The Concept of Dematerialisation of Securities

Origin of Dematerialisation in India

The concept of demat was introduced in Indian capital market in 1996 with the setting up of NSDL. A depository holds securities in dematerialized form. It maintains ownership records of securities in a book entry form and also effects transfer of ownership through book entry. SEBI has introduced some degree of compulsion in trading and settlement of securities in demat form while the investors have a right to hold securities in either physical or demat form, SEBI has mandated compulsory trading and settlement of securities in select securities in dematerialized form. This was initially introduced for institutional investors and was later extended to all investors. Starting with 12 script on15th Jan 1998, all investors are required to mandatory trade in dematerialized form in respect of 2335 securities as at end-June 2001. By Nov, 2001. 3811 companies were under demit mode and the rest of the companies were brought under compulsory demat mode by 2nd Jan. 2002. The securities of companies which fail to establish connectivity with both the depositories on the scheduled date as announced by SEBI are traded on the “trade for trade” settlement window of the exchanges. However in order to mitigate the difficulties of small investors the stock exchanges provide additional windows for sales up to 500 shares in the physical form.

Read: The Depositories Act, 1996

Dematerialisation of Securities

Dematerialization (“Demat” in short form) signifies conversion of a share certificate from its physical form to electronic form for the same number of holding which is credited to your demat account which you open with a Depository Participant (DP)Depository. A Depository (NSDL & CDSL) is an organization like a Central Bank where the securities of a shareholder are held in the electronic form at the request of the shareholder through the medium of a Depository Participant. If an investor wants to utilize the services offered by a Depository, the investor has to open an account with the Depository through a Depository Participant. The Depository can legally transfer beneficial ownership which a custodian cannot. The main objective of a Depository is to minimize the paper work involved with the ownership, trading and transfer of securities.

Read: How To Dematerialize Your Shares

Depository Participant

Similar to the brokers who trade on your behalf in and outside the Stock Exchange; a Depository Participant (DP) is your representative (agent) in the depository system providing the link between the Company and you through the Depository. Your Depository Participant will maintain your securities account balances and intimate to you the status of your holding from time to time. According to SEBI guidelines, Financial Institutions like banks, custodians, stockbrokers etc. can become participants in the depository. A DP is one with whom you need to open an account to deal in electronic form. While the Depository can be compared to a Bank, DP is like a branch of your bank with which you can have an account.

How does the Depository System operate?

The Depository System functions very much like the banking system. A bank holds funds in accounts whereas a Depository holds securities in accounts for its clients. A Bank transfers funds between accounts whereas a Depository transfers securities between accounts. In both systems, the transfer of funds or securities happens without the actual handling of funds or securities. Both the Banks and the Depository are accountable for the safe keeping of funds and securities respectively

Read: Depository System in India

Safety to the investor

  • Securities Exchange Board of India (SEBI) has laid down certain rules and regulations for getting registered as a depository participant. With the recommendation of the Depository and SEBI’s own independent evaluation a DP will be registered under SEBI.
  • The investors account will be credited / debited by the DP only on the basis of valid instruction from the client.
  • The system driven mandatory reconciliation is done between the DP and NSDL.
  • Periodic inspections of both DP and R&T agent are conducted by NSDL.
  • The data interchange between NSDL and its business partners is protected by standard protection measures such as encryption.
  • No direct communication links exist between two business partners and all communications are routed through NSDL.
  • A statement of account is received periodically by the investors. NSDL sends statement of account to a random sample of investors a s a counter check.
  • The investor has the right to approach NSDL if the grievances of the investors are not resolved by the concerned DP.

Advantages of Dematerialisation

  • There is no risk due to loss on account of fire, theft or mutilation.
  • There is no chance of bad delivery at the time of selling shares as there is no signature mismatch.
  • Transaction costs are usually lower than that in the physical segment.
  • The bonus /rights shares allotted to the investor will be immediately credited into his account. Share transactions like sale or purchase and transfer/transmission etc. can be effected in a much simpler and faster way.

Problems of Dematerialisation

Prior to dematerialization there was almost a gap of three months between application date and listing of shares .Dematerialisation has reduced this gap to a great extent. But quick money brings with itself a host of problems. Current regulations prohibit multiple bids or applications by a single person. But the investors open multiple demat accounts and make multiple applications to subscribe to IPO’s in the hope of getting allotment. The recent IPO allotment scam proves that even a highly automated system is not the solution to prevent malpractices, if there is laxity. The scam of Yes bank and IDFC reveal that the investor banker has failed to weed out multiple applications either direct or benami. Not only the investor banker the DP and the depository failed to detect the large number of demat accounts opened names. Lack of coordination between banks, DP’s, broker’s depositories, registrars and investment bankers and clarity of their roles has given rise to such problems.

Remedial measures

  • To prevent the sprouting of fictitious demat accounts at DP’s the allotment of shares should be checked thoroughly.
  • The concerned DP should strictly enforce the Know your client (KYC) norms rather than relying on bank documents and verification of brokers.
  • DP’s should be asked to give monthly figure of accounts opened for the public.
  • Coordination and Clear definition of roles is important to weed out manipulations.

Though dematerialization has several benefits the recent scam has the potential to adversely affect the confidence of retail investors in the capital market .To reap the benefits of dematerialization SEBI, as a regulator has to place a system that is alert and vigilant against unjust gains.