DEPOSITORIES:

ROLE IN SECURITIES MARKET

AYUSH KAUSHIK
A11911113023

AMITY LAW SCHOOL NOIDA

28TH AUGUST 2017

COURSE FINANCIAL MARKET REGULATION

S.NO CONTENT PAGE NO

1. ABSTRACT 3

2. MEANING AND KEY FEATURES 4-7

3. BENEFITS OF THE SYSTEM 7-9

4. PROBLEMS AND SUGGESTIONS 9-14

5. BIBLIOGRAPHY 15

TABLE OF CONTENTS

ABSTRACT
The earlier settlement system on Indian stock exchanges was very inefficient as it was unable
to take care of the transfer of securities in a quick/speedy manner. Since, the securities were
in the form of physical certificates; their quick movement was again difficult. This led to
settlement delays, theft, forgery, mutilation and bad deliveries and also to added costs.

To wipeout these problems, the Depositories Act 1996 was passed. It was formed with the
purpose of ensuring free transferability of securities with speed, accuracy & security.

It has been able to do so by: a) Making securities of public limited companies freely
transferable, subject to certain exceptions; b) Dematerializing the securities in the depository
mode; and c) Providing for maintenance of ownership records in a book entry form.

There are two depositories in India, namely, NSDL and CDSL. For smooth functioning of
the depository system, depository participants act as intermediary between the clients and the
depository. They help in transfer of securities in a smooth manner. They also help in
performing the task of changing physical securities into demat form and vice-versa

The Depository system to some extent works like the banking system. There is a central bank
and the rules and regulations related to the working of all the commercial, foreign, co-
operative and other types of banks are framed by the central bank. In order to do the daily
transactions, the investors open an account with the associate banks, and not with the central
one. Like an investor can have a bank account with more than one bank, similarly one can
have more than one Demat Account.

Depository is known for that entity which holds securities in accounts, Transfers securities
between accounts, Transfers without handling physical securities and in charge of
Safekeeping of securities
MEANING OF DEPOSITORY

A depository is an organisation which holds securities (like shares, debentures, bonds,

government securities, mutual fund units etc.) of investors in electronic form at the request of
the investors through a registered Depository Participant. It also provides services related to
transactions in securities.

Depository means a company formed and registered under the Companies Act, 2013 and
which has been granted a certificate of registration under Section 12(1A) of the SEBI Act,
1992.

A Depository is an organization like a Central Bank where the securities of a shareholder are
held in the electronic form at the request of the shareholder through the medium of a
Depository Participant. To utilize the services offered by a Depository, the investor has to
open an account with the Depository through a Depository Participant.

It is important to note that a depository cannot act as a depository unless it obtains a

certificate of commencement of business from SEBI.Registration of the depository is
required under SEBI (Depositories and Participants) Regulations, 1996 and is a precondition
to the functioning of the depository. Depository and depository participant both are regulated
by SEBI.

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

The 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.

Shares in the depository mode are fungible and cease to have distinctive numbers. In the
Depository mode, corporate actions such as IPOs, rights, conversions, bonus,
mergers/amalgamations, subdivisions & consolidations are carried out without the movement
of papers, saving both cost & time. The issuer gets information on changes in shareholding
pattern on a regular basis, which enables the issuer to efficiently monitor the changes in
shareholdings.

The Depository system links the issuing corporates, Depository Participants (DPs), the
Depositories and clearing corporation/ clearing house of stock exchanges. 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).

THE NEED FOR DEPOSITORY AROSE MAINLY DUE THE FOLLOWING REASONS:

