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The Need For Depository Systems In India

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Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Thu, 18 May 2017

With the existence of 23 recognized stock exchanges, Indian capital market has been witnessing rapid growth in recent past. However, this growth has not matched with supporting infrastructure to handle the growing volume of paper that has flooded the market choking and existing system. This has caused problems like delay in transfer, long settlement periods, bad deliveries etc. With the view to globalize Indian capital market in a real sense, the government of India has initiated a number of financial reforms that were initiated in 1991 as part of the structured reforms comprising industrial de-regulation, privatization and globalization. A thigh committee on financial system with Sh. Narsihma Rao as the chairman has set up in 1991, which made for reaching recommendations for banking sector and non-banking financial sector to improve the flexibility and operational efficiency of the markets. Securities Exchange Board of India, Reserve Bank of India, Department of Company Affairs and Ministry of Finance are the important regulatory bodies of the capital market measuring the effective and efficient functioning of the market.

SEBI also constituted a number of committees such as G.S. Patel Committee to review the system of carry forward transactions in the stock exchanges, Malegram Committee to review the disclosure practices of companies in primary market, Bhave committee to examine problems pertaining to transport shares. The earlier system, a paper based mode, entails cumbersome legal formalities for the purpose of transfer of securities and settlement of transaction theorem. The earlier system suffered from the following shortcomings, thereby arising the need for depository system, these are Lack of supporting infrastructure, Problems in transactions, Delayed settlements, Soaring costs of transaction, Transactions end up as bad deliveries due to faulty compliance of paper work, mismatch of signatures on transfer deeds with specimen record of the issuer, Theft, mutilation of certificates and other irregularities. The modern system i.e. depository system is the system whereby the transfer and settlement of scrips take place not through transfer deeds and physical delivery of scrips which are traditional but through the modern system of effecting transfer of ownership of securities by means of book entry on the ledgers of the depository without physical movement of scrips.

History of stock exchanges

The Indian stock markets are nearly 128 years old, with the Bombay stock exchange, the oldest of them functioning since 1875. At present there are 23 recognized stock exchanges. Stock exchanges are the most perfect type of market for securities whether of government and semi-government bodies or other public bodies as also for shares purchases and sales of shares are made in the conditions of the competitions. The bargains that are struck in the trading ring by the members of the stock exchanges are at the fairest prices determined by the basic laws of supply and demand.

Development in the capital market

The reforms for Indian capital market is mainly focused on market regulation, primary market functioning, secondary markets trading, development of a proper debt securities trading market, development of a derivatives market (futures and options), development of an integrated national market system, technological investment in exchanges, investor protection and more foreign portfolio investment in exchanges. SEBI, the regulatory body of the capital market, has been taking various steps and has introduced various guidelines for the efficient functioning of the market and has also constituted various committees to review the existing system and suggestions for further reforms.

Deficiencies in the existing system of Scrips Transfer

The existing system, a paper based mode, entails cumbersome legal formalities as per section 108 of Indian Companies Act, 1956, for the purpose for transfer of securities and settlement of transaction there on. The present system suffers from the following shortcomings, thereby arising the need for depository system, these are:

Lack of supporting Infrastructure

Problem in transactions

Global Imperatives

Problems in dealing with Securities

Greater mobility of Securities

Cumbersome legal system

Need for depository system

Indian capital market has been witnessing rapid growth in recent past. However, this growth has not watched with supporting infrastructure to handle the growing volume of paper that has flooded the market, choking our existing system. This has caused problems like delay in transfers, long settlement period, high levels of failed trade and bad deliveries, high-risk exposure etc. These characteristics were normally the attributes of an under developed market. As the market grows, there is need for better system to ensure that such impediment to growth is removed. The foreign investors seeking to invest in India are also apprehensive about the reliability of the post trade settlement mechanism used in India.

The biggest deterrent or bottleneck in Indian capital market was largely manual and paper based settlement system that was obsolete for a rapidly growing market. Since 1992, old trading system in Indian stock exchanges has been under constant review. The main deficiencies have been identified in 2 broad areas: –

The clearing and settlement system in stock exchanges whereby delivery of shares by the seller and payment by the purchaser is made and

Procedure for transfer of shares in the name of the purchaser by the company.

