This article is written by Jasmine Talreja who has been working for the past 12 years as an in-house counsel with different companies and is currently working with Cyfirma India Pvt Limited. This article gives us a summary of the Depositories Act.

Introduction 

This article takes you in short through some of the key components of the Depositories Act, 1996. Before we get into the details of the Act, let us in short understand the need for this Act in the first place. India witnessed rapid growth in the capital market in the 21st century. However, the transactions involved paperwork that was tedious as well as voluminous. The existing system was paper-based and had issues like bad deliveries, delays in transfers, settlement periods that were long, etc. These characteristics were the sign of a market that was underdeveloped. Also, this was not on par with international markets and standards. To overcome these challenges, a Depository system was introduced. The aim was to remove the challenges with the state of the art technology. 

What is a depository? 

To explain in simple terms a depository is a place where something is deposited for security purposes. It could be a bank, a company or an institution that holds securities and facilitates the exchange of the securities. The depository is an institution that is allowed to accept monetary deposits from its customers. 

The definition of depositories under the Depositories Act, 1996 is that a “depository” is a company registered under the Companies Act, 1956. It would be granted a certificate of registration under Section 12 subsection (1A) of Securities and Exchange Board of India Act (SEBI), 1992. Hence the Depository becomes an organization like a central bank.  The main role of Depositories is to dematerialize the securities which mean converting the securities from physical form to electronic form and enabling transactions in electronic form. The depository needs to obtain a certificate of commencement of business from SEBI. At present two Depositories are functioning in India: 

1. National Securities Depository Limited (NSDL) 
2. Central Depository Services (India) Limited (CDSL)

How does a depository work?

Let us look at how the depository system works. In the depository system, share certificates belonging to the investors are dematerialized which means shares are converted to electronic form. As per the system the names of the investors are then recorded in the depository as beneficial owners. After this change, the investor’s names in the company register get replaced by the name of the depository as the registered owner of the securities. The depository does not have any voting rights or any other economic rights in respect of the shares as a registered owner. The beneficial owner continues to enjoy all the rights and benefits and is subject to all the liabilities held by a depository. A beneficial owner is a person whose name is recorded with the depository. 

Depository Participant (DP)

The Depository Participant is the link between the owner of the securities and the depositors. He is deemed to be an agent of the depository. Accordingly, he is authorized to offer depository services to investors. As per SEBI regulations and Depository Act, a depository cannot interact directly with beneficial owners. He has to deal with its agents called Depository Participant. Neither can the investors directly approach the depository for any services. They have to interact through the DP.

Services provided by a depository

The following services are provided by a depositor through a DP:

1. Opening a Demat Account

The first step is to open a Demat Account. Demat Account is the short form for Dematerialisation Account. It is the process of holding investments like mutual funds, shares, bonds, government securities, etc. It does away with the hassles of maintenance of physical documents. 

2. Dematerialization

This process is the conversion of physical shares to electronic shares. When a shareholder uses this facility, the Company takes back the physical shares through the depository system and equal numbers of shares are credited into the shareholder’s account. 

3. Rematerialization

This is the exact opposite of Dematerialization. Here physical securities are issued in place of securities in electronic form.  

4. Other services

• Pledging Dematerialized shares

Dematerialized shares can be pledged. After the loan is repaid a request can be made through one’s DP to close the pledge through a standard format. 

• Initial Public Offerings

Public offer credits can be directly received into the Demat account.

• Receipt of cash/non-cash benefits

When rights or bonus or dividend is announced by any corporate event for a particular security, the depository will give the details of all the clients having electronic holdings to the registrar as on that date. The registrar will then calculate the benefits due to all the shareholders. 

• Stock lending and borrowing

Securities in the Demat form can be easily lent/ borrowed. Instructions are to be given to DP through a standard format (which is available with DP). 

• Transmission of securities

In case there is a need for transmission of securities due to death, lunacy, bankruptcy, insolvency, or by any other lawful means, it is possible through the depository system. The claimant will have to fill in a transmission request form supported by valid documents.

• Freezing Account with DP

If at any time one wishes that no transaction should be effected in one’s account, one may advise one’s DP accordingly. DP will freeze the account of the investor until further instructions.

Dematerialization process 

1. Appointing DP 

The investor chooses a DP of his choice and opens an account with him.  The process will be just like opening an account with a bank. The Investor gets an identification number called Client ID. This is just like the bank account number. This no is the reference point for all transactions with DP. Every investor with the help of a DP has to agree with a depository to get his holding dematerialized. This step is necessary whether an investor already has securities or securities are yet to be issued in a fresh issue. 

2. “Demat” Request

The investor makes an application to DP’s in a form called Dematerialisation Request Form is known as DRF.  This form is provided by the DP, the investor hands over his share certificates after cancelling them in writing. The certificates are then surrendered to get dematerialized for Demat. The DP will accept certificates registered only in the investor’s name.

