Why was Depository System Introduced?
Companies turn towards the capital market to meet their capital requirements, because capital market is considered to be a major, flexible and responsive source of funds. Today, investors hold plenty of paper or marketable financial assets or securities. These financial assets are represented in the form of paper certificates.
As numerous securities are bought and sold, the stock brokers have to deliver a large number of paper certificates on behalf of their clients. During such a process, each share transfer deed is subject to different manual checks. However, due to some technical defects in the transfer deed, many share transfers are rejected.
Consequently, investors who have transferred their shares would experience inordinate delay in receiving their money. To overcome all these problems, depository system has been introduced. The use of electronic system while transferring shares is an important aspect of this system
Meaning and Definition of a Depository
Meaning of Depository
A depository is an organization where the securities of a shareholder are held in the electronic form at the request of the shareholder through the medium of a depository participant.
A depository is like a bank for securities. If an investor wishes to avail the services offered by a depository, he/she has to open an account with the depository, through a depository participant. This is very similar to opening of an account with any of the branches of a bank so as to utilize the services of that bank. The depository can legally transfer the beneficial ownership of securities.
Objectives of Depository
The main objective of a depository is to minimize the paper work involved with ownership, trading and transfer of securities.
Definition of depository
The term depository can be defined as follows:
- as a central location for keeping securities on deposit.
- as a facility for holding securities either in certificated or uncertificated form to enable book entry transfer of securities.
- as an institution which transfers the ownership of securities in electronic form on behalf of its members.
Objectives of a depository
The introduction of depository system will result in the elimination of all the problems connected with ownership, trading and transfer of securities. It plays a crucial role in Indian capital market. Depository system enables the capital market to achieve the following objectives:
1. It eliminates the occurrence of bad deliveries, forgery and duplicate share certificates.
2. It avoids delay in transfer of securities.
3. It enhances liquidity of securities by facilitating their easy transfer.
4. It substantially reduces the cost of transactions for the investor.
5. It enables surrender and withdrawal of securities from it with ease.
6. It maintains an accurate record of investors’ holdings by keeping the details in electronic form.
7. It attracts foreign investors by complying with global standards.
8. It provides service infrastructure in a capital market.
Institutions involved in Depository process
To have a better understanding of depository process, it is essential to study the institutions interacting in a depository system.
- The central depository,
- share registrar and transfer agent; and
- clearing and settlement corporations are the three institutions participating in the depository process.
1. Central depository: The central depository keeps securities on behalf of the investor and maintains records in electronic form. The statement given by the depository is the evidence of the ownership of shares.
2. Share registrar and transfer agent: The ‘registrar’ is an institution which controls the issuance of securities. The transfer agent retains the names and addresses of the owners of registered securities.
3. Clearing house: The depository interacts with the clearing house during the share transfer process. When the clearing house confirms that all funds have been received, the depository will then transfer securities from the delivering person to the receiver.
Process involved in Depository System
Having understood the role played by the interacting institutions, the depository processes may further be explained as follows:
Under the provisions of Depository Ordinance, depositories facilitate scrip-less trading in capital market through dematerialisation of securities. Equity shares, debentures, warrants, bonds, units of mutual funds, venture capital funds, commercial paper, certificates of deposit, secured debt, money market instruments and unlisted securities are eligible to be admitted to the depository for dematerialisation.
A depository holds all the securities in the electronic form. It can be regarded as a ‘Bank’ for securities. It converts physical securities into book entry securities, the process of which is called dematerialisation. In this process, certificates in physical form are eliminated altogether. When an investor deposits his physical securities with the depository, his account with the depository is credited for the deposit made. The transfer is effected electronically whenever he buys and sells his shares and his account is credited or debited accordingly.
The institution which acts as a depository is the registered owner of the shares and the members owning the shares in a company will be beneficial owners. A beneficial owner is entitled to all the benefits like dividend, right shares, bonus shares and the voting rights.
A depository interacts with the investors with the help of a depository participant. He is similar to the broker who trades on behalf of the customers in the stock exchanges. As per the SEBI guidelines, financial institutions, banks, custodians, stock brokers etc., can become participants in the depository system.
According to the Depository Ordinance, the holder of securities has an option, whether to remain in non-depository mode or shift to depository mode. Investors who wish to remain in non-depository mode will hold the physical possession of certificate of securities. On the other hand, the investors who opt to hold securities in depository mode shall open an account with a depository participant. The investor who has opened such an account gets an identification number which he will refer to in all his transactions.