WHAT IS DEMATERIALISATION OF SECURITIES ??

The term “DEMATERIALISATION OF SECURITIES.” OR "DEMAT", in India, refers to a dematerialised account for individual Indian citizens to trade in listed stocks or debentures in electronic form rather than paper, as required for investors by the Securities Exchange Board of India (SEBI). In a demat account, shares and securities are held electronically instead of the investor taking physical possession of certificates. A demat account is opened by the investor while registering with an investment broker (or sub-broker). The demat account number is quoted for all transactions to enable electronic settlements of trades to take place.Access to the demat account requires an internet password and a transaction password. Transfers or purchases of securities can then be initiated. Purchases and sales of securities on the demat account are automatically made once transactions are confirmed and completed.With the age of computers and the Depository Trust Company, securities no longer need to be in certificate form. They can be registered and transferred electronically.

WHY THE NEED OF DEMATERIALISATION ARISE ???

During the late eighties, the common man used to stay away from the stock market because of the sheer complexity of the paperwork involved in trading at the market.This resulted in a very low mobilization of funds in the market. Besides this, the paper based system also gave rise to a number of problems like duplication of shares, fake shares, fake signatures, signature mismatches and transfer problems. Stock certificates became the major reason for rising arbitration cases and investor disputes.

When the congress government initiated financial reforms in the early nineties, stock exchanges and financial institutions realized that the paper based system were not able to keep up with the rapid growth which the economy would witness in times to come. There was a need to bring in more investors in the market for greater mobilization of funds, which would eventually feed the economic growth of the country.

A more technologically advanced system was needed to maintain records of all the transactions. The government of India decided to bring a fully automated system for book keeping, in order to eliminate all the risks that came along with the paper based certificates.

The depository system was introduced by the depository act,1996 which helped in eliminating the paper based system and made way for the safer electronic system in which every investor made transactions using a DEMAT ACCOUNT

THE BENEFITS OF OPENING A DEMAT A/C:

Easy and convenient way to hold securities Immediate transfer of securities

No stamp duty on transfer of securities Safer than paper-shares (earlier risks associated with physical

certificates such as bad delivery, fake securities, delays, thefts etc. are mostly eliminated)

Reduced paperwork for transfer of securities Reduced transaction cost No "odd lot" problem: even one share can be sold Change in address recorded with a DP gets registered with all

companies in which investor holds securities eliminating the need to correspond with each of them separately.

Transmission of securities is done by DP, eliminating the need for notifying companies.

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

A single demat account can hold investments in both equity and debt instruments.

Traders can work from anywhere (e.g. even from home).Benefit to the company:The depository system helps in reducing the cost of new issues due to lower printing and distribution costs. It increases the efficiency of the registrars and transfer agents and the secretarial department of a company. It provides better facilities for communication and timely service to shareholders and investors.

Benefit to the investor:The depository system reduces risks involved in holding physical certificates, e.g., loss, theft, mutilation, forgery, etc. It ensures transfer settlements and reduces delay in registration of shares. It ensures faster communication to investors. It helps avoid bad delivery problems due to signature differences, etc. It ensures faster payment on sale of

shares. No stamp duty is paid on transfer of shares. It provides more acceptability and liquidity of securities.Benefits to brokers:It reduces risks of delayed settlement. It ensures greater profit due to increase in volume of trading. It eliminates chances of forgery or bad delivery. It increases overall trading and profitability. It increases confidence in their investors.

REQUISITES FOR DEMATERIALIZATION OF SECURITIES:

1. Investors should have a depository account. 2. Securities should be from the eligible list of securities issued by the depository.3. Securities must be in the name of the account holders and owned by

him. 4. Separate demat requisition form is required for each issuer company. 5. DRF should be signed by all the holders so as to match specimen signature.

OBJECT OF DEMAT A/C:

India has adopted this system in which book entry is done electronically. It is the system where no paper is involved. Physical form is extinguished and shares or securities are held in electronic mode. Before the introduction of the depository system by the Depository Act, 1996, the process of sale, purchase and transfer of shares was a huge problem and the safety perspective was zero.