3. Verification and confirmation by Registrar 

The depository electronically intimates the issuer or its Registrar of the dematerialization request. The issuer or the Registrar has to verify the security certificates. He also has to verify that the DRF has been made by the person recorded as a member in its Register of Members. Once the Registrar is satisfied, it dematerializes the scrip and updates its record. The Registrar then authorizes electronic credit for that security in the investor’s favour and informs the depository of the same.

4. Crediting the Client’s Account

The investor’s account is credited by DP with the number of shares dematerialized. After this, the investor holds the securities in electronic form. The investor gets the information in the form of a statement.  However, in case, there is a rejection then such credit is not given.

Role of SEBI regarding Demat system

As per the Securities and Exchange Board of India, (SEBI), certain guidelines need to be followed for opening a Demat account in India. There are guidelines for opening and closing the account. 

Procedural requirements of SEBI to operate Demat accounts

Following documents are required as per SEBI while opening the account. Application form, address proof, pan card, and bank statement. The purpose of obtaining these documents is to ensure the right information about the investor is obtained.  These documents need to be submitted to the DP. There are no stringent rules to be followed while closing the account however there is a procedure that is expected to be followed from SEBI. An application has to be made for closing the Demat account. Information like DP’s ID, the Client ID is required. Also one needs to give a reason for closing the Demat account. The purpose of asking the reason is to get feedback on the DP.  Below are the general recommendations by SEBI for operating Demat accounts in India:

The charges for Demat accounts are predetermined. 

1. Verifying the account holder is mandatory. 
2. Demat account needs to be linked to the PAN card as per KYC rules. 
3. No minimum amount is necessary to maintain the Demat account 
4. The account holder has to pay annual charges as well as a percentage of investors trading as mandatory brokerage charges. 

SEBI keeps updating the guidelines to ensure that it is safer to maintain these transactions in the market. 

Power of SEBI to issue penalties

Below are a few sections that outline the failure and penalties imposed by the Board. 

Key features of the Depository System in India

1. Securities in dematerialized form

The depository model is more or less similar to holding funds in bank accounts. Transfer of ownership of securities is done through simple account transfer. This method is simpler and avoids cumbersome paperwork.

2. Fungibility

Fungibility means an asset can be interchanged with another asset of a similar type. The dematerialized securities are not identified by share certificate numbers. Hence all securities which are in the same class can be interchanged.

3. Registered and beneficial owner

There are two types of ownership of securities. One is a registered owner and the other is a beneficial owner. For all the dematerialized securities, NSDL is the registered owner but ownership rights, duties and liabilities are with beneficial owners.

4. Easy transferability of shares

The transfer takes place freely through the electronic system and dispenses the procedural formalities related to paperwork.

5. No stamp duty

For the transfer of physical shares, then the stamp duty of 0.5% is payable on the market value of the shares. However, there is no such duty on the electronic form. 

6. No risk

Physical certificates have issues like loss in transit, theft, bad deliveries, etc. There is hardly any risk involved in the electronic system as compared to physical certificates.

Legal framework 

SEBI has laid down and regulates the legal framework for a depository system The Act is regulated by:

1. The Depositories Act, 1996
2. The SEBI (Depositories and Participants) Regulations, 1996 
3. Bye-laws of Depository 
4. Business Rules of Depository. 

Depositories are also governed by certain provisions of: 

1. The Companies Act, 2013
2. The Indian Stamp Act, 1899 
3. Securities and Exchange Board of India Act, 1992 
4. Securities Contracts (Regulation) Act, 1956 
5. Benami Transaction (Prohibition) Act, 1988 
6. Income Tax Act, 1961 
7. Bankers’ Books Evidence Act, 1891 

Conclusion 

Let us compare the advantages and disadvantages of Dematerialization. The advantages are paperless trading and transfer of shares through the use of technology, the transfer is immediate, the investor is relieved of problems with physical certificates like bad delivery, fake certificates, elimination of physical forms, similarly elimination of stamp duty, time and cost gets saved in posting certificates, investors are relieved of issues like loss of certificates, etc. However, there are disadvantages too. The key market players like stockbrokers need to be monitored as they have the capability of market manipulation.  Some multiple legal frameworks and acts need to be adhered to. Also at different levels in the process of Dematerialization, various agreements are entered. This makes the process complex. However, the advantages of dematerialization outweigh the disadvantages.  SEBI emphasizes the level of advancement. As rightly said this Act is the need of the hour!

References

• Subject: Financial Services: Chapter Depository and Custodial services prepared by Dr Sukumar Pal; Associate professor in commerce; Shree Chaitanya Mahavidyalaya
• https://www.takshilalearning.com/features-of-the-depository-system-in-india/
• https://www.motilaloswal.com/blog-details/sebi-guidelines-for-a-demat-account-in-india/19920
• http://www.legalserviceindia.com/articles/dematerialized_securities.html

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