Advantages and disadvantages of the Depository System

Advantages of the Depository System

The advantages of dematerialization of securities are as follows:

  • Share certificates, on dematerialization, are cancelled and the same will not be sent back to the investor. The shares, represented by dematerialized share certificates are fungible and, therefore, certificate numbers and distinctive numbers are cancelled and become non-operative.
  • It enables processing of share trading and transfers electronically without involving share certificates and transfer deeds, thus eliminating the paper work involved in scrip-based trading and share transfer system.
  • Transfer of dematerialized securities is immediate and unlike in the case of physical transfer where the change of ownership has to be informed to the company in order to be registered as such, in case of transfer in dematerialized form, beneficial ownership will be transferred as soon as the shares are transferred from one account to another.
  • The investor is also relieved of problems like bad delivery, fake certificates, shares under litigation, signature difference of transferor and the like.
  • There is no need to fill a transfer form for transfer of shares and affix share transfer stamps.
  • There is saving in time and cost on account of elimination of posting of certificates.
  • The threat of loss of certificates or fraudulent interception of certificates in transit that causes anxiety to the investors, are eliminated.

Disadvantages/Problems of the Depository System

Some disadvantages were about the depository system were known beforehand. But since the advantages outweighed the shortcomings of dematerialisation, the depository system was given the go-ahead.

  • Lack of control: Trading in securities may become uncontrolled in case of dematerialized securities.
  • Need for greater supervision: It is incumbent upon the capital market regulator to keep a close watch on the trading in dematerialized securities and see to it that trading does not act as a detriment to investors. The role of key market players in case of dematerialized securities, such as stock brokers, needs to be supervised as they have the capability of manipulating the market.
  • Complexity of the system: Multiple regulatory frameworks have to be confirmed to, including the Depositories Act, Regulations and the various Bye Laws of various depositories. Additionally, agreements are entered at various levels in the process of dematerialization. These may cause anxiety to the investor desirous of simplicity in terms of transactions in dematerialized securities.

Besides the above mentioned disadvantages, some other problems with the system have been discovered subsequently. With new regulations people are finding more and more loopholes in the system. Some examples of the malpractices and fraudulent activities that take place are:

  • Current regulations prohibit multiple bids or applications by a single person. But investors open multiple demat accounts and make multiple applications to subscribe to IPOs in the hope of getting allotment of shares.
  • Some listed companies had obtained duplicate shares after the originals were pledged with banks and then sold the duplicates in the secondary market to make a profit.
  • Promoters of some companies dematerialised shares in excess of the company’s issued capital.
  • Certain investors pledged shares with banks and got the same shares reissued as duplicates.
  • There is an undue delay in the settlement of complaints by investors against depository participants. This is because there is no single body that is in chargeof ensuring full compliance by these companies.

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