Dematerialisation: An Introduction


G. Vasudha
Asst. Professor
TKR Institute of Management and Science

Dematerialisation is the process of converting the physical form of shares into electronic form. Prior to dematerialisation the Indian stock markets have faced several problems like delay in the transfer of certificates, forgery of certificates etc. Dematerialisation 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 dematerialisation.

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 dematerialisation 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 dematerialisation 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 dematerialisation will appear as balances in the depository account. These balances can be transferred like the shares held in physical form. Dematerialised 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 rematerialisation.

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 dematerialisation

* 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 Dematerialisation.

Prior to dematerialization there was almost a gap of three months between application date and listing of shares .Dematerialisation 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 dematerialisation 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 dematerialisation SEBI, as a regulator has to place a system that is alert and vigilant against unjust gains.


Capital market magazine, Jan30-Feb12, 2006 Iss No.24

Indian financial system, M.Y.Khan, fourth edition, pg nos 8.41 8.44

G. Vasudha
Asst. Professor
TKR Institute of Management and Science

Source: E-mail August 3, 2006


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