i) Depository

Depository functions like a securities bank, where the dematerialized physical securities
are traded and held in custody. This facilitates faster risk free and low cost settlement.
Depository is much like a bank and performs many activities that are similar to a bank
depository:
a) enables surrender and withdrawal of securities to and from the depository
through the process of ‘demat’ and ‘remat’,
b) maintains investors’ holdings in electronic form,
c) effects settlement of securities traded in depository mode on the stock
exchanges,
d) carries out settlement of trades not done on the stock exchanges (off market
trades).
In India a depository has to be promoted as a corporate body under Companies Act,
1956. It is also to be Registered as a depository with SEBI. It starts operations after
obtaining a certificate of commencement of business from SEBI. It has to develop
automatic data processing systems to protect against unauthorised access. A network to
link up with depository participants, issuers and issuer’s agent has to be created.
Depository, operating in India, shall have a net worth of rupees one hundred crore and
instruments for which depository mode is open need not be a security as defined in the
Securities Contract (Regulations) Act 1956. The depository, holding securities, shall
maintain ownership records in the name of each participant. Despite the fact that legal
ownership is with depository, it does not have any voting right against the securities held
by it. Rights are intact with investors. There are two depositories in India at present i.e.
NSDL and CDSL.

ii) Depository Participants (DP)

A DP is investors’ representative in the depository system and as per the SEBI guidelines,
financial institutions/banks/custodians/stock brokers etc. can become DPs provided they
meet the necessary requirements prescribed by SEBI. DP is also an agent of depository
which functions as a link between the depository and the beneficial owner of the
securities. DP has to get itself registered as such under the SEBI Act. The relationship
between the depository and the DP will be of a principal and agent and their relation will
be governed by the bye-laws of the depository and the agreement between them.
Application for registration as DP is to be submitted to a depository with which it wants
to be associated. The registration granted is valid for five years and can be renewed. As
depository holding the securities shall maintain ownership records in the name of each
DP, DP in return as an agent of depository, shall maintain ownership records of every
beneficial owner (investor) in book entry form.
A DP is the first point of contact with the investor and serves as a link between the
investor and the company through depository in dematerialisation of shares and other
electronic transactions. A company is not allowed to entertain a demat request from
investors directly and investors have to necessarily initiate the process through a DP.
FUNCTIONS OF DEPOSITORY
Depository Account
An investor desiring to demat his holdings has to open a depository account where in all details
of investors’ transactions is recorded. Opening such account is as simple as opening a bank
account. Investor can open a depository account with any DP convenient to him.
There is no restriction on the number of depository accounts a person can open. However, if
existing physical shares are in joint names, one has to open a joint account submitting share
certificates for demat. A sole holder of the share certificates cannot add more names as joint
holders at the time of dematerialising his share certificates.
A client can choose to open more than one account with the same DP. In addition to this, he
has a choice of opening accounts with more than one DP. However a broker can open just one
Clearing Member (CM) account per card/stock exchange for clearing purpose, but he can still
open multiple beneficiary accounts. Beneficiary is the personal account wherein brokers can
keep their personal holdings.
A clearing member cannot hold his personal holdings in his clearing member account. A broker
may deal in the depository system as a clearing member only through a special account, known
as the Clearing Member account. This account can be used only for clearing purposes and not
for holding his own securities in it. As this is a transitory account, the securities held in this
account are not eligible for corporate actions. Therefore. the broker will have to open a separate
beneficiary owner account to hold his investments.
There is no compulsion for the client to open his account with the same DP as that of his broker.
Even if he has an account with another DP, he can carry out normal business with his broker.
There is no loss in operational efficiency. But it is possible that opening account with his
broker’s DP may work out to his advantage, as some DPs may offer special charge structure if
the broker and his clients are dealing through him. To open an account one has to:
l Fill up the account opening form, which is available with the DP.
l Sign the DP-client agreement, which defines the rights and duties of the DP and the
person wishing to open the account.
l Receive client account number (client ID).
This client ID along with his DP ID gives investor a unique identification in the depository
system. In depository account, transactions are through demat and remat. Let us discuss these
two along with other two relevant concepts.
i) Dematerialisation (Demat)
‘Demat’ is a process by which investors’ share certificates are taken back by company through
DP, verified and if found in order, demat is confirmed by the company and then an equivalent
number of shares are credited by the DP to investors account as electronic holding. Chart 9.1
explains demat in clear terms. The entire process of dematerialisation, as required by SEBI,
has to be completed within a period of 15 days. Dematerialisation is also known as
immobilisation of securities. Dematerialisation can be done only on the request made by the
investor through participant in a Dematerialisation Request Form (DRF). Thus,
‘Dematerialisation’ is a process where by physical existence of security certificates is made
extinct and converted into electronic holdings.
Chart 9.1 : Switching from Scrip-based System to Depository System (Dematerialization
Process)

