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Iti Jain♠ & Sudhanshu Roy♥


The year is 1995. A small time shopkeeper in Vidharabha makes a small profit in his business. He
decides to invest his profits to buy shares in a major public limited company. To obtain his share
certificates he has to travel all the way to Mumbai. But as luck would have it, his share certificates
are lost on the way back to his village in Vidharabha. With the loss of share certificates, the investor
thus loses all the money that he had invested in the shares of the company. This is because until
recently there was no other system for the companies but to issue physical share certificates
whenever shares are created1. The investors had to keep the shares in safe custody all the time. Of
course they might get duplicate copies of the share certificates but only after complying with a
cumbersome and time-consuming process. They also had to suffer stamp duty for the transfer of
shares2. To avoid all these problems, the concept of paperless scrip has been introduced. The shares
are no longer issued in the physical form. This process of conversion of physical share certificates
into paperless scrips is known as dematerialisation. All these benefits are introduced by the
depositories system brought through by the Depositories Act, 1996.

This paper is mainly a study of the ‘dematerialisation’ process in the Indian capital market,
which was introduced through the aforesaid enactment. The paper is divided into five parts. First
part introduces the depository system in India and also looks at the need and objectives of the
depository system in India. Second part introduces the process of dematerialisation looking at the
players involved in dematerialisation. Third part further dissects the demat process and looks at the

V Year, Hidayatullah National Law University, Raipur, Chhatisgarh.

V Year, Hidayatullah National Law University, Raipur, Chhatisgarh.
1 R. Suryanarayana & V. Varadrajan, ‘SEBI: Listing and Procedure 823’ (Commercial Law Publishers,
2 Id.

procedure involved in dematerialisation of securities. Second last part looks at the pros and cons of
dematerialisation while the last part finally concludes the paper evaluating the success and failure of
the dematerialisation in the Indian capital market.


The rapid growth in number, volume of value of securities in the Indian capital market exposed the
limitation of handling securities in the physical/paper mode. As a result, in line with the
developments in the securities industry worldwide and in the wake of the increasing trading volume
as the local bourse, there emerged the need to replace the existing settlement and clearing system
with depository system or a scrip less trading system3.

As stated above, the depository system in India was introduced through the Depositories
Ordinance of 1996. The Black’s Law Dictionary defines a depository as ‘a party or institution
receiving a deposit. One with whom anything is lodged in trust, as depository is the place where it is
put’4. The Depositories Act, 1996 defines a ‘depository’ as a company formed and registered under
the Companies Act, 1956 and which is granted a certificate of registration under the Securities and
Exchange Board of India (SEBI) Act, 1992, s. 12, sub-s. 1A5. Thus, depository is the person or a
company to whom securities are entrusted for safekeeping and handling dealings in them on behalf
of the owner of the securities6. A depository may also be compared to a bank. A depository holds
securities (like shares, debentures, bonds, Government Securities, units etc) of investors in electronic
form. Besides holding securities, a depository also provides services related to transactions in

3 P. V. Nishanth & Anandita Mishra, ‘Dematerialisation in the Indian Capital Market’.

4 Black’s Law Dictionary 235 (Bryan A. Garner (ed), 7th edn, West Group, St. Paul, 1999).
5 Depositories Act, 1996, s. 2 (1) (e).
6 Dr. K. R. Chandratre, Bipin Acharya, Dr. S. D. Israni & K. Sethuraman, Compendium on SEBI and
Capital Issue Listing 1149 (Bharat Law House, 3rd edn. 2004).

securities7. A depositary is central location for keeping securities, which makes scrip less trading
possible. There are two methods in the depository system:
(1) immobilisation; and
(2) dematerialisation.

Under immobilisation, the securities are held by the depositary in a physical form in its own
vaults, but the transfer of securities takes place through book entries. Under dematerialisation the
securities in a physical form are destroyed (that is dematerialised) and corresponding balances are
electronically credited to the books entries. Dematerialisation essentially aims at eliminating
voluminous and cumbersome paper work involved in the script-based system and offers scope for
‘paperless’ trading through state of-the-art technology. India has adopted the latter method. Thus,
the Companies Act, 1956, s. 68B introduced from 13 December 2000 stipulates that every public
company, making initial public offer of any security for a sum of 10 crore or more, will issue the
same only in dematerialised form. As per SEBI (Disclosure, Investors Protection) Guidelines, 2000,
cls., no company will make public or rights issue or an offer for sale unless:
(1) The company enters into an agreement with a depository for dematerialisation of
securities already issued or proposed to be issued to the public or existing shareholders;
(2) The company gives an option to subscribers/shareholders/investors to receive the
security certificates in physical form or hold the securities in dematerialised from with
the depository 8.

