Prior to the introduction of Depository System in India, the companies used to issue physical share certificates. The Indian share market followed open outcry system, where investors buy and sell shares physically. The physical share certificates represent the shares’ ownership in a company. This system was also known as Scrip-based Trading System.
With the advent of globalization and evolution of information technology, the Depository System was introduced in India in 1996. The Depository system was first introduced in Germany in 1947.
In Depository System, the securities of investors are held in the electronic form with the depository. Since this system dispenses the movement of securities in physical form, therefore it is also called Scripless Trading System. It makes the financial market more systematic and disciplined.
What is Depository System?
Depository system is a system in which the securities of investors are held in the electronic form with the depository. It eliminates the voluminous and cumbersome paper work involved in the scrip-based system The transfer of securities takes place by means of book entries on the ledger of the depository. The depository holds the securities of investors at the request of the investors through a registered depository participant. It holds securities like shares, bonds, debentures, mutual funds, government securities etc.
What is a Demat Account?
A Demat account is like a bank account that shows the securities holding of an investor. It holds securities of investors in digital form. An investor can open Demat account with depository through depository participant. SEBI has made it mandatory for all the public limited companies to have their securities in demat mode only.
Dematerialisation vs Rematerialization
Dematerialisation is the process by which physical certificates of securities of an investor are converted to an equivalent number of securities in electronic form.
Rematerialization is the process of converting securities held in electronic form in a demat account back in physical certificate form.
Functions of Depository System
The prominent functions of depository system are:
- It acts as link between companies that issues securities and investors.
- It allows quick transfer of securities from one investor to another.
- It eliminates the chance of forgery, fake certificates, bad deliveries, theft, damage of securities.
Parties involved in Depository System
There are five parties involved in Depository System:
- Depository Participant
- Beneficial Owner
- Registrar and Transfer Agent (RTA)
The Depository is an institution which maintains an electronic record of ownership of securities. It is company that has been formed and registered under the Indian Companies Act, 2013 & has been granted a certificate of registration by SEBI, subsequent to registration under the Depositories Act, 1996. It is an institution alike bank for securities where the dematerialized physical securities are traded and held in custody. Thus, depository is a custodian of its client’s securities. It interfaces with its investors through its agents called depository participants.
The legal ownership of securities is with depository, but the beneficial ownership is with investor. The depository name is 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.
A Depository Participant (DP) is an agent of the depository through which it interfaces with the investor and provides depository services. DP is the intermediary between the investor and the depository. The relationship between the depository and the DP will be of a principal and agent.
The depository holding the securities maintains ownership records in the name of each DP, DP in return as an agent of depository, maintains ownership records of every beneficial owner (investor) in book entry form.
The following entities can register themselves as depository participant with SEBI:
- Public financial institutions
- Scheduled commercial banks
- Foreign banks operating in India with the approval of the Reserve Bank of India
- State financial corporations
- Clearing corporations / clearing houses
- Registrar to an issue or share transfer agent
A demat account can be opened only though a depository participant of depository. It cannot be opened directly with depository.
The investor whose securities are held in electronic form in a demat account opened with a depository through a Depository Participant is called as ‘Beneficial Owner’ (BO). All the benefits as a result of the holding the securities are given to such beneficial owner.
Issuer means any entity such as a corporate / state or central government organizations issuing securities which can be held by depository in electronic form
Registrar and Transfer Agent (RTA)
An RTA is an agent of the issuer. RTA acts as an intermediary between the issuer and depository for providing services such as dematerialization, rematerialization, initial public offers (IPO) and corporate actions.
The Depositories Act 1996
The Government of India enacted the Depositories Act 1996 to start depository services in India. According to this act, the Depository means:
- A company formed and registered under the Companies Act, 1956 and
- Which has been granted a certificate of registration under section 12(1A) of the SEBI Act, 1992.
Advantages of Depository System
The important advantages of depository system are:
- Dematerialization of securities
- Fungibility: Securities does not carry a distinct number or certificate numbers. Thus, all shares of particular company are identical to each other and are interchangeable. However, 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.
- Free transferability of shares
- No risk like theft or loss of share certificates
- Cost efficiency and convenient
- Faster risk free and low-cost settlement
- Reduction in paperwork
Depositories in India – NSDL vs CSDL
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. The minimum net worth stipulated by SEBI to operate as depository is Rs.100 crores. There are two SEBI registered depositories in India:
- National Securities Depository Limited (NSDL): 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 in 1996.
- Central Depository Services (India) Limited (CDSL): The Central Depository Services (India) Limited (CDSL) is the second depository in India that has been promoted by Bombay Stock Exchange Limited (BSE) together with leading banks such as State Bank of India, HDFC Bank and others in 1999.
Registered Owner vs Beneficial Owner
When physical shares are converted into electronic form, the depository becomes ‘Registered owner” in the books of the company and actual investor’s name is removed from books of the company. However, the actual investor is the “Beneficial Owner” (BO) of the securities. All the benefits of the dematerialized shares are given to the actual investor since the depository holds the securities in a fiduciary capacity on behalf of the investors who have opened a demat account with the depository.
Following services are provided by a depository to the investors through its depository participant:
- Opening a demat account
- Maintaining record of securities held by the beneficial owners in the electronic form
- Settlement of trades by delivery or receipt of securities from / in BO accounts
- Settlement of off-market transactions between Bos
- Receiving electronic credit in respect of securities allotted by issuers under IPO or otherwise on behalf of demat account holders
- Receiving non cash corporate benefits such as allotment of bonus and rights shares or any other non-cash corporate benefits given by the issuers in electronic form on behalf of its demat account holders
- Pledging of dematerialized securities & facilitating loans against shares
- Freezing of the demat account for debits, credits, or both
FAQ on Depository System in India
- How many depositories are there in India?
There are two depositories operating in India namely National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL).
- How many depository participants are there in India?
As on October 2022, there are 285 depository participants operating in India.
- Who is the first depository in depository system in India?
The National Securities Depository Limited (NSDL) was the first depository system established in India
- What is NSDL and CDSL?
NSDL means National Securities Depository Limited and CDSL means Central Depository Services (India) Limited. Both are depositories in India.
- Who owns CDSL?
CDSL is promoted by Bombay Stock Exchange in association with prominent banks of the nation, i.e. State Bank of India, Union Bank of India, Bank of Baroda, Bank of India, Standard Chartered Bank
- Who is the owner of NSDL?
NSDL is promoted by three premier institutions in India, viz., Industrial Development Bank of India (IDBI), Unit Trust of India (UTI) and National Stock Exchange of India (NSE).
- What is the full form of CDSL?
Th full form of CDSL is Central Depository Services (India) Limited
- What is the full form of NSDL?
The full form of NSDL is National Securities Depository Limited
- What is the full form of demat?
Demat is the short form of dematerialised account. A Demat account holds securities of investors in digital form.
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