In this Article, Shreya Basu, pursuing Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata discusses on the dematerialization of shares in India.
The Indian stock market started its journey in the late 18th century when East India Company started to transact loan securities. During the 1830s, trading in stocks of bank and cotton presses had started in Bombay [now Mumbai]. When the American Civil War broke out in the year 1861, the stock market started to flourish. As the war ended, the market had at least 250 brokers participating. The brokers constituted ‘The Native Share and Stockbrokers Association’, an informal group, which was later renamed as the ‘Bombay Stock Exchange’ [BSE] in the year 1875. The BSE was established under the guidance and with the assistance of Premchand Roychand, who was one of the leading stockbrokers of that time. In the initial days, the investors and shareholders of the Bombay Stock Exchange traded for their stocks and shares by calling out the prices of the stocks and/or shares to buy or sell such stocks and shares. On completion of such trade, share certificates were exchanged for money. Keeping a track of the stocks and shares involved extensive manual paperwork and converting the transactions into respective agreement became complicated. There used to be a delay in receipt of securities and the restricted infrastructure in the banking and postal segments made it difficult to manage and control the number of applications and the storage of such share certificates. Furthermore, prior to dematerialization, a minimum gap of three months was required between the date of application and listing of shares.
However, with the advancement of technology, the perception of dematerialization of account came into existence in the mid 90’s over the introduction of the Depository Act of 1996.
Dematerialization: Denotation of the Concept
Dematerialization is the process of converting physical shares into electronic format. An investor who wants to dematerialize his shares needs to open a DEMAT account with Depository Participant. Investor surrenders his physical shares and in turn gets electronic shares in his DEMAT account.
Thus, the basic idea of dematerialization is to store stocks, securities and share certificates of the account holder in an electronic form rather than keeping the said stocks, securities and share certificates in physical form.
The National Securities Depository Limited, India’s first and largest depository system, played a pivotal role as its key purpose was to create a platform which would be similar to the standards followed by the international market dealing with dematerialization of accounts. Not only does the National Securities Depository Limited use versatile and innovative technologies to ensure soundness and safety of the Indian capital market, it also creates settlement solutions which increase the efficiency by minimizing risk and reducing costs.
The Central Depository Services (India) Ltd came into existence in the month of February 1999, which was supported by the Bombay Stock Exchange. It was an attempt to create a joint venture with nationalized banks like State Bank of India, Bank of Baroda, Bank of India, Union Bank of India, Standard Chartered Bank as well as Housing Development Finance Corporation. The main objective of the Central Depository Services (India) Ltd. is providing with reliable, suitable and assured depository services to investors affordably.
Presently, almost every Nationalized Banks, as well as private Banks provide the facility to open a Dematerialization Account to every investor. As per the guidelines of the Securities Exchange Board of India, the country’s stock market regulator, every investor must possess a Dematerialization Account.
The Depositories Act, 1996
In the year 1995, the Depositories Ordinance was introduced which was promulgated on January 07, 1996 as the Depositories Act of 1996 [hereinafter “Act”]. The objective of the Act was to provide the guidelines for the formation of the depositories to record the details of ownership in the book-entry form.
The Act not only provided such guidelines but also made major amendments in the following enactments, viz.-
- Companies Act, 1956;
- Securities and Exchange Board of India Act, 1992;
- Indian Stamp Act, 1899;
- Income Tax Act, 1961; and
- Benami Transactions (Prohibition) Act, 1988.
The primary objective of the Act was to establish an easy transfer of securities in a speedy manner, to provide accuracy and security by making it possible to freely transfer the securities of Public Company. However, the transfer of such securities is subject to certain exceptions which include restricting the Company’s right to the power for effective transfer of securities and providing with the deed of transfer and other requirements according to the provisions under the Companies Act.
The Depositories Act, 1996 was formulated and enacted for providing regulation for the depositories and other allied matters connected thereto.
The terminologies that we usually come across while discussing the topic of dematerialization of Shares are categorically defined under the Depositories Act, 1996.
- As per Section 2 (a) of the Act, “Beneficial Owner” means a person whose name is recorded as such with a depository. A Beneficial Owner holds all the benefits of the dematerialized shares.
- As per Section 2 (b) of the Act, “Board” means the Securities and Exchange Board of India established under section 3 of the Securities and Exchange Board of India Act, 1992 (15 of 1992).
- As per Section 2 (e) of the Act, “Depository” means a company formed and registered under the Companies Act, 1956 (1 of 1956) and which has been granted a certificate of registration under sub-section (1A) of section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992).
- As per Section 2 (g) of the Act, “Participant” means a person registered as such under sub-section (1A) of section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992).
Demat Account – Features
A Demat Account must be opened through a Depository Participant of a depository, but cannot be opened directly with a depository.
A Demat Account can be opened in a single name as well as by joint holders. However, there cannot be more than three account holders, out of which one must be the main holder.
A Demat Account can be opened in the name of a minor. However, such account shall be operated by a guardian until the said minor attains majority. Such guardian shall be the father of the minor. In absence of the father, the mother of the minor shall be the guardian. In case of the absence of the father and the mother of the minor, the guardian shall be appointed by the Court. A minor, however, cannot become a joint holder in a Demat Account.
A Demat Account can be opened in the name of a trust registered under the following Acts:-
- Public Trust Act 1860; or
- Societies Registration Act; or
- Any Public Trust Act [of such state where such Dematerialization Account is to be opened].
In case of any private trust or any unregistered trust, the Demat Account shall be opened in the name of the trustees in an individual account. If there are more than three trustees, the trustees shall decide in whose name the Demat Account shall be opened.