The Need and Objective of Depository System in India

The present system of settlement based on physical delivery of paper certificates was probably

7 NSDL’s Guide to Depositories, available at, http://www.nsdl.co.in/guideto depositories.pdf.

8 The explanation to the section reads, ‘A depository will mean a depository registered with the board
under the SEBI (Depositories and Participants Regulation), 1996’, see generally, DIP Guidelines,
2000, cls.

adequate in the past when there was small number of investors participating in the transaction of the
capital market9. The old trading system was affected by a lot of problems such as unwarranted delay
in transfer of shares, duplicate/fake forged shares, court injunction cases, bad deliveries, loss in
transits/theft/mutilation, disputes or corporate actions, huge transaction cost, longer settlement
cycles, poor infrastructure and large paper volume 10. All these factors serve as barriers to entry of
investors in to the market. This failure gave the idea of setting up of an electronic system with scrip
less trading and quick settlements cycle. The technological revolution was affecting the entire nation
at that time and the Indian capital market took advantage of the prevailing transformation to
introduce the demat form of trading in securities. The recording, keeping and maintaining shares in
a dematerialised form is the worldwide practice these days followed by all the developed and
developing countries of the world.


Dematerialisation is the process by which physical certificates of an investor are converted to an

equivalent number of securities in electronic form and credited in the investor’s account with its
depository participant11. The securities are not identified by numbers or a certificate or title. There
are mainly four players involved in the dematerialisation process:


A depository is the chief player in the system and is basically organised as a company. The
depository may not engage itself in the process unless it is registered with SEBI under the SEBI
(Depositories and Participants Regulation), 199612. It is an organisation where the securities of an
investor are held in electronic form through the medium of Participants. It enables surrender and

9 Nishanth & Mishra, see supra note 4.

10 Id.
11 NSDL’s Guide to Depositories, see supra note 8.
12 See also, the Depositories Act, 1996 s. 3.

withdrawal of securities to and from the depository through the process of demats and remats.
Every depository is obliged to maintain constant continuous electronic means of communication
with all its participants, issuer, clearing houses and clearing corporations13. In India, two depositories
have come up so far. They are the National Securities Depository Limited (NSDL) and Central
Depository Services Limited (CDSL). NSDL is an organisation promoted by UTI and National
Stock Exchange of India Ltd with its headquarters in Mumbai. The aim is to provide facilities for
holding and handling securities in electronic form14. As a depository, NSDL (1) acts as a custodian as
well as legally transfer beneficial ownership, (2) reduces settlement risk by minimising the paper
work involved in trading, and settling and transferring securities. CDSL is the second depository in
the country, after NSDL promoted by the Bombay Stock Exchange (BSE), Bank of India, Bank of
Baroda, HDFC Bank, State bank of India offering services similar to NSDL15.


A participant is assigned the role to act as the agent of the depository 16 under the enactment and
may not act unless registered with the SEBI. In fact, the Depositories Act, 1996 defines a participant
as a person registered as such under SEBI Act, 1992, s. 12, sub-s. 1A17. A participant may belong to
one of the following categories:
(1) a public financial institution as defined in the Companies Act, 1956, s. 4A;
(2) a Bank as per the RBI Act, 1934, sch. II;
(3) a foreign bank operating in India;
(4) a state financial corporation;
(5) an institution promoted by any of the institutions in sub-clauses (1) to (4) above;
(6) a custodian of securities recognised by SEBI;

13 R. Suryanarayana & V. Varadrajan, see supra note 2, 827.

14 P Mohana Rao, Dematerialisation, available at, http://myicwai.com/knowledgebank /fm13.pdf.
15 Id.
16 Depositories Act, 1996, s. 4.
17 Id, s. 2(1)(g).

(7) a clearing corporation or clearing house of a stock exchange;
(8) a stock broker registered with SEBI having net worth as prescribed;
(9) a non-banking finance company as specified; and
(10) a registrar or share transfer agent as specified.