1. Growth in Securities transactions: There has been considerable growth in securities

transactions, especially, in the post-reform period, i.e., since 1991. After 1991, the
Government of India introduced several reforms in the Indian Economy, including
capital market reforms.
2. Limitations of Physical Transfer: There were several limitations relating to physical
transfer of shares. The limitations were:
Delay in transfer of shares.
Problem of bad deliveries
High cost of handling and transfer
Chances of loss of certificates in transit.
Chances of theft of certificates, etc.
3. To comply with global standards: Almost all the developed markets had introduced the
depository system ensuring efficient transfer and settlement of securities. Due to reforms
in capital markets, the foreign institutions investors (FIIs) were allowed to deal in stock
exchanges. For this purpose the government also introduced the depository Act, 1996.
4. To enhance liquidity in stock markets: There was a need to enhance liquidity in Indian
Stock Markets. The seller of securities to get immediate cash payment for their
transactions. The depository undertakes the trade and settlement processing through its
subsidiary.
5. To ensure transparency in allotment of shares: Now-a-days, the allotment of shares is to
be done only through the Demat mode. The allotment of shares is to be effected through
the depository in the Demat account of the investors. This has generated transparency in
allotment of shares and reduced manipulations relating to transfer of shares.
6. Centralised Systems in Securities Dealings: There was a need to adopt a central system
for handling all the securities dealings. This has been made possible by setting up Central
depository system, although there are two different depositories (NSDL, and CDSL).

KEY FEATURES OF THE DEPOSITORY SYSTEM IN INDIA

1. Multi-Depository System: The depository model adopted in India provides for a

competitive multi-depositorysystem. There can be various entities providing depository
services. A depository should be a company formed under the Companies Act, 2013
(erstwhile Companies Act, 1956) and should have been granted a certificate of
registration under the Securities and Exchange Board of India Act, 1992. Presently, there
are two depositories registered with SEBI, namely:
National Securities Depository Limited (NSDL), and
Central Depository Service Limited (CDSL)
2. Depository services through depository participants: The depositories can provide
their services to investors through their agents called depository participants. These
agents are appointed subject to the conditions prescribed under Securities and Exchange
Board of India (Depositories and Participants) Regulations, 1996 and other applicable
conditions.
3. Dematerialisation: The model adopted in India provides for dematerialisation of
securities. This is a significant step in the direction of achieving a completely paper-free
securities market. Dematerialization is a process by which physical certificates of an
investor are converted into electronic form and credited to the account of the depository
participant.
4. Fungibility: The securities held in dematerialized form do not bear any notable feature
like distinctive number, folio number or certificate number. Once shares get
dematerialized, they lose their identity in terms of share certificate, distinctive numbers
and folio numbers. Thus all securities in the same class are identical and interchangeable.
For example, all equity shares in the class of fully paid up shares are interchangeable.
5. Registered Owner/ Beneficial Owner: In the depository system, the ownership of
securities dematerialized is bifurcated between Registered Owner and Beneficial Owner.
According to the Depositories Act, 1996 Registered Owner means a depository whose
name is entered as such in the register of the issuer. A Beneficial Owner means a person
whose name is recorded as such with the depository. Though the securities are registered
in the name of the depository actually holding them, the rights, benefits and liabilities in
 respect of the securities held by the depository remain with the beneficial owner. For the
securities dematerialized, NSDL/CDSL is theRegistered Owner in the books of the
issuer; but ownership rights and liabilities rest with Beneficial Owner. All the rights,
duties and liabilities underlying the security are on the beneficial owner of the security.
6. Free Transferability of shares: Transfer of shares held in dematerialized form takes
place freely through electronic book-entry system.

BENEFITS OF DEPOSITORY SYSTEM

In the depository system, the ownership and transfer of securities takes place by means of
electronic book entries. At the outset, this system rids the capital market of the dangers
related to handling of paper. The system provides numerous direct and indirect benefits, like:

1. Elimination of bad deliveries - In the depository environment, once holdings of an

investor are dematerialised, the question of bad delivery does not arise i.e. they cannot be
held "under objection". In the physical environment, buyer of shares was required to take
the risk of transfer and face uncertainty of the quality of assets purchased. In a depository
environment good money certainly begets good quality of assets.
2. Elimination of all risks associated with physical certificates - Dealing in physical
securities have associated security risks of theft of stocks, mutilation of certificates, loss
of certificates during movements through and from the registrars, thus exposing the
investor to the cost of obtaining duplicate certificates and advertisements, etc. This
problem does not arise in the depository environment.
3. Immediate transfer and registration of securities - In the depository environment, once
the securities are credited to the investors account on pay out, he becomes the legal
owner of the securities. There is no further need to send it to the company's registrar for
registration. Having purchased securities in the physical environment, the investor has to
send it to the company's registrar so that the change of ownership can be registered. This
process usually takes around three to four months and is rarely completed within the
statutory framework of two months thus exposing the investor to opportunity cost of
delay in transfer and to risk of loss in transit.
4. Faster disbursement of non-cash corporate benefits like rights, bonus, etc. Depository
system provides for direct credit of non-cash corporate entitlements to an investors
 account, thereby ensuring faster disbursement and avoiding risk of loss of certificates in
transit.
5. Reduction in brokerage by many brokers for trading in dematerialized securities -
Brokers provide this benefit to investors as dealing in dematerialized securities reduces
their back office cost of handling paper and also eliminates the risk of being the
introducing broker. Reduction in handling of huge volumes of paper and periodic status
reports to investors on their holdings and transactions, leading to better controls.
6. Elimination of problems related to change of address of investor, transmission, etc. - In
case of change of address or transmission of demat shares, investors are saved from
undergoing the entire change procedure with each company or registrar. Investors have to
only inform their DP with all relevant documents and the required changes are effected in
the database of all the companies, where the investor is a registered holder of securities.
7. Elimination of problems related to selling securities on behalf of a minor - A natural
guardian is not required to take court approval for selling demat securities on behalf of a
minor.

THE SIGNIFICANT DIFFERENCES BETWEEN NSDL AND CDSL ARE 1:

1. NSDL is the pioneer electronic depository of securities, established in India. On the

other hand, CDSL is the second central depository of securities which facilitates book
entry transfer of securities.

2. When it comes to promotion, NSDL is promoted by Indias apex institutions like

IDBI (Industrial Development Bank of India), UTI (Unit Trust of India) and NSE
(National Stock Exchange) whereas CDSL is promoted by Bombay Stock Exchange
in association with Bank of Baroda, State Bank of India, Housing Development
Finance Corporation, Union Bank of India, Standard Chartered Bank.

3. NSDL operates in the NSE. Conversely, CDSL operates in BSE.

4. Account wise, the active investor accounts in NSDL are comparatively higher than in
CDSL.

PROBLEMS OF DEPOSITORY SYSTEM 2:

1 Key Differences: http://keydifferences.com/difference-between-nsdl-and-cdsl.html

2Problems of Depository System: https://www.scribd.com/doc/19613607/Problems-of-the-Depository-System-
in-India
The depository system has the following problems3:

1. Discrimination between dematerialized and physical shares will affect transactions in

the market. This has to be avoided.

2. Lack of control: Trading in securities may become uncontrolled in case

of dematerialized securities.

3. Depository system is not effectively regulated by SEBI. This is evident from the fact
that the Clearing and Settlement Corporation is not effectively handled by the SEBI

4. Complexity of the system4: Multiple regulatory frameworks have to be confirmed to,

including the Depositories Act, Regulations and the various Bye-Laws of various
depositories. Additionally, agreements are entered at various levels in the process of
dematerialization. These may cause anxiety to the investor desirous of simplicity in
terms of transactions in dematerialized securities.

5. Promoters of some companies dematerialised shares in excess of the companys issued

capital.

6. Some listed companies had obtained duplicate shares after the originals were pledged
with banks and then sold the duplicates in the secondary market to make a profit.

7. Agency risk: The major issue which keeps the retail investor away from the depository
system is the agency risk. From the view point of the investor, the risk perception in the
depository system is no less than that in the present system of trading and settlement. It
is true to say that in the present system, the agency risk is diversified among various
players like brokers, registrar, postal system etc. In the depository system, though the
depository participant is a reputed bank, the retail investor does not feel confident until
effective insurance coverage is provided.

8. Lack of awareness: It is estimated that in India retail investors hold about 30% of the
market capitalization. In spite of their considerable share in the capital market, they do
not show adequate interest in demat trading. This is mainly due to lack of awareness

3Advantages and disadvantages of the Depository System: www.mbaknol.com/investment-

management/advantages-anddisadvantages-of-the-depository-system/
4 Advantages and disadvantages of the Depository System: www.mbaknol.com/investment-
management/advantages-anddisadvantages-of-the-depository-system/
 among the retail investors or the fear of being caught in the tax net. Most of the
investors are not aware of the benefits of demat trading.