The new system has eliminated paper work, facilitated electronic book entry of the transfer of securities, permitted automatic and transparent screen based trading in securities, shorter settlement periods and improved liquidity in investment in securities. All this has given impetus to the growth of the capital market in India. The transactions in a stock exchange, earlier involved physical movement of paper (the share certificate) which first changed hand from the seller to buyer on payment of price and subsequently was sent to the company (issuer of the share) for the change of the ownership of the shares to be incorporated in the books of the company. The process of verification of the ownership of the seller and hence validity of the sale took a long time, disabling the purchaser from the selling the shares further while the shares were being transferred in his or her name. Though section 113 of the Companies Act, 1956, stipulates that the company effects the transfer within 2 months. In reality transferring shares in ones name took longer. This delay reduced the liquidity of the investor, as during these times, he/she cannot sell the shares. This has proved particularly inconvenient for large investors for whom fast transfers were essential to maintain the liquidity. Apart from this, physical movement of shares also meant the possibility of theft and loss of shares in transit.

The magnitude of the problem has increased manifold as the daily turnover in stock exchange has increased considerably. The average daily turnover of BSE itself amounts to Rs. 500 crores with shares of more than 7500 companies, being traded by more than 650 brokers for more than 30 million investors in the country. This has necessitated the use of better and faster transfer system like computerized records as compared to the physical paper (security)

Emergence of Depositories

There are two depositories that have emerged in India: –

National Securities Depositories Limited

The Honourable Union Finance Minister, Shri. P. Chidambram inaugurated NSDL as the first depository in the country on Nov 8, 1996. It has been promoted by three premier institutions in India the largest mutual fund UTI, the largest stock exchange NSE of India Ltd. Subsequently, the State Bank of India, the largest commercial bank in India has also taken up a stake in NSDL.

NSDL provides for electronic ownership, holding and transfer of securities trading in electronic securities on the NSE commenced in Dec, 96 and the first settlement of transactions in electronic securities was successfully completed at NSDL on Jan 7, 1997. The stock exchange Mumbai BSE also extended the facility of trading in electronic securities from December 27, 1997.

NSDL is responsible to every individual to every individual investor who holds electronic balances with the depository. The depository participant acts as an agent of NSDL for providing its services to the investors.

NSDL has designed the software for the operating systems in such a way that the software systems at the depository participant office are connected. Thus, a highly integrated set up for maintenance of investor accounts through the DP’s has been developed and implemented. NSDL has access to all the accounts of individual maintained by the DP’s to ensure adequate control.

The operating system of NSDL also maintains continuous electronic connectivity with the registrar and transfer departments/agents of the companies whose securities can be dematerialized in NSDL. To all the investors both retail and institutional, NSDL offers the following services:

Maintain beneficial holdings through depository participants.

Provide for dematerialization and Rematerialisation of securities

Dematerialization

Rematerialisation

Effect account transfers for settlement of trades

Allow for receipt of allotment in the electric form

Providing pledging, hypothecation facilities for stocks held with it.

Receive and disburse corporate actions (only securities)

Central Depositories Services Limited

This is the second depository after NSDL. This inter connectivity will be established prior to the commencement of business by CDSL. This will facilitate settlement and movement of assets and custody from one depository to another. CDSL has been promoted by the Stock Exchange, Mumbai (BSE), in association with Bank of India, Bank of Baroda, HDFC Bank and Stare Bank of India. It has been able to tie up with as many as 35 brokers till now.

CDSL and NSDL both have signed a MoU for inter-depository connectivity on 23rd April 1999. The MoU covers the understanding between the depositories for inter-depository transfers arising out of transactions not settled through the CH/CC (off market). The procedure for inter-depository transfers between CDSL and NSDL arising out of transactions settled through a CH/CH (on market) are expected to be finalized separately.

The Depositories Act, 1996

The Depositories Act makes a provision for the setting up of multiple depositories in India. The investor has been granted the option of holding securities in a physical or dematerialized from. Thus it is a matter of choice for the investor as to whether he wants to avail of depository services. The depository has been entrusted with the responsibility of indemnifying beneficial owners for any loss caused due to negligence of the depository or its participants.

For holding securities in the depository, the two routes that are adopted by depositories world over as:

Immobilization

In this the depository holds the securities in the physical form in its own vaults, but

transfer of securities takes place through book entries.

Dematerialization

In this the securities in physical form are shredded and corresponding credit is made in the form of electronic balances that are maintained in the depository account.

The concept of a depository has made a late entry into our country so we are fortunate to have the advantage o hindsight gained from the experience of other depositories the world over as well as adopting the latest technology. Thus, the law in our country has preferred the demat route. The demat securities will be identical and interchangeable as they will not have any unique characteristics such as distinctive number of folio. The depository will facilitate dematerialization of securities. The investor has the option of holding securities in the physical form or in the depository form. He can choose not to opt for depository system by requesting issue of physical certificates. The depository will, thus provide for Rematerialisation.

