yes, especially cybersecurity and confidentiality clauses. - Is ongoing vendor monitoring required?
Yes, particularly for critical vendors. - Are vendor breaches treated as fund incidents?
Yes, they fall under the fund’s accountability. - Does SEBI expect vendor audits?
Not always, but assurance and oversight are expected. - Can vendor risk be managed by MSPs?
Execution can be supported, but oversight must remain internal. - Is vendor risk part of risk registers?
Yes, significant vendor risks should be documented. - Are data processors higher risk vendors?
Yes, vendors handling sensitive data require stronger oversight. - Does SEBI expect incident notification from vendors?
Yes, contracts should mandate timely notification. - Are small AIFs exempt from vendor risk controls?
No, expectations apply proportionately. - Is vendor exit management important?
Yes, data access and retention must be controlled on exit. - Are consultants considered vendors?
Yes, if they access systems or sensitive data. - Does vendor risk affect fundraising?
Yes, LPs increasingly assess outsourcing risks. - Is vendor risk management expensive?
No, structured governance reduces cost and effort. - Can informal vendor oversight pass inspections?
Rarely, structure and evidence are required. - Are cloud providers fully responsible for security?
No, responsibility is shared and must be governed. - Is vendor risk reviewed during audits?
Yes, it is a common audit focus area. - Can vendor issues trigger SEBI scrutiny?
Yes, especially if oversight is weak. - Are vendor access rights reviewed?
They should be reviewed periodically. - Is data localisation a vendor risk factor?
Yes, depending on regulatory context. - Does Infodot help with vendor risk governance?
Yes, Infodot provides structured vendor risk management support. - Are SLAs important for compliance?
Yes, they clarify accountability and expectations. - Is vendor risk management ongoing?
Yes, it is not a one-time activity. - Do auditors ask for vendor lists?
Yes, vendor inventories are commonly reviewed. - Can vendor risk be reduced significantly?
Yes, through classification, oversight, and evidence. - Why should AIFs prioritise vendor risk now?
Because outsourcing risks and regulatory scrutiny continue to increase.