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WHAT IS A DEPOSITORY ???The Depositories Act defines a depository as “a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration under subsection (1A) of section 12 of Securities and Exchange Board of India Act, 1992.” The main function of a depository is to dematerialize securities and enable their transactions in book entry form.As per The Bank for International Settlements (BIS), depository is “a facility for holding securities which enables securities transactions to be processed by book entry. Physical securities may be immobilized by

the depository or securities may be dematerialized (so that they exist only as electronic records)”.In simple terms depository is an organization where securities of an investor are held in electronic form.

WHO IS A DEPOSITORY PARTICIPANT ???A Depository Participant (DP) is an agent of the depository

through which it interfaces with the investor and provides depository services. Public financial institutions, scheduled commercial banks, foreign banks operating in India with the approval of the Reserve Bank of India, state financial corporations, custodians, stock-brokers, clearing corporations /clearing houses, NBFCs and Registrar to an Issue or Share Transfer Agent complying with the requirements prescribed by SEBI can be registered as DP.

Banking services can be availed through a branch whereas depository services can be availed through a DP.As on September 30, 2008, a total of 711 DPs (266 NSDL, 445 CDSL) are registered with SEBI.

NUMBER OF DEPOSITORIES IN INDIA:

At present two Depositories viz.

1.) National Securities Depository Limited (NSDL)

NSDL is a public limited company incorporated under the Companies Act, 1956. Four renowned institutions participate in it. Unit Trust of India (UTI), Industrial Development Bank of India (IDBI), National Stock Exchange of India (NSE), State Bank of India (SBI).UTI is the largest mutual fund of India and IDBI is the largest development bank, NSE is the largest stock exchange of India and SBI is the largest

commercial bank of India having clearing facility. HDFC and Citibank also share in this system. NSDL is managed by Board of directors headed by a managing director. It is governed by its bye-laws and its business operations are regulated by business rules. NSDL interfaces with the investors through players or business partners. Constituents of depository compromise of clearing corporation, brokers, clearing member, registrar and transfer agents, company or issuer, stock exchange, bank depository participant and investors. All are electronically linked to the main depository for the settlement of trades and to perform a daily reconciliation of all accounts held with NSDL.

2) Central Depository Services (India) Limited (CDSL)

Second agency is CDSL - Central Depository Service (India) Limited. Main functions of this agency are centralized database and accounting. Major participant in CDSL are LIC, GIC and BSE. This agency is set up with the object to keep in mind to accelerate growth of scripless trading, with major thrust of individual participation and creating competitive environment, responsible to the users interests and demands to enhance liquidity. CDSL aims to retain the entire data of the investors in the central database of CDSL. It has opted for it with the following objectives:

Within time information is available to issuers/registrar’s and share transfer agents.

Companies can monitor critical holdings, e.g., holding of FIIs and FIs, investment companies, etc., by using up the parameters through their

front-end terminals. There is no other database in the system to reconcile.

No additional security or storage cost of data or critical database residing at the front-end terminals with the issuers/registrars. Recover only the annual maintenance charges.

CDSL signed a memorandum of understanding with NSDL for inter-depository connectivity. Presently, more than half the business of depositories is handled by this agency. Role of both these agencies has become very vital after SEBI’s declaration that there would be no deals in physical form and only dealing to happen in market through demat accounts.

ROLE AND FUNCTIONS OF DEPOSITORIES IN DEMAT SYSTEM:

1. Enable surrender and withdrawal of securities to and from the depository.

2. Maintain investor holdings in the electronic form.

3. Effect settlement of securities traded on the Exchanges.

4. Carry out settlement of trades not done on the Stock Exchanges i.e. Off Market Trades.

5. Coordination of benefits accruing on the depository accounts of investors.

SECURITIES THAT CAN BE DEMATERIALIZED:

The entire depository system in India is governed by the rules made by the market regulator - SEBI. According to the SEBI (Depositories and Participants) Regulations, 1996, the following securities are eligible for holding in dematerialized form.

1. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of similar nature of any incorporated company or other body corporate, including underlying shares of ADRs and GDRs.

2. Units of mutual funds, rights under collective investment schemes and venture capital funds, commercial paper, certificate of deposit, securitised debt, money market instruments, government securities, national saving certificates, kisan vikas patra and unlisted securities.

DEMATERIALIZATION REQUEST FORM:

STEPS INVOLVED IN DEMAT PROCESS:

1) Client/ Investor submits the DRF (Demat Request Form) and physical certificates to DP. DP checks whether the securities are available for demat. Client defaces the certificate by stamping ' Surrendered for Dematerialization'. DP punches two holes on the name of the company and draws two parallel lines across the face of the certificate.

2) DP enters the demat request in his system to be sent to NSDL/CDSL.

Investor DP

NSDL/

CDSLR&T Agent

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2A) DP dispatches the physical certificates along with the DRF to the R&T Agent.

3) NSDL/CDSL records the details of the electronic request in the system and forwards the request to the R&T Agent.

4) R&T Agent, on receiving the physical documents and the electronic request, verifies and checks them. Once the R&T Agent is satisfied, dematerialization of the concerned securities is electronically confirmed to NSDL/CDSL.

5) NSDL/CDSL credits the dematerialized securities to the beneficiary account of the investor and intimates the DP electronically. The DP issues a statement of transaction to the client.

PROCEDURE FOR DEMATERIALISATION OF SHARES OF COMPANY: 1. The company should amend its Articles by passing a special resolution at general meeting to insert the articles relating to dematerialisation of shares. 2. The company should sign agreements with the Depositories, NSDL and CDSL after getting it approved by the board of Directors in Board meeting. SEBI has stipulated that if a company wishes to provide demat facility to its investors it must sign agreements with both the depositories. 3. In order to dematerialise its shares, a company must have electronic connectivity with the depositories. Electronic connectivity can be established either in-house by investing in computer hardware, software and other equipment or through a Registrar which has got the required infrastructure. In case a company opts foran outside Registrar, the agreement mentioned above will be a tri-partite agreement. 4. Once the company is admitted in the depository system, an ISIN (International Securities Identification Number) is allotted by the depository. This number is unique for each security of the company that is admitted in the depository. 5. After establishment of electronic connectivity, Depositories inform the name and ISIN of the company, which has joined the depository System, to the Participant. 6. The company should inform the Stock Exchanges, where its shares are listed that the company's shares are eligible for dematerialisation. The shareholders should also be informed that the company's shares

can be held in dematerialised form. This can also be done by issuing an advertisement in newspapers or byway of a mention in the Annual Report of the Company.

PROCEDURE TO BE FOLLOWED BY DP ON RECEIVING OF REQUEST FROM THE INVESTOR:

1. In order to dematerialise the Physical Share Certificates, an investor

will have to first open an account called as Demat A/c or Security A/c with any of the DP of his choice. 2. Obtain the Account No. from his DP. 3. Obtain the Dematerialised Request Form (DRF) from his DP. 4. This DRF, together with the Share Certificates desired to be dematerialised is to be submitted to DP. 5. The DP upon receipt of the shares and the DRF, will issue an acknowledgement and will send an electronic request to the Company/Registrars and Transfer Agents of the Company through the Depository for confirmation of demat. 6. DP, then issues an acknowledgement to the investor and afterwards follows the following procedure:(a) Defaces the Share Certificates by putting a rubber stamp "Surrendered for Dematerialisation" and by punching two holes on the name of the company on the Share Certificate.(b) Generates a Demat Request Number (DRN) through his Depository Participant Module (DPM) and fills the same in DRF at the appropriate place.(c) Sends an electronic communication to Depository viz. NSDL or CDSL, as the case may be, to the effect that so many shares of this company (Identified by ISIN) have been received for dematerialisation.(d) Sends the DRF and Share Certificates to the company by courier. The role of DP comes to an end with this but he must send a reminder in case credit of shares is not received in demat account of investors within a month. 7. The depository electronically downloads the particulars of demat request, received from DP and sends to the electronic Registrar of the

company so that these shares could be dematerialized. Ultimately, the company or its RTA, as the case may be, receives two kinds of communications:(a) DRF and Physical Share Certificates from DP.(b) Electronic Download of Demat Request from depository through electronic Registrar.

