Financial Market: Operations and Services

UNIT 9 DEPOSITORIES
Objectives
After going through this unit, you will be able to:
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explain the concept of depositories; discuss the importance of depository; elucidate the functioning of depositories; and describe the mechanism of dematerialisation appreciate involvement of technology in depository.

Structure
9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 9.10 9.11 9.12 9.13 Introduction Depository System Functioning of a Depository Switching over to Depository Is Depository System Beneficial? Selling and Buying of Dematerialised Share Depository System in India Technology and Depository Legal Set up for Depositories in India Summary Key Words Self Assessment Questions Further Readings

9.1

INTRODUCTION

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A significant development of the 20th century particularly in its later part is expansion of financial market world over which mostly was driven by globalization, technology, innovations and increasing trade volume. India has not been an exception with probably largest number of listed companies with a very large investor population and ever increasing volumes of trades. However, this continuous growth in activities increased problems associated with stock trading. Most of these problems arose due to the intrinsic nature of paper based trading and settlement, like theft or loss of share certificates. This system required handling of huge volumes of paper leading to increased costs and inefficiencies. The process beginning from buying shares through the stock exchanges till getting the certificates duly endorsed in the buyers name was indeed quite complex and time-consuming and was riddled with a variety of problems. Growing number of investors participating in the capital market has increased the possibility of being hit by a bad delivery, The cost and time spent by the brokers for rectification of these bad deliveries tends to be higher with the geographical spread of the clients. The increase in trade volumes lead to exponential rise in the back office operations thus limiting the growth potential of the broking members. The inconvenience faced by investors (in areas that are far flung and away from the main metros) in settlement of trade also limits the opportunity for such investors, especially in participating in auction trading. The physical form of holding
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and trading in securities also acted as a bottleneck for broking community in capital market operations. Risk exposure of the investor also increased due to this trading in paper. Some of these associated risks were: delay in transfer of shares, possibility of forgery on various documents leading to bad deliveries, legal disputes etc., possibility of theft of share certificates, prevalence of fake certificates in the market, mutilation or loss of share certificates in transit. Thus, the system of security transactions was not as investor-friendly as it ought to be. In this scenario dematerialized trading under depository system is certainly a welcome move. This popular financial service emerged in Germany first time.

Depositories

9.2

DEPOSITORY SYSTEM

Depository system essentially aims at eliminating the voluminous and cumbersome paper work involved in the scrip-based system and offers scope for paperless trading through state-of-the-art technology. It is an institution which maintains an electronic record of ownership or securities. The storage and handling of certificates is hence immediately eliminated which generates a reduction in costs like back office cost for handling, transporting and storing certificates. Depositary participant is an institution akin to bank for securities. When an investor hands over securities to a depository participant, investors account is credited. The investors depository system account will show their holdings. His account is updated for his transactions of sale and purchase but without physical movement of scrips or transfer deeds. In depository system, share certificates belonging to the investors are dematerialised (demats). Dematerialisation or Demat is a process whereby investors securities like shares, debentures etc, are converted into electronic data and stored in computers by a Depository. Securities registered in investors name are surrendered to depository participant (DP) and these are sent to the respective companies who will cancel them after Dematerialization and credit investors depository account with the DP. The securities on Dematerialization appear as balances in ones depository account. These balances are transferable like physical shares. If at a later date, investors wish to have these demat securities converted back into paper certificates, the Depository does this and their names are entered in the records of depository as beneficial owners. The beneficial ownership will be with investor but legal ownership will be with the depository. Consequently, benefits like interest, dividend, rights: bonus and voting rights will be with investors. Since depository is to get securities transferred in its name, the depository name will be registered in the ownership register maintained by the company. Thus, instead of name of several owners, the name of depository figures in the register of company. Since transfer will be affected only in depository, register of company need not be updated on every transactions of sale or purchase of companys share. It alleviates the hardships currently faced by the investors and it also offers option for converting the shares from electronic to physical or paper form through a process of rematerialisation (remat). Depository system is, indeed, time tested and long prevalent in many advance countries and has been playing a significant role in stock markets around the world. Constituents of Depository System The depository system comprises of: i) ii) iii) iv) Depository Depository Participants (DPs) Companies/Registrars Investors
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Out of these first two need discussion since last two components are general.

Financial Market: Operations and Services

i) Depository Depository functions like a securities bank, where the dematerialized physical securities are traded and held in custody. This facilitates faster risk free and low cost settlement. Depository is much like a bank and performs many activities that are similar to a bank depository: a) b) c) d) enables surrender and withdrawal of securities to and from the depository through the process of demat and remat, maintains investors holdings in electronic form, effects settlement of securities traded in depository mode on the stock exchanges, carries out settlement of trades not done on the stock exchanges (off market trades).

In India a depository has to be promoted as a corporate body under Companies Act, 1956. It is also to be Registered as a depository with SEBI. It starts operations after obtaining a certificate of commencement of business from SEBI. It has to develop automatic data processing systems to protect against unauthorised access. A network to link up with depository participants, issuers and issuers agent has to be created. Depository, operating in India, shall have a net worth of rupees one hundred crore and instruments for which depository mode is open need not be a security as defined in the Securities Contract (Regulations) Act 1956. The depository, holding securities, shall maintain ownership records in the name of each participant. Despite the fact that legal ownership is with depository, it does not have any voting right against the securities held by it. Rights are intact with investors. There are two depositories in India at present i.e. NSDL and CDSL. ii) Depository Participants (DP) A DP is investors representative in the depository system and as per the SEBI guidelines, financial institutions/banks/custodians/stock brokers etc. can become DPs provided they meet the necessary requirements prescribed by SEBI. DP is also an agent of depository which functions as a link between the depository and the beneficial owner of the securities. DP has to get itself registered as such under the SEBI Act. The relationship between the depository and the DP will be of a principal and agent and their relation will be governed by the bye-laws of the depository and the agreement between them. Application for registration as DP is to be submitted to a depository with which it wants to be associated. The registration granted is valid for five years and can be renewed. As depository holding the securities shall maintain ownership records in the name of each DP, DP in return as an agent of depository, shall maintain ownership records of every beneficial owner (investor) in book entry form. A DP is the first point of contact with the investor and serves as a link between the investor and the company through depository in dematerialisation of shares and other electronic transactions. A company is not allowed to entertain a demat request from investors directly and investors have to necessarily initiate the process through a DP. Activity 1 a) List four major reasons for emergence of depositories: ...................................................................................................................... ......................................................................................................................
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...................................................................................................................... ...................................................................................................................... b) What is depository service? (answer in five lines). ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... c) List five DPs operating in India or your locality. ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... ......................................................................................................................