All rights with respect to the securities held in the depository will be with the beneficial owner (investor) and not with the depository, the depository acting as the registered owner only. When transacting through a depository, the investor will not be required to pay stamp duty on transfer of shares within the depository.

The depository will interface with the investors through market intermediaries called DP’s. The depository will hold beneficial owner the level in formation through its network of DP’s. The depository is obliged to provide this information to the issuer company or its registrar and transfer agent at regular intervals. This will facilitate proper distribution of benefits arising out of the investors holdings such as dividend, interest, bonus and rights as on a given record date by the issuer company or its registrar and transfer agent.

The SEBI Regulations, 1996

Based on the depositories ordinance, SEBI has notified regulations on 16th May 1996, which specify the norms for functioning and operations of depositories. The depository system is very similar to banking environment. Thus, while a bank performs the function of holding, transferring and allowing withdrawal of funds, a depository performs the function of holding, transferring and allowing withdrawal of securities. A bank reaches out to the masses by setting up its branches. Similarly, a depository reaches out to the general investor through its agents that are the DP’s. The regulations have selected various categories of market participants, who are eligible to become DP’s and have a well-established customer interface network and are therefore the ideal choice to become the agents of a depository.

The categories are:

Public Financial Institutions

Scheduled Banks

RBI approved Foreign Banks operating in India.

State Financial Corporations

Certified custodians of securities

Clearing corporations of stock exchanges

Registered stock brokers

Non-Banking Financial Companies.

Entities desiring to become DP’s must apply to the depository and are required to be recommended to SEBI by the depository. If approved and registered by the SEBI, the DP can be admitted on to the depository. The depository has to formulate its own set of criteria for selection of participants.

The regulations require the depository to list out through its byelaws the securities, which are eligible to be admitted to depository for dematerialization. Equity shares, debentures, warrant, bonds, units of mutual funds etc. are part of list of eligible securities. The depository is empowered to set its own criteria for selection of securities and make securities eligible to be maintained in the form of electronic holdings on the holdings of the depository.

Agreements should be entered into by the following entities:

Depository and every participant

Participant and every client

Depository, issuer company and the registrar

The drafts of these agreements are to be included in the byelaws and to be approved by SEBI. It is important that participants are connected to the depository through a continuous electronic communication system. The same is true for registrars or corporates communicating with the depository. In addition, for enabling settlements of securities, the depository is also to be connected electronically to clearing entities. This imposes the need for automatic data processing systems with necessary security features and forms one of the criteria for selecting securities for dematerialization.

The depository required to ensure that sufficient safeguards are there to protect the data available with it and with the participants. To reduce risk in operations, the regulations stipulate that the depository and DP’s must provide for, adequate insurance cover as well.

Since the depository acts as the source of information for the registrar in terms of providing beneficial ownership details, the depository has to reconcile data internally with the participants to ensure validity of data. The regulations require this reconciliation to be carried out on a daily basis.

Further the depositories and the registrar will also reconcile balances on a daily basis and periodic basis.

SHOWING THE DEPOSITORY INTERFACE WITH THE INVESTOR AND THEIR BUSINESS PARTNERS

NSDL

ISSUER R&T AGENT

CLEARING HOUSE

CLEARING MEMBER

DEPOSITORY PARTICIPANT

STOCK EXCHANGE

TRADING MEMBER

INVESTOR

NSDL is electronically linked to its DP’s, the R&T department of the issuer co. and the clearing corporation/ clearing house of the stock exchange. This is done in order to facilitate the settlement of trades and to perform a dealing reconciliation of all the accounts balances with NSDL. The entire system is called the NEST (National Electronic Settlement & Transfer) system. Thus a higher integrated set up for maintenance of investor accounts has been developed and implemented.

Constituents of Depository System

Depository

Depository Participant

Beneficial Owner

Issuer

Benefits/Advantages of Depository System

Benefits of depository system are:

To the Nation

Growing and more liquid capital markets to provide financing and development stemming from more efficient post trade systems with reduced transactions costs.

Increase in competitiveness in the International market place and attracting investors and fund managers by complying with stipulated international standard for and efficient and risk free trading environment.

Improved prospects for privatization of public sector units by creating a conducting environment.

Restoration of faith in the capital market on the participants with system to minimize settlement risk and frauds.

Considerable reduction in the delay in registration which can currently impact trading.

To the Investing Public

Reduction of risks associated with loss, mutilations, theft and forgery or physical scrips.