PROCEDURE TO BE FOLLOWED BY COMPANY AFTER THE COMPLETION OF FORMALITIES BY DP: 1. Separate folios should be created in computer in the names of NSDL and CDSL to which dematerialised shares will be transferred. 2. The particulars mentioned in DRF should be checked from Share Certificates. This is very much similar to scrutiny of Share Certificates and Transfer Deed in case of Transfer of shares. However, special

attention should be given that the pattern of holding written on DRF is the same as the endorsement on Share Certificates. 3. Signatures or shareholders on DRF should be verified from the specimen signatures as per records of the company. All the joint holders should sign the DRF. 4. The ISIN should be mentioned in the DRF. This, to a certain extent, ensures that the security mentioned in the DRF is the one, which the investor intends to dematerialise. 5. Odd lot share certificates can also be dematerialised. In fact the market lot in demat mode is one share and an investor can even hold one share in a company. 6. The investor can dematerialise part of his holdings and hold the balance in physical mode for the same security. 7. The data of all demat requests received viz. DRN, DP-Id, Client-Id, Distinctive Nos. of Shares are entered in computer. 8. After completion of data entry, a checklist containing all the demat requests is generated which should be checked thoroughly to ensure that only those shares for which Share Certificates have been received are dematerialised. 9. After ensuring that all corrections pointed out during checking of check list have been made out, updation is done in computer as a result of which the shares are transferred from the Folios of various shareholders, who have surrendered their shares for demat, to NSDL/CDSL Folio as the case may be. Hence, the Register of Members gets updated.

10. In the end a report is generated which contains the details of DRNs, which have been dematerialised in company's records as well as DRNs, which have been rejected on account of some objection. The report is forwarded to the company's electronic Registrar which in turn uploads the data of confirmed demat requests to depository for credit of shares in demat account of shareholders. Similarly the DRNs rejected are also uploaded to depository so that an intimation regarding rejection of demat requests is sent to DPs. Once the DRNs are either accepted or rejected for dematerialisation these are removed from pending list of company. 11. The DRFs & Share Certificates, which are rejected due to any objection should be returned to respective DP so that the same can be lodged again after generating a fresh DRN and rectification of objection. 12. The company should furnish the data of shares dematerialised comprising of Folio No., Name of Shareholder, No. of Shares, Distinctive No. of Shares to Stock Exchanges as per SEBI (Depository and Participant) Regulations, 1996 to enable Stock Exchange to update their database. A certificate to this effect should also be sent to the Depositories. 13. Depositories, then confirm the dematerialisation of shares to DP. 14. DP, then credit the holding of shares into account, electronically. 15. Dematerialisation will normally take about 30 days. 16. Partly paid up shares and fully paid up shares are identified by separate ISINs (International Securities Identification Number). These are also traded separately at the Stock Exchanges. The company

issues call notices to the beneficial holders of partly paid up securities in the electronic form. The details of such beneficial holders will be provided to the RTA/Company by the Depositories. After the call money realisation, RTA/Company will electronically convert the partly-paid up shares to fully paid up shares

FEES INVOLVED:There are four major charges usually levied on a demat account: account opening fee, annual maintenance fee, custodian fee and transaction fee. Charges for all fees vary from DP to DP.

Account-opening fee:Depending on the DP, there may or may not be an opening account fee. Private banks, such as HDFC Bank and AXIS Bank, do not have one. However, players such as ICICI Bank, Globe Capital, Karvy Consultants, Bajaj Capital Limited and State Bank of India do impose an opening fee. Most players levy this when re-opening a demat account. However, the Stock Holding Corporation offers a lifetime

account opening fee, which allows the investor to hold on to his/her demat account for a long period. The fee is also refundable.