Depositories

9.3

FUNCTIONING OF A DEPOSITORY

As mentioned earlier that, depository system operates through depository account. Let us see what it is. Depository Account An investor desiring to demat his holdings has to open a depository account where in all details of investors transactions is recorded. Opening such account is as simple as opening a bank account. Investor can open a depository account with any DP convenient to him. There is no restriction on the number of depository accounts a person can open. However, if existing physical shares are in joint names, one has to open a joint account submitting share certificates for demat. A sole holder of the share certificates cannot add more names as joint holders at the time of dematerialising his share certificates. A client can choose to open more than one account with the same DP. In addition to this, he has a choice of opening accounts with more than one DP. However a broker can open just one Clearing Member (CM) account per card/stock exchange for clearing purpose, but he can still open multiple beneficiary accounts. Beneficiary is the personal account wherein brokers can keep their personal holdings. A clearing member cannot hold his personal holdings in his clearing member account. A broker may deal in the depository system as a clearing member only through a special account, known as the Clearing Member account. This account can be used only for clearing purposes and not for holding his own securities in it. As this is a transitory account, the securities held in this account are not eligible for corporate actions. Therefore. the broker will have to open a separate beneficiary owner account to hold his investments. There is no compulsion for the client to open his account with the same DP as that of his broker. Even if he has an account with another DP, he can carry out normal business with his broker. There is no loss in operational efficiency. But it is possible that opening account with his brokers DP may work out to his advantage, as some
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Financial Market: Operations and Services

DPs may offer special charge structure if the broker and his clients are dealing through him. To open an account one has to:
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Fill up the account opening form, which is available with the DP. Sign the DP-client agreement, which defines the rights and duties of the DP and the person wishing to open the account. Receive client account number (client ID).

This client ID along with his DP ID gives investor a unique identification in the depository system. In depository account, transactions are through demat and remat. Let us discuss these two along with other two relevant concepts. i) Dematerialisation (Demat) Demat is a process by which investors share certificates are taken back by company through DP, verified and if found in order, demat is confirmed by the company and then an equivalent number of shares are credited by the DP to investors account as electronic holding. Chart 9.1 explains demat in clear terms. The entire process of dematerialisation, as required by SEBI, has to be completed within a period of 15 days. Dematerialisation is also known as immobilisation of securities. Dematerialisation can be done only on the request made by the investor through participant in a Dematerialisation Request Form (DRF). Thus, Dematerialisation is a process where by physical existence of security certificates is made extinct and converted into electronic holdings.
Chart 9.1 : Switching from Scrip-based System to Depository System (Dematerialization Process)
s

2 6 DEPOSITORY PARTICIPANT
s
s

NSDL
s s

4
s

5
s

3
s

REGISTRAR

INVESTOR

1) 2) 3) 4) 5) 6) 7)

Investor surrenders certificates for dematerialization to DP. DP intimates depository of the request through the system. DP submits the certificates to the registrar. Registrar confirms the dematerialization request from depository. After dematerializing, registrar updates accounts and informs depository of - the completion of dematerialization. Depository updates its accounts and informs the DP. DP updates its accounts and informs investor.

ii) Rematerialisation (Remat) Rematerialisation is a process (Chart 9.2) of converting electronic holdings of investor back into share certificates in paper form. The process of rematerialisation is also carried out through DP and the process has to be completed within a period of 30 days. Thus, once security is dematerialised it is not necessary that investor is to continue in depository mode for all times to come. He can switch over to remat whereby he gets back physical possession of security scrips. The client of DP has to submit a request for remat. This request is forwarded for necessary action to depository. The depository confirms the rematerialisation request to the Registrar and
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Transfer Agents. The Registrar updates the accounts and print the desired certificate. The depository is informed by Registrar and certificate is sent to the investor. The depository updates its records and communicates to DP to incorporate necessary changes in the account of the client.
Chart 9.2 : Switching from Depository System to Scrip-based System (Rematerialisation Process)
s

Depositories

2 4 DEPOSITORY PARTICIPANT 1 5
s s

NSDL 3 REGISTRAR
s

INVESTOR

1) 2) 3) 4) 5)

Beneficial owner requests for rematerialisation. DP intimates of the Depository request through the system. Depository confirm Rematerialisation request to the registrar. Registrar updates accounts and prints certificates. Depository updates accounts and downloads details to DP. Registrar dispatches certificates to investor.

iii) Fungibility In the depository system, since the physical form of security loses its relevance, the securities are to be fungible. Prior to amendment in 1996, the Companies Act 1956 required every specific physical scrip of security as shares or debentures to have distinctive number for each security when issued or transferred. Securities have been made fungible by deleting section 83 of the Companies Act, 1956. Now the certificates will not carry a distinct number and will form a part of a fungible mass. Dematerialized shares do not have any distinctive or certificate numbers. These shares are fungible - which means that 100 shares of a security are the same as any other 100 shares of that security. All the certificate of the same security will become interchangeable in the sense that the owner of the security will lose the right to obtain the exact certificate. The situation of certificate is now that of currency note and the number of currency note has no association with ownership of currency note. Each security held in dematerialized form is given an identity and it is in form of a distinctive ISIN (International Securities Identification Number). ISIN is a 12 character long identification mark. iv) Delivery vs. Payment It is just not sufficient to have a depository for securities. The concept of Delivery versus Payment (DVP) also needs to be looked into. DVP involves exchange of securities for funds to take place simultaneously between the parties to a trade. While the depository system would be able to handle the accounting of securities by book entry, the funds part would have to be handled by the banking system. Therefore the two systems have to be integrated in order to have DVP. It is too simplistic to think that DVP would be possible without having an efficient electronic funds transfer systems because in India, the payment systems are still not upgraded. A quantum jump is required in the level and mode of interaction among the various banking institutions.