Elimination of financial loss owing to loss of physical scrips.

Greater liquidity from speedier settlements and reduction in delays in registration.

Faster receipt benefit and rights resulting from corporate action.

Improved production of shareholder rights resulting from more timely communication from the issuers.

Reduced transactions costs through greater efficiency.

To issuer

Upto date knowledge of shareholders names and addresses.

Savings in costs of new issuers from reduction in printing and distribution costs.

Increase in efficiency of registrars and transfer agent functions

Better facilities for communication with shareholders conveying benefits of corporate actions and information notices.

Improved ability to attract international investors without having to incur the expenditure of issuance in overseas market.

Objectives of the study

To know the perception and viewpoint of the investors regarding depository system.

To know the satisfaction level of investors regarding depository services.

Related Researches

Alton (1994) found the principles of converting shares into dematerialized form. He also commented that with a grand start the concept of demat of shares in Indian Market is all pervasive and set to conquer the stock market.

George (1996) studied the growth and the dematerialization of products and found that the concept of dematerialization is coming at a very fast pace.

Kumar (1998) studied the advantages of dematerialization and opening of Demat account. He also compared the effect on trading of shares of the companies have dematerialized their shares and who have not dematerialized their shares.

Mittal (1998) presented an extensive information on dematerialization of shares, their advantages, investor grievances and insurance aspect related to dematerialized shares and found that a very large potential of dematerialization of shares exists in the Indian Market.

Cholamandalam (1998) conducted research on requirements to be fulfilled by a company to get its shares listed at a depository so that they can be easily dealt in dematerialized form.

Hughes India Limited (1999) conducted a research to study the benefits and drawbacks, which are to be borne in mind by company that is planning to dematerialize its shares and get them registered with NSDL.

Law (1999) in his article “Depository Revolution” has discussed that depository is not just removing fake shares and bad deliveries from the capital market but to prove a great catalyst for reform. The depository is a reality today. The concept of depository is set to revolutionize trading practices, reduce transaction costs and increase investor safety.

Kumar (1998) in his Article “Demat trading – simpler the better” has shed light on the different fees structure charged by NSDL from depository participants and by depository participants from the investors. NSDL charges nominal fees under three heads i.e. transaction fees in case of purchases, custody fees and rematerialisation fees.

Gajra (1999) in his article “Claim your rights” has provided us the useful information that the investors get the compensation or the loss due to the depository participant’s mistake. The investors for protecting their return should give debit instruction to their DP’s for sale at least a day or two before settlement day. Then the investor has to look for an instruction carried out properly. If he failed to get it, then he should approach NSDL, for arbitration. DP’s are personally liable for their losses. This article was given in regard when SCHIL, one of the largest DP’s failed to transmit instructions of its investor-clients to NSDL on time before settlement pay in.

Saikia (1999) in his article “Compulsory demat within a year” has shed light on the views expressed by Ministry of Finance that one year has been set in adopting the full demat route for primary and secondary market shares.

Research Methodology

The study is based on descriptive research design. The primary data was collected and used for the research purpose. Primary data was collected by survey with the help of a questionnaire. The questionnaire was administered by the personal interview i.e. questions were asked from the respondents in a face-to-face meeting and the study was conducted with the help of pre-structured non-disguised questionnaire. Respondents were interviewed with the help of structured questionnaire. An investor residing and availing Depository Services in Ludhiana was taken as a sample. In the present study, non-probability sampling technique i.e. convenience sampling is used to collect the sample. Here in the study, population consists of all the investors of Ludhiana and a sample of investors have been taken from it. It is a convenience sampling because the respondent investors are chosen from those who happened to visit the office of a particular broker and the brokers themselves. The respondents were interviewed with a structural questionnaire by the researcher. A smaller sample but well selected sample may be superior to a larger but badly selected sample. A total of 100 respondents’ were selected from the city for the study.

Investors ranked various advantages of depository. Rank was determined by computing the weighted average i.e. 4 points were attached to rank first, 3 points to rank second, 2 points to rank third and 1 point to rank fourth. Then for calculating ranks for various advantages, points allotted by investors were added and divided by 100 i.e. sample size. The advantage with the highest weighted average was ranked first and the advantage with the lowest weighted average was ranked fourth i.e. last.

Similarly, the investors ranked problems faced by investors in depository system. Weighted average method was used. For rating the satisfaction level regarding depository services and the investors view point regarding depository system, weighted average method as well as factor analysis were used. The points were given as such. For highly satisfied +2, for satisfied +1, for indifferent 0, for dissatisfied -1 and for highly dissatisfied -2.

