The Need for Establishing Depository Service

The Indian Capital market has witnessed unprecedented growth in use of information technology in the past few years. This has made it possible to carry out modernization in trading and settlement systems. Automation of the trading mechanism has given us a trading system comparable with the best in the world. Establishment of a settlement guarantees mechanism removed the counter party risk in stock exchanges. Though the advent of automated trading brought with it several associated benefits such as transparency in trading and equal opportunity for market players all over the country; the problems related to the settlement of trades such as high instances of bad deliveries and long settlement cycles have continued.

A transaction covering sale/purchase of securities is completed only after the buyer becomes the rightful owner of the securities and the seller gets the sale consideration. Traditional settlement system involving handling of physical securities gave rise to several settlement risks due to the time that lapsed before trades were settled. After once settled at the stock exchange the transfer of securities involved sending the same along with seller's transfer deeds for registration to the isser. Ih many cases the process took more than two months and significant portion of the transactions ended up in bad delivery due to faulty compliance of paper work. Theft forgery, muilation of certificates and other irregularities were rampant. These are in addition to the issuer's rigfht to refuse the transfer of security.

A way out to solve these myriad settlement problems, the Government passed The Depositories Act, 1996 giving retrospective effect to the provisions of the Act from 20th day of September, 1995. The National Securities Depository Limited (NSDL) was inaugurated in Nov 1996 as the first depository in the country. The latest major development, which helped hasten the awakening of the capital market, was that from Jan 4th, 1999, all category of investor can deliver only in dematerialized form with respect to a select list of securities. It is therefore of interest to know what are depositories and what service they provide to the investors?

Depositories, as stated above, are constituted under the Depositories Act, 1996. As per the Act - "Depository means a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration by the Securities and Exchange Board of India". More particularly described a depository is an organization, which holds the shares in the form, of electronic accounts, at the request of the investor (referred as "beneficial owner") through a registered Depository Participant, in the same way a bank holds the money. Buying and selling electronic shares in the market is just like selling physical shares, only it's much more simple and safe. Under the Depository System, transfer of ownership of securities is done by book entry similar to a bank deposit account. Under the system, the Depository Company ensures delivery of shares against payment. The company (Issuer) also undertakes to distribute dividends, Bonus shares, etc. to its account holders and monitor all the accounts. A depository should have minimum net worth of is Rs. 100 crore. A depository can commence business only after it obtains a certificate to the effect from SEBI.

The key terms used in this context i.e. "beneficial owner", "issuer" and "dematerialisation are explained as under:

• "beneficial owner" means a person whose name is recorded as such with a depository. He is the lawful owner of the shares. He keeps custody of his securities with the depository in electronic form. All securities held by a depository shall be dematerialised and shall be in a fungible form. The beneficial owner enters into an agreement with the depository for availing its services through a participant. The agreement is signed in the form as specified by the bye-laws of the depository.

• "Registered Owner" - As per the Act the Depository is not consideredasa mere custodian, but deemed to be the Registered owner of the securities held by it in electronic form. This enables the depository to effect transfer of securities easily and quickly and and deal directly with the issuers.

• "issuer" means any person making an issue of securities; These are the companies and other corporate bodies, whose shares are held by the depository in electronic form. The investor who has entered into an agreement with the depository shall surrender the certificate of security, for which he seeks to avail the services of a depository, to the issuer. The issuer, on receipt of certificate of security shall cancel the certificate of security and substitute in its records the name of the depository as a registered owner in respect of that security and inform the depository accordingly. A depository shall, on receipt of information enter the name of the investor in its records, as the beneficial owner.

• Dematerialization 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.

1. Every person subscribing to securities offered by an issuer shall have the option either to receive the security certificates or hold securities with a depository.

2. Where a person opts to hold a security with a depository, the issuer shall intimate such depository the details of allotment of the security, and on receipt of such information the depository shall enter in its records the name of the allottee as the beneficial owner of that security.

A depository interfaces with its investors through its agents called depository participants (DPs). A DP can offer depository services only after it gets proper registration from SEBI. If an investor wants to utilizes the services offered by a depository, the investor has to open an account with a DP. This is similar to opening an account with any branch of a bank in order to utilize the bank's services. As present approximately 390 DPs are registered with SEBI.

A Depository can be compared with a bank, which holds the funds for depositors. A Bank - Depository Analogy is given in following table:

1. A depository shall be deemed to be the registered owner for the purposes of effecting transfer of ownership of security on behalf of a beneficial owner.

2. However the depository as a registered owner shall not have any voting rights or any other rights in respect of securities held by it.

3. The beneficial owner shall be entitled to all the rights and benefits and be subjected to all the liabilities in respect of his securities held by a depository

A depository carries out its functions and exercises powers as defined by its bye laws. A depository can codify its bye-laws, with the previous approval of SEBI consistent with the provisions of the Depositories Act and the regulations drawn by SEBI. Such bye-laws must provide for -

1. the eligibility criteria for admission and removal of securities in the depository;

2. the conditions subject to which the securities shall be dealt with;

3. the eligibility criteria for admission of any person as a participant;

4. the manner and procedure for dematerialisation of securities;

5. the procedure for transactions within the depository;

6. the manner in which securities shall be dealt with or withdrawn from a depository;

7. the procedure for ensuring safeguards to protect the interests of participants and beneficial owners;

8. the conditions of admission into and withdrawal from a participant by a beneficial owner;

9. the procedure for conveying information to the participants and beneficial owners on dividend declaration, shareholder meetings and other matters of interest to the beneficial owners;

10. the manner of distribution of dividends, interest and monetary benefits received from the company among beneficial owners;

11. the manner of creating pledge or hypothecation in respect of securities held with a depository;

12. inter se rights and obligations among the depository, issuer, participants and beneficial owners;

13. the manner and the periodicity of furnishing information to the Board, issuer and other persons;

14. the procedure for resolving disputes involving depository, issuer, company or a beneficial owner;

15. the procedure for proceeding against the participant committing breach of the regulations and provisions for suspension and expulsion of participants from the depository and cancellation of agreements entered with the depository;

16. the internal control standards including procedure for auditing, reviewing and monitoring

Benefits are enumerated below:-

• A safe, convenient way to hold securities;

• Immediate transfer of securities;

• No stamp duty on transfer of securities;

• Elimination of risks associated with physical certificates such as bad delivery , fake securities, Delays, thefts etc.;

• Reduction in paperwork involved in transfer of securities;

• Reduction in transaction cost;

• No odd lot problem, even one share can be sold;

• Nomination facility;

• Change in address recorded with DP gets registered with all companies in which investor holds securities electronically eliminating the need to correspond with each of them separately;

• Transmission of securities is done by DP eliminating correspondence with companies;

• Automatic credit into demat account of shares, arising out-of bonus/split/consolidation/merger etc.

We will deal with the concepts of Depositories from technical & legal points of view in the next article