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Financial Market: Operations and Services

9.4

SWITCHING OVER TO DEPOSITORY

After discussing in brief the system, ingredients and participants of depository system we will discuss the stages involved in the process of switching over to depository system from scrip based system. i) Appointing DP Any investor who intends to transact through depository system has to engage one depository participant (DP). He can approach a DP of his choice and open an account with him just like one opens an account with a bank. Investor gets an identification number called Client ID ( just as one gets ones bank account number) which serves as a reference point for all his transactions with D.P. Every investor before getting his holding dematerialised has to enter into an agreement with the depository through a participant. This step is necessary whether investor already has securities or securities are yet to be issued in a fresh issue. The investor contracts only with that depository which accepts his securities in depository mode since it is not necessary that all eligible securities must be in depository mode and with all the depositories. The decision on whether or not to hold securities within the depository mode and if in depository mode, with which depository or participants, would be entirely with the investor. ii) Request for Demat After any agreement is entered for getting securities dematerialised and his account is opened, the investor makes an application to depository participants in form called Dematerialisation Request Form (DRF) to be provided by the DP and hands over his share certificates duly cancelled by writing surrendered for dematerialisation to them for demat. The DP will accept certificates registered only in investors name. The request for dematerialisation with the depository participants is sent to the depository through depository network with which DP is connected. Simultaneously DP submits the securities certificates to the issuer company or its Registrar of transfer. iii) Approach the Company or Registrar of Transfer The depository will electronically intimate the issuer or its Registrar and transfer agent of the dematerialisation request. The issuer or the Registrar and transfer agent has to verify the validity of the security certificates as well as the fact that the DRF has been made by the person recorded as a member in its Register of Members. If the issuer or its Registrar is satisfied, it dematerialises the scrip and updates its record. iv) Confirmation of Demat The Registrar to transfer or the concerned company when satisfied with the case of demat has to inform the depository of the completion of dematerialisation authorising an electronic credit for that security in favour of the investor. v) Crediting the Clients Account DP credits investors account with the number of shares so dematerialised and thereafter investor hold the securities in electronic form. If there is rejection of demat request then such credit is not given. After crediting the account, the client is send the necessary information in form of a statement like we get bank statement after bank transactions.
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Option of Rematerialisation Investor also has the option of converting his electronic holding into share certificates by requesting DP for a remat in a Rematerialisation Request Form (RRF) and through a similar process, company will issue new certificates to investor for the shares so rematerialised. Activity 2 a) Can you identify similarities between depository account and bank account? ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... b) What is dematerialisation? ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... c) What do you understand by Fungibility of securities? ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... d) Briefly explain DRF, Client 10, RRF. ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... e) Collect formats from any DP for the following and study their contents: i) ii) iii) Opening depository account DRF RRF

Depositories

9.5

IS DEPOSITORY SYSTEM BENEFICIAL?

The emergence of depository system is a sign of prosperity of financial market system specially capital market. Depository makes the market more systematic and disciplined. On many fronts depository system is appreciated. Depositories pass on the benefits and rights to the transferee quickly since the whole system is efficient and automated. Time lost in communication too is very low. Fraudulent encashment of dividend warrants and loss of bonus or rights can be avoided. Since depository is to have a scrip-less capital market, exchange of physical scrips is not desired. Thus, the risk of loss, mutilation: theft and forgery of security certificates is nil. Financial loss owing to loss of physical scrip will no longer haunt the investors. A depository system provides benefits to all the constituents of the capital markets viz. the country, investors, intermediaries and the issuers. Official expectations from dematerialisation of securities was expressed by SEBI in following words in its Annual Report 1996-97.

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Financial Market: Operations and Services

It is expected that as the network of depository participants and the proportion of securities dematerialized in the depository increases, the benefits of reduced risk and lower transaction costs will extend to the vast majority of the market participation and lead to improved investor protection and services. Benefits of Demat Transacting the depository way has several advantages over the traditional system of transacting using share certificates. Some of the benefits are:
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Trading in demat segment completely eliminates the risk of bad deliveries, which in turn eliminates all cost and wastage of time associated with follow up for rectification. This reduction in risk associated with bad delivery has lead to reduction in brokerage to the extent of 0.5% by quite a few brokerage firms. In case of transfer of electronic shares, one saves 0.5% in stamp duty. Cost of courier/notarization/the need for further follow-up with broker for shares returned for company objection is also saved. In case the certificates are lost in transit or when the share certificates become mutilated or misplaced, to obtain duplicate certificates, one may have to spend at least Rs.500 for indemnity bond, newspaper advertisement etc, which can be completely eliminated in the demat form. One can also receive bonuses and rights into depository account as a direct credit, thus eliminating risk of loss in transit. One can also expect a lower interest charge for loans taken against demat shares as compared to the interest for loan against physical shares. This could result in a saving of about 0.25% to 1.5%. Some banks have already announced this. RBI has increased the limit of loans against dematerialized securities as collateral to Rs.2 mn per borrower as against Rs.1 mn per borrower in case of loans against physical securities. RBI has also reduced the minimum margin to 25% for loans against dematerialized securities as against 50% for loans against physical securities. .

The perceptions about safe keeping, risk taking, liquidity and credibility of the market has undergone a sea change with the full scale operation of depository system and electronic funds payment coupled with the automated trading systems.

