DEPOSITORY SYSTEM

The Depository System functions very much like the banking system. A bank holds funds in
accounts whereas a Depository holds securities in accounts for its clients. A Bank transfers
funds between accounts whereas a Depository transfers securities between accounts. In both
systems, the transfer of funds or securities happens without the actual handling of funds or
securities. Both the Banks and the Depository are accountable for the safe keeping of funds
and securities respectively.

The system essentially aims at eliminating the voluminous and cumbersome paper work
involved in the scrip-based system and offers scope for paperless trading through state-of-
the-art technology. It is an institution which maintains an electronic record of ownership or
securities.

In the depository system, share certificates belonging to the investors are dematerialized 1 and
their names are entered in the records of depository as beneficial owners. Consequent to these
changes, the investors names in the companies register are replaced by the name of
depository as the registered owner of the securities. The securities on Dematerialization
appear as balances in ones depository account. These balances are transferable like physical
shares. If at a later date, investors wish to have these demat securities converted back into
paper certificates, the Depository does this and their names are entered in the records of
depository as beneficial owners. The beneficial ownership will be with investor but legal
ownership will be with the depository. The depository, however, does not have any voting
rights or other economic rights in respect of the shares as a registered owner. The beneficial
owner continues to enjoy all the rights and benefits and is subject to all the liabilities in
respect of the securities held by a depository.

Shares in the depository mode are fungible and cease to have distinctive numbers. In the
Depository mode, corporate actions such as IPOs, rights, conversions, bonus,
mergers/amalgamations, subdivisions & consolidations are carried out without the movement
of papers, saving both cost & time. The issuer gets information on changes in shareholding

1 Dematerialisation or Demat is a process whereby investors securities like

shares, debentures etc., are converted into electronic data and stored in
computers by a Depository.
pattern on a regular basis, which enables the issuer to efficiently monitor the changes in
shareholdings.

The Depository system links the issuing corporates, Depository Participants (DPs), the
Depositories and clearing corporation/ clearing house of stock exchanges. It alleviates the
hardships currently faced by the investors and it also offers option for converting the shares
from electronic to physical or paper form through a process of rematerialisation (remat).

THE NEED FOR DEPOSITORY AROSE MAINLY DUE THE FOLLOWING REASONS 2:

1. Growth in Securities transactions: There has been considerable growth in securities

transactions, especially, in the post-reform period, i.e., since 1991. After 1991, the
Government of India introduced several reforms in the Indian Economy, including
capital market reforms.
2. Limitations of Physical Transfer: There were several limitations relating to physical
transfer of shares. The limitations were:
Delay in transfer of shares.
Problem of bad deliveries
High cost of handling and transfer
Chances of loss of certificates in transit.
Chances of theft of certificates, etc.
3. To comply with global standards: Almost all the developed markets had introduced the
depository system ensuring efficient transfer and settlement of securities. Due to reforms
in capital markets, the foreign institutions investors (FIIs) were allowed to deal in stock
exchanges. For this purpose the government also introduced the depository Act, 1996.
4. To enhance liquidity in stock markets: There was a need to enhance liquidity in Indian
Stock Markets. The seller of securities to get immediate cash payment for their
transactions. The depository undertakes the trade and settlement processing through its
subsidiary.
5. To ensure transparency in allotment of shares: Now-a-days, the allotment of shares is to
be done only through the Demat mode. The allotment of shares is to be effected through
the depository in the Demat account of the investors. This has generated transparency in
allotment of shares and reduced manipulations relating to transfer of shares.

2 The Need For Depository Systems In India Finance:

www.ukessays.com/essays/finance/the-need-for-depositorysystems-in-india-
finance-essay.php?cref=1
6. Centralised Systems in Securities Dealings: There was a need to adopt a central system
for handling all the securities dealings. This has been made possible by setting up Central
depository system, although there are two different depositories (NSDL, and CDSL).

KEY FEATURES OF THE DEPOSITORY SYSTEM IN

INDIA3
1. Multi-Depository System: The depository model adopted in India provides for a
competitive multi-depository system. There can be various entities providing depository
services. A depository should be a company formed under the Companies Act, 2013
(erstwhile Companies Act, 1956) and should have been granted a certificate of
registration under the Securities and Exchange Board of India Act, 1992. Presently, there
are two depositories registered with SEBI, namely:
National Securities Depository Limited (NSDL), and
Central Depository Service Limited (CDSL)
2. 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.
3. 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.
4. 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.
5. 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, 1996 Registered Owner means a depository whose
name is entered as such in the register of the issuer. A Beneficial Owner means a person
3 Features of the Depository system:
https://www.icsi.edu/Docs/Webmodules/CM&SL.pdf
 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.
6. Free Transferability of shares: Transfer of shares held in dematerialized form takes
place freely through electronic book-entry system.