Dematerialization: An Introduction
Dematerialization is the process of converting the physical form of shares into
electronic form. Prior to dematerialization the Indian stock markets have faced several
problems like delay in the transfer of certificates, forgery of certificates etc.
Dematerialization helps to overcome these problems as well as reduces the transaction time
as compared to the physical segment. The article discusses the procedures, advantages and
problems of dematerialization.
The Indian Stock markets have seen a major change with the introduction of
depository system and scrip less trading mechanism. There were various problems like
inordinate delays in the transfer of share certificates, delay in receipt of securities and
inadequate infrastructure in banking and postal segments to handle a large volume of
application and storage of share certificates .To overcome these problems physical dealing
in securities should be eliminated . The Indian stock market introduced the system of
dematerialization recognizing the need for scrip less trading.
According to the Depositories Act, 1996, “an investor has the option to hold
shares either in physical or electronic form .The process of converting the physical form of
shares into electronic form is called dematerialization or in short demats. The converted
electronic data is stored with the depository from where they can be traded. It is similar to
a bank where an investor opens an account with any of the depository participants.
Depository participant is a representative of the depository .The DP maintains the investors
securities account balances and intimates him about the status of holdings”.
Procedure for converting the physical shares into electronic form.
To convert the shares into electronic form the investor should open an account with
any of the depository participants. For opening an account the investor has to fill up the
account opening form. An account number (client ID) will be allotted after signing the
agreement which defines the rights and duties of the DP and the investor wishing to open
the account. The client ID along with the DP ID gives a unique identification in the
depository system. Any number of depository accounts can be opened.
After opening an account with the DP the investor should surrender the physical
certificates held in his name to a depository participant. These certificates will be sent to the
respective companies where they will be cancelled after dematerialization and will credit the
investors account with the DP. The securities on dematerialization will appear as balances in
the depository account. These balances can be transferred like the shares held in physical
form. Dematerialized shares are in the fungible form and do not have any distinctive or
certificate numbers .The securities in the demat can again be converted into physical form
which is called as dematerialization.
Safety to the investor
* Securities Exchange Board of India (SEBI) has laid down certain rules and regulations for
getting registered as a depository participant. With the recommendation of the Depository
and SEBI's own independent evaluation a DP will be registered under SEBI.
* The investors account will be credited/debited by the DP only on the basis of valid
instruction from the client.
* The system driven mandatory reconciliation is done between the DP and NSDL.
* Periodic inspections of both DP and R&T agent are conducted by NSDL
* The data interchange between NSDL and its business partners is protected by standard
protection measures such as encryption.
* No direct communication links exist between two business partners and all
communications are routed through NSDL.
* A statement of account is received periodically by the investors. NSDL sends statement of
account to a random sample of investors a s a counter check.
* The investor has the right to approach NSDL if the grievances of the investors are not
resolved by the concerned DP.
Advantages of dematerialization
* There is no risk due to loss on account of fire, theft or mutilation.
* There is no chance of bad delivery at the time of selling shares as there is no signature
mismatch.
* Transaction costs are usually lower than that in the physical segment.
* The bonus /rights shares allotted to the investor will be immediately credited into his
account.
* Share transactions like sale or purchase and transfer/transmission etc. can be effected in
a much simpler and faster way.
Problems of Dematerialization.
Prior to dematerialization there was almost a gap of three months between application date
and listing of shares .Dematerialization has reduced this gap to a great extent. But quick
money brings with itself a host of problems. Current regulations prohibit multiple bids or
applications by a single person. But the investors open multiple demat accounts and make
multiple applications to subscribe to IPO's in the hope of getting allotment.
The recent IPO allotment scam proves that even a highly automated system is not the
solution to prevent malpractices, if there is laxity. The scam of Yes bank and IDFC reveal
that the investor banker has failed to weed out multiple applications either direct or benami.
Not only the investor banker the DP and the depository failed to detect the large number of
demat accounts opened with the same address but different names. Lack of coordination
between banks, DP's, brokers depositories, registrars and investment bankers and clarity of
their roles has given rise to such problems.
Remedial measures
* To prevent the sprouting of fictitious demat accounts at DP's the allotment of shares
should be checked thoroughly.
* The concerned DP should strictly enforce the Know your client (KYC) norms rather than
relying on bank documents and verification of brokers.
* DP's should be asked to give monthly figure of accounts opened for the public.
* Coordination and Clear definition of roles is important to weed out manipulations.
Though dematerialization has several benefits the recent scam has the potential to
adversely affect the confidence of retail investors in the capital market .To reap the benefits
of dematerialization SEBI, as a regulator has to place a system that is alert and vigilant
against unjust gains.