Results of the Study

Respondents Profile

As per the study, majority respondents were professional i.e. 33% such as C.A’s, MBA’s and C.S., where as 22% were post-graduates and the remaining 45% were graduates. The study found that majority of the investors i.e. 46% belonged to age group 30 or less than 40. 18% of the investors were belonging to age group 20 or less than 30, 26% of the investors were belonging to the age group 40 or less than 50 and 10% of the investors belong to the age group 50 or more. As per the study majority of the respondents i.e. 44% of the investors were found operating in the capital markets for 6 years or more. Whereas 29% of the investors have been operating for 4 years of less than 6 years, 18% have been operating for 2 years or less than 4 years and the remaining 9% have been operating for less than 2 years. As per the study, majority of the respondents had opened their demat accounts in year 2000 and 1999.

The Different Sources Of Information From Where The Investors Came To Know About The Depository System.

Sources of Information

No. Of Investors

Percentage

Brokers

42

42

Friends

6

6

Newspapers & Magazines

36

36

T.V. Programmes

2

2

Others

14

14

Total

100

100

As per the study, majority respondents had brokers, newspapers and magazines as the best source of information regarding depository system.

The Depository Participants With Whom The Investors Had Opened Up Their Demat Account

Depository Participants

No. Of Investors

Percentage

SHCIL

30

30

Master Capital

22

22

LSE Securities

16

16

Karvy Consultants

18

18

Others

14

14

Total

100

100

The study revealed that Majority participants had opened their accounts with Stock Holding Corporation of India Limited followed by Master Capital, Karvy Consultants, LSE Securities and other depositary participants.

The Reasons For Opening Demat Account With Particular DP By The Investor

The respondents were asked to tick the various factors being considered for opening demat account with a particular DP.

Reasons

Percentage

Nearness to location

15

Fast transaction

30

Infrastructure Facility

25

Good client dealing

15

Goodwill of the Organization

10

Others

05

Total

100

As per the study, the major factor contributing in selecting the depository was Fast Transaction followed by other factors such as Availability of Proper Infrastructure, Client Dealing, Goodwill of the organization, approachability etc.

The Ranking Given By The Investors To Various Advantages Of Depository System

Advantages

Mean Scores

Ranking

No scope for any risk of loss, theft or fraud regarding share certificates

1.32

1

Investment is highly liquid

1.96

2

No stamp duty

3.9

4

Bad deliveries are almost eliminated

2.82

3

The study found that majority of the investors were of the view that the depository system would overcome the chances of loss, theft or fraud as a first advantage followed by other such as liquid investments, elimination of bad deliveries and absence of stamp duties.

The Ranks Being Given By Investors To Different Problems Of Depository Services.

Problems

Mean Scores

Ranking

Not fully aware of the mechanism

3.64

4

Fear of enquiries from Income Tax Department

2.45

3

Increase in transactions costs

2.27

2

Difficulty in maintaining accounts

2.25

1

Increased paper work

4.39

5

As per the study the investors thought maintenance of accounts as a major problem of Depository System and ranked it at first place. The study highlighted the other problems such as increase in the cost of transaction, fear of enquiries from Income Tax Department, not full awareness about the system and increased paper work.

Satisfaction Level Of The Investors Regarding Depository Services

Attributes

Mean Scores

Satisfaction Level

Dealing of DP’s

1.6

Highly Satisfied

Fees structure of DP’s

0.94

Satisfied

Service time of DP’s

0.32

Indifferent

Infrastructure Facilities of DP’s

0.97

Satisfied

Dematerialization/Rematerialisation procedure

1.14

Satisfied

The study found that the investors were highly satisfied with dealing of Depository participants and satisfied from other services such as fee structure, infrastructure facilties and demateralisation/rematerialisation procedures. However, many of the respondents were found indifferent from service timings of DPs.

The Investor’s View Regarding The Different Factors Of Depository Services

Sr. No.

Factors

Mean Scores

View Point

1

More transparency in depository system

2

Strongly Agree

2

Fear of losing physical possession of share certificates

-1.36

Disagree

3

More cost involved in opening, maintaining and closing of demat account

1.05

Agree

4

Manipulation done by DP’s and Brokers

-0.02

Indifferent

5

Burden on small investor has been increased

0.21

Indifferent

6

Cost of Depository System matches with the revenues from it

1.22

Agree

7

Demat process is a lengthy one

1.14

Agree

8

Business for brokers has been increased

1.58

Strongly Agree

9

Need of single Depository

0.02

Indifferent

10

Demat has a bright future


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