9. Risk of loss in transit5:Distribution of cash benefits accruing to investors can be

expedited under depository system. But cash benefits cannot be disbursed
electronically. Still they have to be sent by post. So, the risk of loss in transit is to be
borne by the investor.

10. Multiplicity of charges:Under depository system, there are charges for opening of
account, dematerialization, rematerialisation, etc. Apart from this, investors who intend
to hold their investments in dematerialised form have to pay custody charges to the
depository participant. All these charges may deter the retail investors from taking
advantages of the system.

11. Reluctance for trading: Most of the existing shareholders do not opt for depository
system. They intend to keep their securities only in physical form.

12. Fear of tax liability:A large number of transactions related to securities are not
accounted for, because most of the buyers and sellers are not comfortable with their
names appearing in computer print-outs as they fear being brought into tax net. This
aspect prevents the investors from taking advantage of the depository system.

13. Inadequate infrastructure:In India, the infrastructure available for trading in demat
shares is inadequate. The Depository Act and SEBI have overlooked the role of
Clearing and Settlement Corporation.

14. For the successful operations of the depository, there should be a centralized clearing
and settlement corporation handling the trade in all exchanges. The establishment of
such a central institution will effectively facilitate smooth interaction with the various
exchanges. Another problem is that the investors living in smaller towns will find it
impossible to open a demat account.

15. Need for greater supervision: It is incumbent upon the capitalmarket regulator to keep a
close watch on the trading indematerialized securities and see to it that trading does not
actas a detriment to investors. The role of key market players incase of dematerialized

5 Problems in Depository System: http://accountlearning.com/problems-depository-system-india/

 securities, such as stock brokers, needs tobe supervised as they have the capability of
manipulating themarket.

SUGGESTIONS

Investors in securities must be assured that they will be given a fair deal and protected
adequately againstthe risks. There is no doubt that the dematerialisation of securities has
significantly eliminated the risk, such as bad delivery, inordinate delays in transfer oftitle,
high stamp duty, etc. But that doesnt mean that the Depositories System istotally free from
the flaws. Following are a few suggestionsgiven to eliminate or to minimise these problems:

i) Uniformity in practices of both the Depositories: There are two Depositories in our
country: NSDL and CSDL. The practices of both depositories are not uniform and this
leads to uncertainty in the mind of investors. They follow different patterns ofallotting
account6 number and they have differentpricing structures7.
ii) Chargesfor transferring securitiesto selfshould be abolished: In the Demat system, a
person is allowed to maintain any number of accounts with any ofthe
DepositoryParticipant. But ifa customer is transferring securities from one of his
account to his other account, he has to pay sale charges in the account from where the
securities are going. He also hasto pay buy charges in the account where he is
transferring the securities. The customer is, thus, penalised for transferring
hissecuritiesfrom one accountto another, irrespective ofthe fact that both the accounts
are ofthe same person. Therefore, it is suggested that the charges for transferring the
securities from one account to another account of the same person can be waived off.
iii) Rematerialisation should not be discouraged: As perDepository Regulations, one can
optforrematerialisation any time he wants. In this process, electronic shares are
converted into physical shares, and the client can keep these physical shares with him.
But this option exists only on the papers, as practically it is very difficultto get any
security rematerialized. The companies don't pay any attention to the rematerialisation
request. It is, therefore, necessary that steps should be taken to ensure that the client is
always given the choice ofgetting his physicalshares back in case he wants to do so and
the companies should entertain such request within reasonable time.
iv) Framing ofStringent rules& making sure they are implemented: Many companiesdo not
follow the procedures laid down in the Depository Agreement. The regulator and the