Annual maintenance fee:This is also known as folio maintenance charges, and is generally levied in advance.

Custodian fee:This fee is charged yearly and depends on the number of securities (i.e. ISINs) held in the account. It generally ranges between Rs 0.5 to Rs 1 per ISIN per month. DPs will not charge a custody fee for an ISIN on which the companies have paid one-time custody charges to the depository.

Transaction fee:The transaction fee is charged for crediting/debiting securities to and from the account on a monthly basis. While some DPs, such as SBI, charge a flat fee per transaction, HDFC Bank and ICICI Bank peg the fee to the transaction value, which is subject to a minimum amount. The fee also differs based on the kind of transaction (buying or selling). Some DPs charge only for debiting the securities, while others charge for both. Some DPs also charge the investor even if the instruction to buy/sell fails or is rejected. In addition, service tax is also charged by the DPs.In addition to the other fees, the DP also charges a fee for converting the shares from the physical to the electronic form or vice-versa. This fee varies for both demat (physical-to-electronic) and remat (electronic-to-physical) requests. For demat transactions, some DPs charge a flat fee per request in addition to the variable fee per certificate, while others charge only the variable fee.

For instance, Stock Holding Corporation has charged Rs 25 as the request fee and Rs 3 per certificate as the variable fee. However, SBI has charged only the variable fee, as Rs 3 per certificate. Remat requests also have charges akin to that of demat. However, variable charges for remat are generally higher than demat.Some of the additional features (usually offered by banks) are as follows. Some DPs offer a frequent-trader account, where they charge frequent traders at lower rates than the standard charges. Demat account holders are generally required to pay the DP an advance fee for each account that will be adjusted against the various service charges. The account holder needs to raise the balance when it falls below a certain amount prescribed by the DP. However, if the holders also hold a savings account with the DP, they can provide a debit authorisation to the DP for paying this charge. Finally, once choosing a DP, it would be prudent to keep all accounts with that DP, so that tracking of capital gains liability is easier. This is because when calculating capital gains tax, the period of holding will be determined by the DP, and different DPs follow different methods. For instance, ICICI Bank uses the first in first out (FIFO) method to compute the period of holding. The proof of the cost of acquisition will be the contract note. The computation of capital gains is done account-wise.

SEBI GUIDELINES:

SEBI has taken various policy initiatives to popularize the demat concept. One of them is delivery of demat shares compulsorily for institutional investors and OCBs. However, these investors have been allowed to buy shares in physical form, get them transferred in their names and thereupon get them dematerialized. The implementation of the guidelines is subject to the condition that the company shall get a certificate of practice that the company has followed the procedure mentioned in the scheme and to affect that:

The company has followed the necessary procedures for effecting the original transfer; The register of members of the company was, accordingly, amended and the shares were transferred in favour of the transferee; The company has adequate procedures and has satisfied itself that the transferee and the entity requesting dematerialization are one and the same and before confirming the dematerialization request; company has further amended its register of members to indicate the transfer

from the transferee to any agency; The company has defaced and cancelled/mutilated all the certificates.The company has adequate system to ensure that the investor does not lose his corporate benefits on account of the transfer entries in favour of the agency.

PRECAUTIONS TO BE FOLLOWED WHILE OPENING A DEMAT A/C:

Holdings in those securities that have not yet been admitted for dematerialisation by NSDL cannot be dematerialised. List of securities admitted for dematerialisation should be verified before defacing the securities.

Holdings in street name cannot be dematerialised. The combination of names of holders as printed on the physical

certificate should be identical with the names initiating the dematerialisation request.

Separate dematerialisation requests will have to be filled for locked-in and free holdings.

Separate dematerialisation requests will have to be filled for holdings locked-in for different reasons.