9.6

SELLING AND BUYING OF DEMATERIALISED SHARES

Trading in dematerialized securities is quite similar to trading in physical securities. The major difference is that at the time of settlement, instead of delivery receipt of securities in the physical form, it is done through account transfer. An investor cannot trade in dematerialized securities through his DP. Trading at the stock exchanges can be done only through a registered trading member (broker) of the stock exchange irrespective of whether the securities are held in physical or dematerialized form. Any investor who buys securities from any of the stock exchanges where dematerialized securities are available, may receive his delivery in the dematerialized form as dematerialized shares can be delivered in the physical segment at the option of the seller. When investor wants to purchase shares in electronic form, he has to instruct his broker to purchase the dematerialized shares from the stock exchanges. Once the order is executed, he has to instruct his DP (vide a simple format which is available with the DP) to receive securities from his brokers clearing account.
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Selling dematerialized shares in stock exchanges is similar to the procedure for selling physical shares. Under depository system instead of delivering physical shares to the broker, one instructs ones DP to debit his account with the number of shares sold and credit his brokers clearing account. For this, a delivery instruction has to be given to DP in a standardized format, which will be available with DP. Other Services a) Pledging Dematerialized Shares: Dematerialized shares could be pledged; in fact, this is more advantageous as compared to pledging share certificates. After loan is repaid one can request for a closure of pledge by instructing ones DP through a standard format. The pledgee on receiving the repayment as well as the request for closure of pledge will instruct his DP accordingly. Even the locked-in securities can be pledged. The pledgor continues to remain the beneficiary holder of those securities even after the securities are pledged. Initial Public Offerings: Credits for public offers can be directly received into demat account. In the public issue application form of depository eligible companies, there will be a provision to indicate the manner in which securities should be allotted to the applicant. One is to mention ones client account number and the name and identification number of DP. All allotment due to investor will be credited into required account. Receipt of Cash/non-cash Benefits: When any corporate event such as rights or bonus or dividend is announced for a particular security, depository will give the details of all the clients having electronic holdings in that security as of the record date to the registrar. The registrar will then calculate the corporate benefits due to all the shareholders. The disbursement of cash benefits such as dividend/ interest will be done directly by the registrar. In case of non-cash benefits, depository will directly credit the securities entitlements in the depository accounts of all those clients who have opted for electronic allotment based on the information provided by the registrar. Stock Lending and Borrowing: Through the depository account securities in the demat form can be easily lent/ borrowed. Securities can be lent or borrowed in electronic form through an approved intermediary, who has opened a special intermediary account with a DP. Instructions are to be given to DP through a standard format (which is available with DP) to deposit securities with the intermediary. Similarly to borrow securities from the intermediary, one has to instruct DP through a standard format (which is available with your DP). Transmission of Securities: Transmission of securities due to death, lunacy, bankruptcy, insolvency or by any other lawful means other than transfer is also possible in the depository system. In the case of transmission, the claimant will have to fill in a transmission request form, (which is available with the DP) supported by valid documents. Freezing Account with DP: If at any time as a security measure one wishes that no transaction should be effected in ones account, one may advise ones DP accordingly. DP will ensure that account of such investor is totally frozen until further instructions from him.

Depositories

b)

c)

d)

e)

f)

Tax Aspect In case of dematerialized holdings cost of acquisition and period of holding for calculation of capital gains tax is determined on the basis of First In First Out (FIFO) method. This is as per the amendment to the Income Tax Act. The proof of the cost of acquisition will remain to be the contract note.
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Financial Market: Operations and Services

9.7

DEPOSITORY SYSTEM IN INDIA

In April 1996 the Governing Board of SEBI approved the draft of SEBI (Depositories and Participants) Regulations 1996. The Securities and Exchange Board of India notified these regulations on May 16, 1996. The government of India in 1996 introduced in Lok Sabha the Depository Bill to usher in scrip less trading and avoid bad delivery, theft and forgery in share transfer and settlement . National Securities Depositories Ltd. (NSDL) promoted by Industrial Development Bank of India, Unit Trust of India and National Stock Exchange emerged as the first depository to be registered in India. There was a great debate on central-versusmultiple depository system. Ultimately multiple depository system became a choice. Considering the sheer size of the network that would have to be established, a single organisation may not be able to handle it. To have competition, multiple depository is a must. Subsequently, another depository emerged on Indian scene i.e. Central Depository Services Limited (CDSL). It received a certificate of commencement of business from SEBI on February 8, 1999. CDSL was set up with the objective of providing convenient, dependable and secure depository services at affordable cost to all market participants. All leading stock exchanges like the National Stock Exchange, Calcutta Stock Exchange, Delhi Stock Exchange, The Stock Exchange, Ahmedabad, etc have established connectivity with CDSL. 29th November, 1996 was a red letter day for Indian capital market as in rnore than 100 year history of stock exchanges in India, for the first time National Stock Exchange witnessed trade in dematerialised scrips of an Indian Company i.e. Reliance Industries. The very first lot of transaction was, as expected, at premium in comparison to prevailing price for physical delivery due to inherent qualities of quick settlement. clean deliveries and exemptions from stamp duty. To make the system operational on large scale, Government of India promulgated an ordinance to amend the Depository Act to enable the shares of statutory bodies such as IDBI. SBI, UTI and other public sector banks and the units of mutual funds to transact through depositories. The changes in last few years in mechanism of capital market has made market more efficient. About 99% of settlements are through depositories. Besides overcoming the problems of bad deliveries, paper deliveries etc. this system has cut down the time taken in settlement. Indian market now has attained T+3 settlement effectively and efficiently through NSDL and CDSL Some of the important statistics about depositories in India at present (May 2004) is as under: Features DPs (no.) Investors (Iakhs) Demat (qty- Crores) Demat (Value Rs- Cr) No. of Co.s (equity) (Source: NSDL and CDSL ) NSDL 216 53.53 8672 912812 5311 CDSL 220 6.71 1428 103338 4837

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Working of National Securities Depositroy Limited (NSDL) NSDL is the first depository in India till now registered with SEBI in June 1996. It has been promoted jointly by lDBI, UTI and NSE. NSDL operates through a network of DPs who interact with investors. However, as required by the Depositories Act, NSDL is responsible to every individual investor holding an account with the depository. It operates on a two-tier structure, wherein it maintains the accounts of the DPs, who in turn maintain the clients accounts. The online software provided by NSDL to the DPs give an access to each account maintained by depository participants so that their functioning can be monitored and controlled. NSDL also maintains online connectively with the registrars and transfer agents (R& T) of the securities and perform a daily reconciliation of all the account balances to ensure that the number of securities issued and dematerialised in the depository tallies. NSDL operates through DPs to perform the relevant functions which are as under: a) b) c) d) Getting withdrawal and surrender of securities from and to the depository. Maintain investor holding in electronic form. Effect settlement of securities traded on the exchanges. Carry out settlement of trades not done on the stock exchanges, i.e. off market trades.