6In NSDL, every account number and the DP ID number is required to identify the account holder, whereas the
CDSL allots only one number containing both the information.
7NSDL charges custody fee whereas the CSDL does not charge any custody fee
 NSDL should ensure that the rules framed are followed in the right spirit. The
Companies, which are notfollowing the rules, should be imposed heavy penalty or
debarred. These Companies are making mockery of the processes and procedures. The
sanctity ofthe system should be maintained in every case and at all costs. Nobody
should be allowed to play with the spirit of the law.
v) Increase the Applicability:There are some companies which have not entered into the
agreementwith any ofthe Depositories. Steps should be taken by the regulator to ensure
that these Companies also enterinto the agreement atthe earliest. The investors of these
Companies suffer, asthey are not able to take the advantages, offered by the Depository
System.
vi) Investors Education: The investors should be properly educated about rules and
procedures ofthe Depository System and their implications. The Depositories and the
intermediariesshould ensure that the investors are properly educated about their rights
and duties in the Demat System. Most ofthe investors are still not aware the functioning
ofthe System. In the process, ifthey suffer any loss due to their ignorance, they blame
the system. Therefore, it is necessary to educate the investors. It would serve two
purposes: First, Investors would be better off and, the second is that more and more
people might be interested in investing securities market. This would in turn make the
number of people and amount invested in the securities market, high.
vii) Adequate disclosure practices: The regulatorshould ensure that the companies are
providing adequate information to the investors. Efforts should be made by SEBI to
ensure better corporate governance in the companies. If adequate information is
provided to the investors, only then they can make judicious informed decisions
regarding the securities they hold.
viii) More Powers should be given to SEBI: SEBI has been able to bring Indian
Stockmarkets almost atpar with the international securitiesmarkets. There is ageneral
tendency that when something goes wrong with the markets, SEBI is blamed for it. The
regulator can control systematic and operational risks, but not the frauds. There is a
need to empower the regulatory authority further. The punishment thatthe regulatory
body awards should be strong enough to deter people doing the same kind of acts in the
future.
ix) Net-Worth Limit should be raised: The networth for becoming a Depository Participant
should be raised from 1 crore to 5 crores. It will reduce the possibility of frauds made
by brokers Depository Participants.
x) There is a tendency found that in more than 90% cases of DPs their business has been
clubbed with some other business of the stock market like brokerage. Even now banks
 have also started extending the services of DPs. This clubbing has a few benefits as
well as many ills attached to it. My suggestion is that either the business of depositories
should be kept a separate business otherwise very strict guidelines to be given so that
even iota of the injustice with the Investors could not be spotted.
xi) To check the issues of excessive multiple demat account something is to be done.
Multiple accounts have been made legal in the system. There could be some restrictions
like only 2 or 3 demat accounts are allowed should be introduced.
xii) To stop the Benami accounts practice, the DPs should follow the policy of KYC
(Know Your Customer) very seriously.
xiii) Every customer could be issued a unique identification number so that not only his
transactions be traced easily but also the problem of excessive demat account would
have been solved fully.
xiv) The day trading which has been made legitimate in the name of providing liquidity in
India should be stopped. This creates excessive speculation and lets the confidence of
real investors go low. At least privileged treatment of day traders should be stopped
with immediate effects.
xv) Procedure of becoming DP should be made less exhaustive. Rather it should be made
user friendly. Instead of making the procedure stringent, adherence to all the guideline
to the DPs should be made more strict and punitive action sort of policies should be
developed for the sake of poor Investors.
xvi) There is no mechanism to facilitate research and academic inputs in the affairs of
depositories. Their dependence on SEBI for everything is not a prudent measure.
Depositories should develop their own research wing so that they could understand the
issues directly from the Investors.
xvii) Reduction of the cost of dematerialization and other depository charges

If the above steps are taken, dematerialization will not only go a long way in improving our
capital market but will also make our capital market on par with other foreign capital
markets, as a result of which linking of our capital market with other foreign markets will be
made easy.
 BIBLIOGRAPHY

Dematerialisation in the Indian Capital Market By P.V Nishanth

Security analysis and portfolio managementBy Prasanna Chandra

Securities Laws and CompliancesBy Institute of Company Secretaries of India

NSDLs Guide to Depositories

Development of Securities Market The Indian Experience By Narendra Jadhav

www.nsdl.co.in/
investor.sebi.gov.in/
www.cdslindia.com/
en.wikipedia.org/
www.investorwords.com
http://www.legalserviceindia.com/articles/
 http://www.indianmba.com/
www.indiabulls.com
www.moneycontrol.com
www.sebi.com
www.accountlearning.com
www.ukessays.com
www.icsi.edu