Depository System

What is Depository System in India

Table of Contents:-

  • What is Depository System?
  • Advantages of Depository System in India
  • Functions of Depository System
  • Constituents of Depository System
  • Meaning of Depository
  • Objectives of Depository

What is Depository System?

The depository system involves the participation of a depository, company/registrars, depository participants and investors. The company is also called the issuer.

The depository system operates along the lines of a banking system. A bank holds and transfers funds between accounts, whereas a depository holds and transfers securities between accounts. In both systems, the transfer of funds or securities occurs without the actual handling of securities or funds. Depositories and banks are accountable for the safekeeping of funds and securities, respectively.

Before the introduction of the depository system, the problems faced by investors and corporations in handling large volumes of paper were as follows:

  1. Fake certificates,
  2. Bad deliveries,
  3. Mutilation of certificates,
  4. Loss of certificates in transit,
  5. Long settlement cycles,
  6. Mismatch of signatures,
  7. Delays in transfer,
  8. Delay in refund and remission of dividend interest, etc.

Depository SystemAdvantages of Depository System in India

This need for a Depository System in India was realized in the 1990s for various reasons:

1) The process of allotment and transfer of shares consumed a lot of time, impeding the healthy growth of the capital market.

2) Large-scale irregularities in the securities scam of 1992 exposed the limitations of the existing settlement system.

3) The mounting fiscal deficit made the government realize that foreign investment was essential for the growth of the economy and that was being restricted due to the non-availability of depositories.

4) With the opening up of the Indian economy, there was a widespread equity cult which resulted in an increased volume of transactions.

5) There were various problems associated with dealing in physical shares, such as :

i) Problems of theft, fake and/or forged transfers.

ii) Share transfer delays particularly due to signature mismatches, and

iii) Paperwork involved in buying, selling, and transfer leading to costs of handling, storage, transportation, and other back office costs.

To overcome these problems, the government of India enacted the Depositories Act in 1996 to start depository services in the country.

Functions of Depository System

The main functions of the depository system are:

1) It de-materializes the securities in the depository mode;

2) It ensures free transferability of securities with speed, accuracy and safety,

3) The name of the depository appears as the registered owner of securities in the records of the issuer,

4) It provides for the maintenance of ownership of records in a book entry form entry without making the securities move from person to person physically,

5) It provides benefits to the beneficial owner for availing all the rights and liabilities associated with the securities;

6) The name of the actual owner as beneficial owner – appears in the records of the depository,

7) It transfers securities from one account to another through book entry only on the instructions of the beneficial owner.

8) It assists in opening an account (i.e., Demat Account) with a depository through a depository participant (DP) for availing depository services by the owner of securities;

Constituents of Depository System

The players/constituents of a depository system are as follows:

1) Depository Participant

A depository participant (DP) is an agent of the depository and functions as the interacting medium between the depository and the investor. A DP is a person registered with SEBI and must possess the requisite qualifications prescribed by the depository of which he is a participant.

2) Depository

The term depository is defined as a place where something is deposited for safekeeping; banks in which funds or securities are deposited by others, usually under the terms of a specific depository agreement.

3) Investor

The beneficial owners are the actual investors in securities. In the depository system, the depository serves as the registered owner of the shares in the register of members maintained by the issuer company.  On the other hand, the actual investors are the beneficial owners and their details are kept by the depository participants.

4) Company/Registrars and Share Transfer Agents

The Company or its Registrar and Transfer Agent are the third link in the process. Complete details of physical shareholding along with relevant data are available with the company or its R&T agent who handles the transfer-related activities. The share certificates submitted for dematerialization are sent by the depository participant to the company or its R&T agent for completing the dematerialization process.

5) Clearing Corporation/Clearing House and Clearing Members

Clearing corporations are those institutions in the business of handling clearing operations for respective stock exchanges. The clearing corporations/houses of stock exchanges also have to be electronically linked to the depository to facilitate the settlement of the trades done on the stock exchanges for dematerialized shares. At present, all the major clearing corporations/houses of stock exchanges are electronically connected to NSDL. Clearing Members (CMs) are the members of the Clearing Houses/Clearing Corporations who facilitate the settlement of trades done on stock exchanges. They could be a broker or custodian registered with SEBI. Such entities are important intermediaries in the capital market and essential links in the depository system.

6) Stock Exchanges and Stockbrokers

A stock exchange is an organized market for dealings in securities. It is also commonly referred to as a ‘secondary market‘ because the securities dealt at a stock exchange were issued at some previous point in time. One of the main functions of the stock exchange is ‘price discovery, i.e., to cause prices to reflect currently available information about a security. Stockbrokers are members of the stock exchange. Brokers primarily engage in two major activities. As brokers (in an agency capacity), they buy and sell securities for their clients charging a commission/brokerage, and as dealers or traders (in a principal capacity), they buy and sell on their account for trading gains.

Meaning of Depository

The term depository is defined as “a place where something is deposited for safekeeping, banks in which funds or securities are deposited by others, usually under the terms of specific depository agreement”.

A depository is defined as “one who receives a deposit of money, securities, instruments, or other property—a person to whom something is entrusted, a trustee, a person or  group entrusted with the preservation or safekeeping of something.”

A depository is an organization where the securities of an investor are held in electronic form and carries out the securities transactions by book entry. It is distinguished as a ‘custodian’ of securities. A depositary can legally affect the transfer of securities by book-entry, but a custodian cannot. A depository offers its services to investors through its agents called Depository Participants (DPs).

If the depository service has to be availed, the investor has to open an account with a DP. This is similar to opening an account with any branch of a bank to utilise the bank’s services.

Objectives of Depository

The objectives of depository are as follows:

1) Forgery of certificates.

2) To standardise the Indian settlement practice.

3) To reduce the paper handling cost in the capital market.

4) Tearing and mutilation of scripts due to reckless handling.

5) Loss of certificates by postal authorities/registrars/investors.

6) To free the Indian securities market from the paperwork grid.

7) To increase the growth potential of the Indian capital market.

8) Less liquidity is prevalent in the markets with poor consumer confidence.

9) To implement an achievable clearing, settlement, and depository solution which is not expensive to develop and maintain.

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