Depositories

In the operations of NSDL besides DPs there is another organisation called as National Securities Clearing Corporation Ltd. (NSCCL). It is responsible for the clearing and settlement system for its clearing members (CM) and investors to settle the trades in the depository section. The procedure is as under: i) The cycle of delivering and receiving securities in this market segment broadly remains similar to the existing cycle for physical securities, that is, from Wednesday to Tuesday with the exception that pay-in and payout of both securities and funds are affected on the same day, that is Tuesday. In the physical segment, today, a seller delivers paper securities to his CM who in turn, pays in such securities in the clearing house in the depository segment, the seller is required to instruct his DP to transfer securities from his account with the DP to the CMs pool account with the DP. On or before the time specified for the pay- in by NSCCL, the CM instructs its DP to move the required balance from its pool account to its delivery account. The NSDL then moves the balances from CMs delivery accounts to NSCCL settlement account within the depository as per schedule set up for the pay in of depository securities. Payout is received from NSCCL into the CMs account from where the CM instructs his DP to distribute the securities to the buyers.

ii)

iii)

iv)

v)

NSDL also provides stock lending and borrowing facilities to the investors, subject to the regulations on lending and borrowing. The investor can also receive his corporate benefits through NSDL. The disbursement of cash benefits such as dividend/interest will be done by the registrar whereas the distribution of securities entitlements will be done by the depository based on the information provided by the registrar. The NSDL fee structure The NSDL has specified a fee structure for all the players in the system and it is as follows:

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i) Depository participants Some of the important fee heads and charges are as under: NSDLs Fee Structure Fee Type Custody fee company Transaction fee Pledge creation Securities borrowing Rematerialisation Dematerialisation Security deposit Registration fee ii) Issuers and registrars No fees charged iii) Investors The DPs make different charges to render services to investors like for opening accounts, closing the account, Demat, Remat, custody, market transfers (sale or purchase). Some DPs also ask for security deposits. These costs at the moment are keeping small investors away from depository. Further, psycofear of not holding share certificate in physical form is also keeping investors away from depository. Charges Made by a Sample of DPs to Investors: a) b) c) d) e) f) g) h) i) Advance deposit of Rs.1200 (Valid for 2 years) and account maintenance charges of Rs.600 per annum. Transaction charges 0.04 % (Minimum Rs.20) + NSDLs settlement charges. Transaction charge 0.04 % (Minimum Rs.20) RS.15 per transaction + NSDL settlement charge. Transaction charges RS.60 for value upto Rs.1 lac and 0.02 % for value exceeding Rs. 1 lac. Account Maintenance on slab basis. Account maintenance is found to vary among DPs from zero to Rs. 450 per annum, the most common range being Rs. 200 300. Some DPs demand security deposits. Some DPs have the policy of cross selling among their associative businesses by giving discount to the favoured customers Rate of Fees Rs. 6 per annum per total holding In a I Rs.10 per transaction (charged to seller only) Rs.25 per instruction Rs. 25 per instruction Rs. 10 per certificate No charges Rs. 10 lakh Rs. 1.5 lakh

iv) Companies Companies wanting their scrips to be de-materialised need to invest Rs. 20 lakh to Rs. 25 lakh in establishing connectivity with the exchange. This is in fact not a fee but this amount is required for creation of desired infrastructure.
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Not Very Happy Situation A point to be noted is that share depository service has unfortunately not evolved in India as a voluntary commercial service, to be priced attractively for the users but as a compulsory bureaucratic requirement prescribed by SEBI for trading shares. Making demat compulsory and allowing the depositories to exploit their nearmonopolistic position by charging whatever fees they like, is nothing but robbing of the small investors. This is pushing the small investors out of the equity market. Demat has never been compulsory in the US. The Working Group, set up by SEBI in 1994, on the legal framework of a depository system for India, had envisaged that it would be optional for an investor to hold and transfer the securities through or outside the depository, although, in long run, the bulk of the securities may be held in the depository form. The group also recognised that in many cases, investors would be residing at a place where no depository facilities are available and a small investor might find it costly to transfer the shares through depository. A survey conducted by SCMRD on household investors and its empirical data on the extent of acceptance of the depository system among ordinary investors reveals that a vast majority of middle class shareowners in India have preferred not to go for demat and to continue holding paper certificates but this leaves them on the horns of a dilemma. Also, about 40 per cent of listed companies, mainly the smaller ones, have not joined the depository system but, as the traditional trading system has been almost dismantled in haste, the shareholders of such companies are also suffering. This has created serious difficulties for mid-sized and small companies in tapping the public market for capital. All these aspects are not being given proper consideration by policy makers and regulators concerned with the capital market. The depositories levy certain fees from Depository Participants (DPs), who are its agencies for providing depository services to investors. The investors have direct contact only with the DPs and no contact at all with depositories. They leave DPs completely free to decide in what manner and how much they will charge to the investors for the depository services. Most DPs charge for account opening, account maintenance, custody, transaction settlement, pledge creation and closure, etc. The DPs have to charge to investors substantially more than what the depositories charge to DPs in total because DPs have to recover their own operational expense besides the fee they pay to the depositories. In view of the high cost of depository system for custody purposes alone, an investor, who is not a frequent trader, is being quite rational by not going for demat. The whole depository system in India seems to have been designed mainly keeping in view the needs of frequent traders and speculators rather than the needs of long-term investors who may trade only once in a while. Perhaps: those who designed the depository system were also motivated by the objective of maximising the depositorys income rather than serving the actual needs of the clients in the most economical way. Dematerialisation should be optional (especially for below par value shares) as small investors find the charges very high,. At times, the cost of the shares is less than the dematerialisation. Compulsory demat should be abolished and transactions should be allowed for physical sale or purchase in case of small investors.