Separate dematerialisation requests will have to be filled for fully paid up and partly paid-up holdings.

Separate dematerialisation requests will have to be filled for holdings in the different ISINs of a company.

RE-MATERIALIZATION :Rematerialisation is a process, by which a client can get his electronic holdings converted back into the physical holdings, i.e., he can get back the physical form of share certificates. To get the certificate back, he has to fill up a remat request form and submit it to its depository with whom he has an account. The new certificates may not necessarily bear the same folio or distinctive numbers as previously existed. The facility to rematerialise again is offered to all those scrips which are eligible for demat in the depositories` list of securities available for dematerialisation.The whole process of rematerialisation is completed within 30 days from the receipt of request.

DISADVANTAGES OF DEMAT:

Trading in securities may become uncontrolled in case of dematerialized securities. 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.

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.

However, the advantages of dematerialization outweigh its disadvantages and the changes ushered in by SEBI and the Central Government in terms of compulsory dematerialization of securities is important for developing the securities market to a degree of

advancement. Freely traded securities are an essential component of such an advanced market and dematerialization addresses such issues and is a step towards the advancement of the market.

IMPLICATIONS OF THE STUDY:

Dematerialization of shares was a major change in the Indian securities markets and it has wide ramifications on various sectors of the capital markets. In order to rightly understand and appreciate the implications, there is a need to make a scientific study of the impact that dematerialization generated on the market microstructure of Indian stock exchanges.

- To classify a stock market one of the important parameters is liquidity. Higher liquidity provides opportunity for easy entry and exit options to the investors. Dematerialization definitely increased volumes traded thus providing higher liquidity. At the same time, control group recorded negative growth or lesser growth in the number of shares traded, definitely suggesting the positive impact of dematerialisation on liquidity.

- More number of shares traded per trade is yet another sign to indicate better liquidity. More and more institutional players appear to be participating in a bigger way in post-demat period in the market indicating increased level of confidence in the Indian stock market.

- Ultimate test of any stock market is the returns to the investor. Generally,always though not possible, investors expect to earn abnormal returns on their investments. Dematerialised shares by and large provided in most cases abnormal returns in short-run. Not only did they earn abnormal returns but also they are statistically significant. The abnormal returns taper off over a period. This abnormal returns are a phenomenon of a short term in nature due to any event in the capital markets. Non-demat (control group) companies, in fact, mostly posted negative returns in the study period.

- Volatility and returns go hand-in-hand. Higher volatility sometimes brings higher positive returns. In the study period, volatility as a whole (index) slightly increased and concurrently the companies studied also had higher volatility.

- On the whole, dematerialisation played a very positive role in further modernisation of Indian capital market by providing higher liquidity, higher returns and lower volatility.

- The findings are based on the assumptions of CAPM in a given market, therefore, the findings have same criticism as for the underlying model.

SOME RELEVANT QUESTIONS ASKED BY CLIENTS WHILE OPENING A DEMAT A/C:

1. Is dematerialisation compulsory? 2. Is a transfer deed required for dematerialising

certificates?3. Can I dematerialise any share certificate? 4. What is “Transposition cum Demat” ? 5. Can I dematerialise shares sent for transfer? 6. Can odd lot shares be dematerialised? 7. Do demat shares have distinctive or certificate numbers? 8. Can my electronic holdings be converted back to

certificates?9. What is ISIN? Is it compulsory to mention the ISIN number

of the company while filling up the DRF?

I 1) Is dematerialisation compulsory?

According to Depositories Act, 1996, an investor has the option to hold shares in either physical or electronic form. However SEBI has notified a list of securities where the transactions will take place only in electronic mode for all investors. Hence if you wish to buy or sell securities which fall in the SEBI notified list of securities, then you would have to do so in the electronic mode only.

2) Is a transfer deed required for dematerialising certificates?

No, There is no need for a transfer deed. The certificates have to be accompanied by a Dematerialisation Request form (DRF), which can be obtained from the DP.

3) Can I dematerialise any share certificate?