A participant is a first point of contact with the investor. The depository participant serves a
link between the investor and the company through the depository in dematerialisation of shares
and other electronic transactions.18 As the depository is operated electronically, every participant
shall at all times have adequate automatic data processing systems, adequate and competent staff,
risk management systems and procedures.19


The issuer is the company which issues the security20. DIP Guidelines, 2000, cls. 2.1.provides that if
a company makes a right issue of a value exceeding Rs. 50 lakhs or a public issue, it will enter into an
agreement with a depository for dematerialising its shares or other securities21. In case of the listed
companies, which have shares already in the physical form, SEBI is making them enter into
agreements with a depository to have their securities converted into dematerialised form.

Beneficial Owner

In the case of shares, the beneficial owner is the person who is known as the member of a company
holding shares and share certificates in the physical mode. In case of a demat account, the situation
is a bit different. By a legal fiction, the depository is the registered owner and the person to whom

18 P Mohana Rao, see supra note 15.

19 R. Suryanarayana & V. Varadrajan, see supra note 1, 828.
20 Depositories Act, 1996, s. 2 (1) (f).
21 SEBI (Disclosure, Investors Protection) Guidelines, 2000, cls. 2.1.2,

the share is allotted as the beneficial owner22. The Depositories Act, 1996 defines a ‘beneficial
owner’ as a person whose name is recorded as such with a depository 23. For facilitation of transfer
and avoidance of scrips, the depository has the power to affect transfers without referring the matter
to the issuer. Other than this, the beneficial owner is entitled to the same rights and obligations due
to a member of the company under the Companies Act, 1956.


Dematerialisation is the process of conversion of physical certificates into the electronic form.
Existing listed companies and new companies proposing to issue securities in public or any person
holding securities in the physical mode may enter into an agreement with a depository to convert his
securities in the demat form24. The Depository Act, 1996 does not make it compulsory for every
investor to convert its shares in the demat form, but rather makes it optional25.

The whole dematerialisation process may be explained through a simple flow chart.

Depository Depository

Company ----------------------Corporate Benefits------------------- Investor

22 R. Suryanarayana & V. Varadrajan, see supra note 2, 829.

23 Depositories Act, 1996, s. 2 (1) (a).
24 Dr. K. R. Chandratre et al, see supra note 7, 1162.
25 Depositories Act, 1996, s. 6.

Figure 1: Flow Chart of the Dematerialisation Process

The operation is a simple six-step process, as characterised by P. Mohana Rao and P.V. Nishanth’s
and Anandita Mishra’s study on dematerialisation in the Indian capital market. In the flow process,
assuming that the depository is NSDL, the various steps that are involved are:

Step 1

Shareholder/Investor approaches to a depository participant of his choice and opens an account just
like an account with a bank. With the opening of account, shareholder gets an identification number
called ‘Client’s ID’ which serves as a reference point for all transactions and correspondence with
the depository participant. The shareholder fills up a Dematerialisation Request Form (DRF) to be
provided by the depository participant and hands it over along with share certificates duly cancelled
by writing ‘Surrendered for dematerialisation’ to the depository participant for demat26. The DP will
accept certificates registered only in the name that holds the share certificates.

Step 2

Upon receipt of DRF along with the original share certificates, the DP sends an electronic request to
company through NSDL for conformation of demat and simultaneously surrenders the
shareholdings. DRF and share certificates are accompanied by standard letter to the company for
demat confirmation.

Step 3

26 Depositories Act, 1996, ss. 5 and 6.

A Company must be equipped with the requisite hardware/software facility. It must be linked to the
NSDL network through a V-Sat connection.

Step 4

On receipt of the DRF and share certificates of the shareholder, necessary verification is done and
demat is confirmed to NSDL by the registrar.

Step 5

NSDL further confirms the demat to the shareholder’s DP.

Step 6

DP credits the shareholders’ account with the number of shares so dematerialised and thereafter the
shareholder holds the securities in electronic form. DP of the shareholder gives a statement of
holdings and updates account after each transaction just like bank account.

