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Study Of The Depository System In India Finance Essay

Depositories Act, 1996, defines a depository as"a company formed , registered under the Companies Act, in 1956 and which has been granted by the certificate of the registration of the Securities and Exchange Board of India Act, 1992.

At present, the two depositories are registered with SEBI

The National securities depository Limited (NSDL)

Central Depository Services Limited (CDSL).

The term depository is defined as the central location for keeping securities on deposit”. It can also defined as the facility for holding securities,or either in certificated or uncertificated form to enable the book entry transfer of securities”. It is understood from the above definitions that the depository is the place where securities are stored, and recorded in the books on the behalf of the investors. Therefore, a depository can also be defined as, “an institution which transfers the ownership of the securities in electronic mode on the behalf of its members”.

The operations of depositories are primarily governed by Depositories Act, 1996,and the Securities and Exchange Board of India Regulations, 1996,and Bye-Laws approved by the SEBI, and Business Rules framed in the accordance with the Regulations and Bye-Laws. Only the company registered that is under a Companies Act, in 1956 and are sponsored by the specified category of institutions can be set up the depository in India. Before the commencing operations,and depositories should obtain the certificate of the registration and a certificate of the commencement of business from the SEBI.

The principal function of the depository is to dematerialize securities and to enable their transactions in the book-entry form. The securities are transferred by the debiting the transferor's depository account and crediting the transferee depository account.

FUNCTIONS OF DIPOSITORY

Dematerialization:

The primary functions of the depository is to eliminate or to minimize the movement of the physical securities in the market. This can be achieved through dematerialization of the securities. Dematerialization is the process of the converting securities held in physical form into the holdings in book entry form.

Account Transfer:

The depository gives effects to all the transfers resulting from the settlements of the trades and other transactions between the various beneficial owners by the recording entries in the accounts of such beneficial owners.

Transfer and Registration:

A transfer is the legal change of ownership of the security in the records of the issuer. For effecting the transfer , certain legal steps have to taken like endorsement , and execution of the transfer instrument and payment of the stamp duty. The depository accelerated the transfer of process by registering the ownership of the shares in the name of the depository.

Corporate Actions:

A depository made handle corporate actions in the two ways. In the first case , it is merely provides information to issuer about the persons entitled to receive corporate benefits. And in the next case , depository itself takes the responsibility of the distributing the corporate benefits.

Pledge and Hypothecation:

The securities held with NSDL may be used as the collateral to secure loans and other credits by clients. In the manual environment, borrowers are required to be deliver pledged securities in the physical form to the lender or custodian. These securities are verified for the authenticity and often need to be transferred in name of lender. This has the time and money cost by the way of transfer fees or stamp duty. If borrower wants to substitute the pledged securities, then these steps have to be repeated. Use of depository services for the pledging/hypothecating the security makes process very simple and cost effective. The securities pledged or hypothecated are transferred to the segregated or collateral account through the book entries in the records of the depository.

Linkages with Clearing System:

Whether it is the separate clearing corporation attached to the stock exchange or clearing house (department) of stock exchange, the clearing system performs the functions of the ascertaining the pay-in (sell) or pay-out (buy) of the brokers who have been traded on the stock exchange. Actual delivery of the securities to the clearing system from the selling brokers and the delivery of securities from clearing system to the buying broker is done by depository. To achieve this,the depositories and the clearing system should electronically linked.

Key Features of the Depository System in India

Multi-Depository System: The depository model adopted in India provides for acompetitive multi-depository system. There can be various entities providing depository services. A depository should be a company formed under the Company Act, 1956 and should have granted a certificate of registration under Securities and Exchange Board of the India Act, 1992. Presently, there are two depositories registered with SEBI, namely: o National Securities Depository Limited (NSDL), and Central Depository Service Limited (CDSL).

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.

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.

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.

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, ‘Registered Owner’ means that a depository whose name is to entered as such in the register of 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 the Registered 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.

Free Transferability of shares: Transfer of shares held in dematerialized form takes place freely through electronic book-entry system.

Need of Depository System

Time consuming trading system

Inefficient system to transfer of ownership

Risk of theft , forgery and mutilation of securities

Time consuming and costlier settlement

Benefits/Advantages of the Depository System

The advantages of dematerialization of securities are as follows:

Share certificates, on dematerialization, are cancelled and the same will not be sent back to the investor. The shares, represented by dematerialized share certificates are fungible and, therefore, certificate numbers and distinctive numbers are cancelled and become non-operative.

It enables processing of share trading and transfers electronically without involving share certificates and transfer deeds, thus eliminating the paper work involved in scrip-based trading and share transfer system.

Transfer of dematerialized securities is immediate and unlike in the case of physical transfer where the change of ownership has to be informed to the company in order to be registered as such, in case of transfer in dematerialized form, beneficial ownership will be transferred as soon as the shares are transferred from one account to another.

The investor is also relieved of problems like bad delivery, fake certificates, shares under litigation, signature difference of transferor and the like.

There is no need to fill a transfer form for transfer of shares and affix share transfer stamps.

There is saving in time and cost on account of elimination of posting of certificates.

The threat of loss of certificates or fraudulent interception of certificates in transit that causes anxiety to the investors, are eliminated.

Disadvantages/Problems of the Depository System

Some disadvantages were about the depository system were known beforehand. But since the advantages outweighed the shortcomings of dematerialisation, the depository system was given the go-ahead.