1) Investor surrenders certificates for dematerialization to DP.

2) DP intimates depository of the request through the system.
3) DP submits the certificates to the registrar.
4) Registrar confirms the dematerialization request from depository.
5) After dematerializing, registrar updates accounts and informs depository of - the
completion of dematerialization.
6) Depository updates its accounts and informs the DP.
7) DP updates its accounts and informs investor.
ii) Rematerialisation (Remat)
Rematerialisation is a process (Chart 9.2) of converting electronic holdings of investor back
into share certificates in paper form. The process of rematerialisation is also carried out through
DP and the process has to be completed within a period of
30 days. Thus, once security is dematerialised it is not necessary that investor is to continue in
depository mode for all times to come. He can switch over to remat whereby he gets back
physical possession of security scrips. The client of DP has to submit a request for remat. This
request is forwarded for necessary action to
depository. The depository confirms the rematerialisation request to the Registrar and Transfer
Agents. The Registrar updates the accounts and print the desired certificate. The depository is
informed by Registrar and certificate is sent to the investor. The depository updates its records
and communicates to DP to incorporate necessary changes in the account of the client.
1) Beneficial owner requests for rematerialisation.
2) DP intimates of the Depository request through the system.
3) Depository confirm Rematerialisation request to the registrar. Registrar updates
accounts and prints certificates.
4) Depository updates accounts and downloads details to DP.
5) Registrar dispatches certificates to investor.
iii) Fungibility
In the depository system, since the physical form of security loses its relevance, the securities
are to be ‘fungible’. Prior to amendment in 1996, the Companies Act 1956 required every
specific physical scrip of security as shares or debentures to have distinctive number for each
security when issued or transferred. Securities have been made fungible by deleting section 83
of the Companies Act, 1956. Now the certificates will not carry a distinct number and will form
a part of a ‘fungible mass’. Dematerialized shares do not have any distinctive or certificate
numbers. These shares are fungible - which means that 100 shares of a security are the same as
any other 100 shares of that security. All the certificate of the same security will become
interchangeable in the sense that the owner of the security will lose the right to obtain the exact
certificate. The situation of certificate is now that of currency note and the number of currency
note has no association with ownership of currency note.
Each security held in dematerialized form is given an identity and it is in form of a distinctive
ISIN (International Securities Identification Number). ISIN is a 12 character long identification
mark.
iv) Delivery vs. Payment
It is just not sufficient to have a depository for securities. The concept of Delivery versus
Payment (DVP) also needs to be looked into. DVP involves exchange of securities for funds to
take place simultaneously between the parties to a trade. While the depository system would
be able to handle the accounting of securities by book entry, the funds part would have to be
handled by the banking system. Therefore the two systems have to be integrated in order to
have DVP.
It is too simplistic to think that DVP would be possible without having an efficient electronic
funds transfer systems because in India, the payment systems are still not upgraded. A quantum
jump is required in the level and mode of interaction among the various banking institutions.