Depositories

9.8

TECHNOLOGY AND DEPOSITORY

After gong through this lesson up to now, you can appreciate that to think of depositories without technology is impossible. Depositories carry out their activities through various functionaries as DPs, Issuing corporates and their Registrars and Transfer agents, clearing houses etc. Depositories are electronically linked to each of

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such partners via a satellite link. The norms laid down by SEBI for Depositories are also technology oriented. In order to facilitate transfers between investors having accounts in the two existing depositories in the country the Securities and Exchange Board of India has asked all stock exchanges to link up with the depositories. SEBI has also directed the companies registrar and transfer agents to effect change of registered ownership in its books within two hours of receiving a transfer request from the depositories. Once connected to both the depositories the stock exchanges have also to ensure that inter-depository transfers take place smoothly. It also involves the two depositories connecting with each other. The NSDL and CDSL have signed an agreement for inter-depository connectivity. All this cannot be possible in absence of technology. Use of internet provides user friendly features besides efficient control on settlement process. Both the depositories have successfully harnessed technology to the full advantage of the investors and investment culture in India. In NSDL, Very Small Aperture Terminals (VSATs) is such a link and its entire integrated system has been named as NEST (National Electronic Settlement & Transfer). To ensure uninterrupted service NSDL has three level back up. Machine level back up: The IBM mainframe situated at Trade World (NSDL office in Mumbai) in which the data is processed has adequate redundancy built into its configuration. There is a standby central processing unit (CPU) to which processing can be switched over to in case of main system CPU failure. The disk has RAID implementation, which ensures that a single point failure will not lead to loss in data. All network components like router, communication controllers etc, have on-line redundancy and thus a failure does not result in loss of transaction. Disaster back up site: In addition, a disaster back up site equipped with a computer identical to the mainframe computer and computing resources has been set up at a remote location about 175 km away from Mumbai. This site has been tested for operations from the site. Back-up in case of power failure: Continuity in power supply to the main systems is assured by providing for; dual uninterrupted power supply (UPS) for IBMMainframe and related components wherein the two UPSs are connected in tandem. In case of failure of primary UPS, the secondary UPS takes over instantaneously and thus, there is no interruption in operation, and back-up diesel generator set. To ensure safety to investors SEBI desires that where records are kept electronically by the participant, it shall ensure that the integrity of the data processing systems is maintained at all times and take all precautions necessary to ensure that the records are not lost, destroyed or tampered with and in the event of loss or destruction, ensure that sufficient back up of records is available at all times at a different place. If an investor looses his statement of holdings, he may inform his DP and obtain a duplicate statement of holdings. The loss of statement of holding will not affect his actual holdings. Depository account details are confidential. There are strict systems and procedures established to protect the confidentiality of investor information at the depository to ensure that these are available to only authorized persons. Even a DP other than your own, cannot have access to your account. IT and schemes of CDSL i) easi. electronic access to securities information easi is a convenient, simple to operate facility, which allows Beneficial Owners (BOs) and Clearing Members (CMs) to access their demat account through an internet enabled PC for obtaining information about their holdings and transactions, anywhere. 7 days a week. 24 hours a day, through CDSLs website www.cdslindia.com. It allows SO/CM an anytime-

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anywhere access of the holdings and transactions in his demat account. Thus, a BO can, not only monitor his account but also does not require approaching his DP each time a statement of account is required. The portfolio valuation facility also saves valuable time for investors in looking up stock quotes daily. The almost real-time information available through easi makes it very convenient for a BO to make effective decisions on his portfolio. A BO can avail of this facility only if the DP with whom he maintains his account is registered for this facility. Registering to easi is a very simple process. One is to log into website site www.cdslindia.com. and proceed as directed. A BO can use easi for: a) b) c) Viewing, downloading and printing of details of holdings and status of transactions on almost real time basis, anytime-anywhere. Obtaining the valuation of his holdings in his account as on the previous day closing price on BSE. To print/download the statement of account as and when required.

Depositories

easi also provides a convenient overdue report to CMs which facilitates them to monitor pay-in of securities. CMs can view the overdue status of pay-in instructions provided by clients and can also monitor the client level payout through easi. ii) easiest (electronic access to securities information and execution of secured transactions) is another scheme wherein internet facility permits clearing members (CMs)/Beneficial Owners (BOs) to submit debit / credit transaction instructions to effect off-market, on-market, interdepository and early pay-in transactions. Moreover, all the facilities and benefits of easi are automatically available to a subscriber of easiest.

9.9

LEGAL SET UP FOR DEPOSITORIES IN INDIA

Protecting the interest of investors is of paramount importance to SEBI and in this direction it regulates the provisions of Depositories Act, 1996. It is the statute which gives directions to depository business in India. As per the Act a depository should be a corporate body and should get certificate of Commencement of Business from SEBI. The Act specifies Rights and Obligations of depositories, participants, issuers and beneficial owners. Some of the important provisions are: Depository shall enter into an agreement with one or more participants as its agent. All securities held by a depository shall be in a fungible form. A depository shall be registered owner of securities for the purposes of effecting transfers of ownership on behalf of a beneficial owner. Beneficial owners shall be entitled to all the rights and benefits in respect of his securities held by a depository. Beneficial owner with prior information can pledge or hypothecate securities held in depository. Depository shall furnish needed information to beneficial owners and Issuers. Depository is to indemnify beneficial owners for any loss incurred due to negligence of participants. Depositories have powers to make byelaws for related matters with prior approval of SEBI.
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(also refer to Appendix)

Financial Market: Operations and Services

To facilitate operations of the said Act SEBI (Depositories and Participants) Regulations 1996 were issued. These regulations, which regulate depository system, run in seven chapters with 69 regulations, two schedules and five form formats. These regulations cover the registration of depositories who are to submit application in specified forms along with prescribed information and registration fee. Certificate of registration is granted subject to some conditions (See Regulation No.7). On getting certificate of registration, SEBI issues Certificate of Commencement of Business for which a specified form is to be submitted. SEBI considers all matters which are relevant to the efficient and orderly functioning of depository (See Regulation 13). Participants are also to be granted Certificate of Registration (See Regulations 16 to 20). These certificates of Registration can be renewed. The regulations also discuss rights and obligations of depositories, participants and issuers. Regulations also specify mode of communication for the system. Provisions have also been made to facilitate creation of pledge and hypothecation of securities of investor held in depository mode. SEBI has right to appoint inspecting officers to undertake inspection of the books of accounts, records, documents and infrastructure systems and procedure of a depository, participant, a beneficial owner, an issuer or its agent, either of its own or on any complaint. Some of the important regulations for depositories are given in Appendix. Activity 3 a) List five important benefits of demat. ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... b) Briefly discuss the followings in relation with depositories: Pledging of securities, Stock lending, Transmission of securities. ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... c) Name the two depositories in India. ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... d) Visit the sites of the two depositories and collect latest data. ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... e) Visit three DPs and compare various fee charged by them from investors. ...................................................................................................................... ...................................................................................................................... ...................................................................................................................... f) What way technology facilitates depositories to work? ...................................................................................................................... ...................................................................................................................... ......................................................................................................................