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

Need for greater supervision: It is incumbent upon the capital market regulator to keep a close watch on the trading in dematerialized securities and see to it that trading does not act as a detriment to investors. The role of key market players in case of dematerialized securities, such as stock brokers, needs to be supervised as they have the capability of manipulating the market.

Complexity of the system: 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. Besides the above mentioned disadvantages, some other problems with the system have been discovered subsequently. With new regulations people are finding more and more loopholes in the system.

Process

There are four parties in the demat transaction: the customer, the depository participant, the depository, and the share registrar and transfer agent.

Opening an account

An investor who want to avail of the services will have to be open an account with depository through a DP, who could ethier be the custodian , a bank, a broker, or individual with a minimum net worth rs. 1 crore. The investor has to enter into an agreement with the DP after which he is issued a client account number or the client ID number.

Dematerialisation Process

Dematerialisation is a process by which the physical certificates of an investor are taken back by the Company or its Registrars and an equivalent number of securities is electronically credited in the demat account of that investor. In other words, the shareholding gets converted from physical form to that of electronic form.

For Dematerialisaion of securities, an investor will have to first open an account with a Depository Participant and then submit request for dematerialisation of the securities in a specified form alongwith relevant certificates. The demat request alongwith the certificates is forwarded by DP to the Company or its Registrar who after due verification will confirm the dematerialization and the investor's account with his Depository Participant will get credited to the extent of shares applied for demat. However, in the records of the Company or its Registrar the Depository's account will get credited as it is holding the securities on behalf of the investor, and the name of the investor is shown in records as beneficial owner of shares.The entire process of Dematerialisation has to be completed within a period of 21 days from the date of receipt of demat request by Depository Participant (DP). Whenever there is any Corporate Action, like, distribution of dividend or issue of bonus shares, the company will obtain the shareholding position of dematerialised shares from the Depository through a Beneficial Position statement called BENPOS, and then issue Corporate Benefits to shareholders on that basis.

Rematerialisation Process

Rematerialisation is a process of converting electronic share holding back into the physical holding. The Depository Participant should be given a request for Rematerialisation in a specified form who in turn will forward the same to the Depository. The Depository after verifying that the investor has necessary securities balance, will intimate the company or its Registrar accordingly, who in turn, will print the relevant certificate and despatch the same to the investor.

The entire process of Rematerialisation has to be completed within a period of 30 days from the date of receipt of Remat request.

The DPs charge for certain items like

Account opening charges

Demat charges,

Remat charges,

Transaction charges, etc.

Investors should carefully choose a DP after evaluating various factors like

Quantum of charges

Quality of services offered

Convenience of dealing

Their overall reputation etc.

Distributing dividend

A company or a registrar and transfer agent shall make known the depository of the corporate actions such as date for books closure, redemption or maturity of security, conversion of warrants and call money from time to time. The depository will then electronically provide the list of the holdings of the client as on the cut off date. The company can then distribute dividend, interest and the monetary benefits directly to the client on the basis of the list . if the benefit are from the securities, the company or its registrar and the transfer agent may distribute these provided the newly created securities in the eligible security and the client has consented to retrieve the benefits through depository.

Closing an account

A client waiting to close an account shall make the application in the format specified to effect to the participant. The client can close his account if no balances are outstanding in his credit in the account. If any balances exist, then the account may be closed .

Function of NSDL and CDSL

National securities depository limited is the first depository to be set up in india. It was incorporated on dec 12, 1995. The industrial development bank in india, unit trust of india- the largest development bank in india, unit trust of india- the largest Indian mutual fund and NSE, sponsored the setting up of NSDL and subscribed the initial capital

Function of NSDL

NSDL performs the following functions through depository participants.

Enables the surrender and withdrawal of securities to and from the depository.

Maintains investor holdings in the electronic form.

Effect settlements of securities traded on the exchanges.

Carriers out settlements of trade not done on the stock exchange

Transfer of securities.

Pledging / hypothecation of dematerialization securities.

Electronic credit I public offerings of companies or corporate actions.

Receipt of non cash corporate benefits like bonus rights, etc in electronic forms.

Stock lending and borrowing.

CSDL

A depository facilitates holding of securities in the electronic form and enables securities transactions to be processed by book entry by a DP, who as an agent of the depository ,offers depository services to investors. According to SEBI guidelines, financial institutions, bank,etc are eligible to act as DPs. The investor who is known as an beneficial owner for dematerialization of his holdings and transferring securities.

The balances in the investors account recorded and maintained with CDSL can be obtained through the DP. The DP is required to provide the investor, at regular intervals, a statement of account which gives the details of the securities holdings and transactions. The depository system has effectively eliminated paper-based certificates which were prone to be fake, forged, counterfeit resulting in bad deliveries. CDSL offers the efficient and instantaneous transfer of the securities.

CDSL was promoted by Bombay Stock Exchange Limited (BSE) jointly with leading banks such as SBI, BOB, HDFC Bank, Standard Chartered Bank, Union Bank of India and Centurion Bank

CDSL was set up with the objective of providing convenient, dependable and secure depository services at affordable cost to all market participants. Some of the important milestones of CDSL system are:

CDSL received the certificate of commencement of business from SEBI in February, 1999.

Honourable Union Finance Minister, Shri Yashwant Sinha flagged off the operations of CDSL on July 15, 1999.

Settlement of trades in the demat mode through BOI Shareholding Limited, the clearing house of BSE, started in July 1999.

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.

As at the end of Dec 2007, over 5000 issuers have admitted their securities (equities, bonds, debentures, commercial papers), units of mutual funds, certificate of deposits etc. into the CDSL system.

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