A Demat Account cannot be opened in the name of a Hindu Undivided Family [HUF], but the shares can be held in the name of the Karta of the HUF.
An investor can open multiple Demat Accounts in the same name by the same depository participant as well as with different depository participants. In order to create a single account or multiple accounts, the investor must comply with the “Know Your Client” [KYC], which includes submitting the proof of identity, proof of address as specified by the Securities and Exchange Board of India.
Opening a Demat Account – Steps Involved
- In order to open a Demat Account, the investor must approach a Depository Participant, who acts as an agent between the investor and the depository. According to the provisions of Section 3(1) of the Depositories Act, 1996 a depository cannot act as a depository unless it has obtained the certificate of commencement of business from the Board. Further, such certificate granted under sub-section (1) of Section 3 shall be in the form as specified by regulations. However, the Board can grant such certificate of commencement if the depository has sufficient systems and provisions to avoid manipulation of records and transactions. Moreover, before such granting of a certificate, the depository must be given an opportunity of being heard. Such grant of a certificate cannot be refused without explanation. A Depository Participant must be registered with the Central Depository Services Limited and/or the National Securities Depository Limited, which holds such electronic securities and allows the investor to make transactions.
- According to the provisions of Section 5 of the Depositories Act of 1996, a Beneficial Owner shall enter into an agreement with the depository for availing its services. The investor must fill up an Account Opening Form, which is provided by the Depository Participant. Along with such Account Opening Form, documents relating to proof of identity, such as Voter Identity Card, Driving License, Telephone bills or electricity bills must be provided. Similarly, documents relating to proof of address should also be furnished according to the guidelines as specified by the Securities and Exchange Board of India.
- The investor should also produce the original Permanent Account Number (PAN Card) at the time of opening the Demat Account as per the guidelines specified by the Securities and Exchange Board of India.
Advantages of Dematerialization of Shares
Dematerialization reduces the risk of theft and robbery
Dematerialization of Shares minimizes the chance of the investor’s certificate being stolen and forged since the stocks and/or shares are stored in an electronic format, rather than being in a physical format, which was previously practised.
Transfer of stocks and shares made easy
In the earlier days, it was compulsory for the investor to send the stocks and shares had to the Registrar or the concerned Company for getting the stocks and shares transferred to an individual’s name. It took several days to get those stocks and shares transferred, and sometimes such transfer took months also. Further, there was a high risk of such stocks and shares being lost in transit.
No requirement of Stamp Duty on Transfer
A security transaction tax is required to be paid by the investor. However, it is not necessary to buy share transfer stamps and paste them below the certificates as was practised earlier. Previously, in order to purchase such share transfer stamps, one had to visit the stock exchange.
Selling one share is possible
In the earlier days, it was not possible for an individual shareholder to sell an odd number of shares. However, such practice has been abolished now, making it possible for an individual shareholder to sell any number of shares, as the minimum number of share to be sold by an individual shareholder has been reduced to one.
Earlier it was not possible to nominate any individual while opening a Dematerialization Account as it was mandatory to have a joint holder. According to the guidelines specified by the Securities and Exchange Board of India, all nominations should be recorded for a Dematerialization Account which is held by an individual. Where no nomination is to be given, the account holder(s) shall give a written and signed declaration to the effect.
Operating with a single account
It is no more compulsory to open a separate account for buying debt like bonds, Non-Convertible Debentures, Tax-Free bonds etc. However, some debt instruments such as bank accounts and company fixed deposits require separate accounts. That apart, most of the instruments can be operated from a single Dematerialization Account.
Instantly crediting Bonus and Rights Shares
It is now possible to credit bonus and rights shares immediately and one does not have to wait for the certificate for a long period of time as was done earlier.
Benefits of Dematerialization of Shares
To the Company
The introduction of the depository system has helped the concerned companies to a great extent as the expense of printing and distribution has been curtailed. It improves the capability of the Registrars, the Transfer Agents and the Secretarial Departments of the concerned Companies. Communication with the shareholders and investors has become more convenient and the services related to it have also improved.
To the Investors
By introducing the depository system, the risks such as theft, loss, damage, forgery, etc. involved in holding a physical certificate, has been considerably diminished. Not only has the depository system protected the transfer of settlement, but also minimized the delay in the registration of shares. Communication with investors has become swift. Avoiding delivery problems due to signature mismatch has also reduced. The sale of shares has also become prompt and no stamp duty is required to be paid on the transfer of such shares. The depository system is much accepted and provides liquidity of shares.
To the Brokers
Delay in the settlement has been reduced by the introduction of the depository system. As the scope of trading has increased the profit margin has also escalated. The possibility of bad delivery or forgery has been eliminated. The effectiveness of trading, profitability and confidence of the investors has improved.
From the foregoing discussion, thus, it can be concluded that the DEMAT Account has become a necessity for an investor, who want to trade stocks online.
DEMAT accounts eliminate the complications that investors have to face while dealing with securities. It minimizes paperwork. It facilitates faster transactions and makes the trade of securities extremely convenient.
Though the DEMAT Accounts are subject to the charges like Annual Maintenance Charge levied on a fixed basis, DEMAT and REMAT Charges, Debit Transactions based on the value of the transaction, Failed/Rejected Instruction and Pledge Charge/Invocation charges based on the value of securities, nonetheless with everything taking place in the virtual world, dematerialization of shares enables investors to trade in shares in a safe and secure way with no risk of forgery, theft, misuse or destruction and the details of the account can be accessed online anywhere anytime.