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g)

Which enactment regulates depositories in India? ...................................................................................................................... ...................................................................................................................... ......................................................................................................................

Depositories

9.10 SUMMARY
Depository system essentially aims at eliminating the voluminous and cumbersome paper work involved in the scrip-based system and offers scope for paperless trading through state-of-the-art technology. It is an institution which maintains an electronic record of ownership or securities. Depository functions like a securities bank, where the dematerialized physical securities are traded and held in custody. This facilitates faster, risk free and low cost settlement. Constituents of Depository System are: Depository, Depository Participants (DPs), Companies/Registrars and Investors. In depository system, share certificates belonging to the investors are dematerialised (demats). Dematerialisation or Demat is a process whereby investors securities like shares, debentures etc, are converted into electronic data and stored in computers by a Depository. Securities can again be converted into physical form and it is called Rematerialisation . In the depository system, since the physical form of security loses its relevance, the securities are to be fungible. Each security held in dematerialized form is given an identity and it is in form of a distinctive ISIN (International Securities Identification Number). There are two depositories in India having about 436 DPs. Their fee charges for investors differ and are high for small investors. Both the depositories have successfully harnessed technology to the full advantage of the investors and investment culture in India. Depositories in India are regulated by Depository Act 1996 and to facilitate operations of the said Act SEBI (Depositories & Participants) Regulations 1996 were issued. It is a general feeling that depository service has added to the efficiency of capital market in India.

9.11 KEY WORDS

Demat : Investor securities like shares, debentures, etc. are converted into electronic data and stored in computers by a depository. Depository : Functions like a securities bank, where the dematerialized physical securities are traded and held in custody. Depository Account : An account which the investor opens with a DP wherein all the details of the investors transactions are recorded in demat form. Dematerialisation (Demat) : Is a process where by physical existence of security certificates is made extinct and converted into electronic holdings. Rematerialisation : Converting the shares from electronic to physical or paper form.

9.12 SELF ASSESSMENT QUESTIONS

1 ) Discuss the need of Depository System in a financial system. 2) Write notes on : a) b) c) Depository Participant Depository account Fungibility
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3) 4) 5)

Discuss the process of dematerialisation. What type of records are maintained by DPs? Discuss the process of creating pledge of securities held in depositories.

9.12

FURTHER READINGS

Gupta, L.C., Naveen Jain: Indian Securities Depository System, What has Gone Wrong? Economic and Political Weekly, May 17, 2003 Kullu Rao, P. : Custodial services need for change, Chartered Secretary, October, 1996. NSDL : A handout, National Securities Depositories Ltd., Bombay, 1997. SEBI : SEBI (Custodian of Securities) Regulations, 1996. SEBI (Depositories and Participants) Regulations, 1996. Shah, Ravi : Emergence of Securities Depositories in India, The City, Aug-Sep 2002 Stock Lending scheme, 1997.

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Appendix
The Depositories Act, 1996 gives power to depositories to make bye-laws but such bye laws should be consistent with the provisions of this Act and the SEBI Regulations. Such bye-laws shall provide for: a) b) c) d) e) f) g) h) i) the eligibility criteria for admission and removal of securities in the depository; the conditions subject to which the securities shall be dealt with; the eligibility criteria for admission of any person as a participant; the manner and procedure for dematerialisation of securities; the procedure for transactions within the depository; the manner in which securities shall be dealt with or withdrawn from a depository; the procedure for ensuring safeguards to protect the interests of participants and beneficial owners; the conditions of admission into and withdrawal from a participant by beneficial owner; the procedure for conveying information to the participants and beneficial owners on dividend declaration, shareholder meetings and other matters of interest to the beneficial owners; the manner of distribution of dividends, interest and monetary benefits received from the company among beneficial owners; the manner of creating pledge or hypothecation in respect of securities held with a depository; inter se rights and obligations among the depository, issuer, participants, and beneficial owners;

Depositories

j) k) l)

m) the manner and the periodicity of furnishing information to the Board, issuer and other persons; n) o) the procedure for resolving disputes involving depository, issuer, company or a beneficial owner; the procedure for proceeding against the participant committing breach of the regulations and provisions for suspension and expulsion of participants from the depository and cancellation of agreements entered with the depository; the internal control standards including procedure for auditing, and monitoring. reviewing

p)

SEBI (Depositories and Participants) Regulations, 1996 Board (SEBI) grants a certificate of registration to a depository subject to the following conditions, namely: a) b) c) d) the depository shall pay the registration fee specified within fifteen days of receipt of intimation from the Board; the depository shall comply with the provisions of the Act, the Depositories Ordinance, the bye-laws, agreements and these regulations; the depository shall not carryon any activity other than that of a depository unless the activity is incidental to the activity of the depository; the sponsor shall, at all times, hold at least fifty one per cent of the equity capital of the depository and the balance of the equity capital of the depository shall be held by its participants;

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e) f)

no participant shalf at any time, hold more than five per cent of the equity capital of the depository; If any information previously submitted by the depository or the sponsor to the Board is found to be false or misleading in any material particular, or if there is any change in such information, the depository shall forthwith inform the Board in writing; the depository shall redress the grievances of the participants and the beneficial owners within thirty days of the date of receipt of any complaint from a participant or a beneficial owner and keep the Board informed about the number and the nature of redressals: The depository shall make an application for commencement of business under regulation 14 within one year from the date of grant of certificate of registration under this regulation; and The depository shall amend its bye-laws as directed by SEBI.