Other features of Dematerialisation

(1) Once a shareholder opens an account with the depository participant, he may buy or
sell shares in electronic form without any paper work;
(2) the need for stamp duty of 0.5 per cent is also done away with27;
(3) A shareholder may open accounts with any number of DPs of his choice just as
opening bank account with a number of banks. Shareholder may trade in depository
mode through any broker registered with National Stock Exchange.
(3) there is no minimum balance required in a demat account28;

27 Depositories Act, 1996, s. 8A.

(4) shareholders may pledge/hypothecate shares held in electronic form by making an
application to the participant29;
(6) at any time, as a security measure, shareholder may stop transaction in his account, he
may accordingly advise his depository participant. DP will ensure the customer
shareholders that his account is totally frozen until further instructions from the
shareholders; and
(7) the shareholder has also got the option of converting his electronic holdings into share
certificates by requesting his depository participant for a remat. The process is known
as rematerialisation.


It has already been stated, a number of times, that the Indian capital market was affected by a
number of malaises due to the scrip based system. The introduction of the demat system has done
away with such disadvantages and as such offers a number of benefits to the players involved.

Advantages to the Issuer

(1) The companies would be able to substantially reduce the costs associated with public
issues. Such costs include printing of share certificates and postal charges;
(2) globalisation being the current buzzword, demat will enhance the image of the
(3) up-to-date knowledge of shareholder’s names and addresses;
(4) improved ability to attract international investors without having to incur the
expenditure of issuance in overseas market; and
(5) the approval procedure for transfers would be eliminated30.

28 ‘Demat Simplified’, available at, http://www.nsdl.co.in/dsimp.pdf.

29 Depositories Act, 1996, s. 12.

Advantages to the Investors
(1) Electronic transactions eliminate the problems and delays out scrip-based system;
(2) there is no scope of any risk of loss, theft, damage or fraud and bad deliveries are
(3) there is no hassle of filling a transfer deeds and lodging/dispatching the transfer
documents with the company;
(4) shareholders no longer have to wait for the shares transferred in his name. Delay is
almost eliminated;
(5) this system totally eliminates risks associated with loss/fraudulent interception of share
certificates in postal transit;
(6) shareholders save stamp duty @ 0.5 per cent of the market value of shares. Of course,
he has to incur some service charges charged by the DPs;
(7) in the physical mode, shares may only be sold and bought at marketable lot. No such
hassle is experienced in the demat mode;
(8) in the physical mode, there is scope for the Board of Directors registration of a transfer
of power vested with the Board by the Articles of Association of the Company. No
such discretion is available to the Board of Directors as the transfer of shares does not
pass through the company in the demat mode31; and
(9) genuineness is always guaranteed in the demat mode.

Other than this there are many benefits that would accrue to the Indian capital market as a
whole. The markets would be henceforth more liquid and in line with the international standards. It
would also create improved prospects for privatisation of the public sector units by creating a

30 Venkatraman, see supra note 2, 828.

31 Id.

conducive environment32. It would also restore the faith in capital markets and the participants with
systems to minimise settlement and fraud.

Perhaps the only drawback that has been highlighted about the dematerialisation system is
that the company has no means to refuse transfer of the shares as the depository holds them. But, as
shown above, this might be a good thing from the investors’ point of view as he is sure, that once
the sale of shares is affected through the stock exchange, the purchaser is not subjected to any doubt
whether the transfer would be refused by the board of directors33.


This study has been a small effort to look at the basics of the demat system highlighting its both
advantages and disadvantages.

The Indian capital market has been invariably linked to the international one and the market
regulator SEBI, has taken up many steps to ensure that the market remains liquid and investor
friendly. Dematerialisation of shares is one such process. Due to many benefits of the system, it
became more popular in the capital market in India. It is much improved method over the scrip-
based system. This system is more flexible in the sense that it may be reconverted into
rematerialisation from electronic process to ordinary certificates at the option of the security holders.

But the above in no way demonstrates that the system is foolproof. The role of the
depository participant has not yet been clear enough and has remained undefined. The hype created
by the system has also meant that there has been a flood of demat requests from the investors and
clearly, only two depositories, NSDL and CDSL, have not been able to cope up with the glut.

32 Dr. K. R. Chandratre et al, see supra note 7, 1155.

33 R. Suryanarayana and V. Varadrajan, see supra note 2, 827.

However, it was the draw back of the old system prompted its evaluation and led to the birth
of the depository system. Looking at the old system, the process of dematerialisation has been more
than successful.