g)

h)

i)

Certificate of Commencement of Business The Board shall take into account for considering grant of certificate of commencement of business, the following points, namely, whether a) b) c) The depository has a net worth of not less than rupees one hundred crore; The bye-laws of the depository have been approved by the Board; The automatic data processing systems of the depository have been protected against unautharised access, alteration, destruction, disclosure or dissemination of records and data: the network through which continuous electronic means of communications are established between the depository, participants, issuers and issuers agents is secure against unauthorised entry or access; The depository has established standard transmission and encryption formats for electronic communications of data between the depository, participants, issuers and issuers agents; the physical or electronic access to the premises, facilities, automatic data processing systems, data storage sites and facilities including back up sites and facilities and to the electronic data communication network connecting the depository, participants, issuers and issuers agents is controlled, monitored and recorded; the depository has a detailed operations manual explaining all aspects of its functioning, including the interface and method of transmission of information between the depository,- issuers, issuers agents, participants and beneficial owners; the depository has established adequate procedures and facilities to ensure that its records are protected against loss or destruction and arrangements have been made for maintaining back up facilities at a location different from that of the depository; the depository has made adequate arrangements including insurance for indemnifying the beneficial owners for any loss that may be caused to such beneficial owners by the wrongful act, negligence or default of the depository or its participants or of any employee of the depository or participant; and The grant of certificate of commencement of business is in the interest of investors in the securities market.

d)

e)

f)

g)

h)

i)

j)

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The Board shall, before granting a certificate of commencement of business makes a physical verification of the infrastructure facilities and systems established by the depository. Record of Services by Depository Participant (DP) i) Types of records Every participant shall maintain the following records and documents, namely: a) b) c) d) Records of all the transactions entered into with a depository and with a beneficial owner; Details of securities dematerialised, rematerialised on behalf of beneficial owners with whom it has entered into an agreement; Records of instructions received from beneficial owners and statements of account provided to beneficial owners; and Records of approval, notice, entry and cancellation of pledge or hypothecation, as the case may be.

Depositories

Every participant shall make available for the inspection of the depository in which it is a participant all records referred above. Every participant shall allow persons authorised by the depository in which it is a participant to enter its premises during normal office hours and inspect its records. Every participant shall intimate the Board the place wrlere the records and documents are maintained. The participant shall preserve records and documents for a minimum period of five years. ii) Where records are kept electronically by the participant, it shall ensure that the integrity of the data processing systems is maintained at all times and take all precautions necessary to ensure that the records are not lost. Destroyed or tampered with and in the event of loss or destruction, ensure that sufficient back up of records is available at all times at a different place. If a participant enters into an agreement with more than one depository, it shall maintain the specified records separately in respect of each depository. No participant shall assign or delegate its functions as participant to any other person, without the prior approval of the depository.

iii) iv)

Agreement by Issuer Every issuer whose securities have been declared as eligible to be held in dematerialised form in a depository shall enter into an agreement with the depository. Records to be Maintained by Depository Every depository shall maintain the following records and documents, namely: a) b) c) d) e) f) records of securities dematerialised and rematerialised; the names of the transferor, transferee, and the dates of transfer of securities; a register and an index of beneficial owners; records of instructions received from and sent to participants, Issuers, issuers agents and beneficial owners; records of approval, notice, entry and cancellation or pledge or hypothecation, as the case may be; details of participants;
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g)

details of securities declared to be eligible for dematerialisation in the depository; and any other record required by SEBI.

Every depository shall intimate the Board the place where the records and documents are maintained. Depository shall preserve records and documents for minimum period of five years. Manner of Creating Pledge or Hypothecation Investor shall make an application in this regard to the depository through the participant who has his account in respect of such security in the manner specified in regulations. On receipt of application of the beneficial owner through the participant, the depository shall make such investigation as it may consider, necessary and if it approves the creation of the pledge or hypothecation, it shall enter the particulars of the intended pledge or hypothecation in its r9cords and where he does so, intimate the participant who shall also amend its records accordingly and immediately intimate the beneficial owner. On receipt of the intimation the beneficial owner may create a pledge or hypothecation and where he does so, he shall intimate the depository through the participant of the creation of such pledge or hypothecation. The participant, on receipt of such intimation, shall substitute for the notice of pledge or hypothecation in its records and entry of pledge or hypothecation as the case may be and shall inform the pledgee, beneficial owner and the depository. Then depository shall make in its records the changes referred to . The entry of pledge made shall be cancelled by the participant when the beneficial owner redeems the pledge or hypothecation and makes a request, with the concurrence of the pledgee, to the participant to cancel the entry of pledge or hypothecation, and the participant shall inform the depository accordingly. Then the depository shall make in its records the required changes. Other Points
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Every depository shall extend such co-operation to the beneficial owners, issuers, issuers agents, custodians of securities, other depositories and clearing organizations as is necessary for the effective, prompt and accurate clearance and settlement of securities transactions and conduct of business. No depository shall assign or delegate to any other person its functions as a depository, without the prior approval of the Board. Every participant shall enter into an agreement with a beneficial owner before acting as a participant on his behalf, in a manner specified by the depository in its bye-laws. Separate accounts shall be opened by every participant in the name of each of the beneficial owners and the securities of each beneficial owner shall be segregated, and shall not be mixed up with the securities of other beneficial owners or with the participants own securities. A participant shall register the transfer of securities to or from a beneficial owners account only on receipt of instructions from the beneficial owner and thereafter confirm the same to the beneficial owner in a manner as specified by the depository in its bye-laws. Every entry in the beneficial owners account shall be supported by electronic instructions or any other mode of instruction received from the beneficial owner in accordance with the agreement with the beneficial owner. Every participant shall maintain continuous electronic means of communication with each depository in which it is a participant. Every participant shall have adequate mechanism for the purposes of reviewing, monitoring and evaluating the participants internal accounting controls and systems.
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