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HIMACHAL PRADESH NATIONAL LAW UNIVERSITY

An Assignment of Investment and Security Law

On The Topic

Role and Functions of Depositories In

Securities Market

SUBMITTED BY: COURSE IN-CHARGE:

KUNAL MEHTO MR. AYUSH RAJ

1020161716. TEACHING ASSOCIATE OF LAW

B.A. LL.B. (HONS.)

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ACKNOWLEDGMENT

Every project big or small is successful largely due to the effort of a number of wonderful people
who have always given their valuable advice or lent a helping hand. I sincerely appreciate the
inspiration; support and guidance of all those people who have been instrumental in making this
project a success.
I, KUNAL MEHTO, the student of H.P. National Law University (Shimla), am extremely
grateful to H.P. National Law University (Shimla) for the confidence bestowed in me and
entrusting my assignment of Banking Laws.
At this juncture I feel deeply honored in expressing my sincere thanks to Honorable.
REGISTRAR Prof. S.S. Jaswal and Honorable VICE CHANCELLOR Prof.(Dr.) Nishtha Jaswal
for making resources available at right time and providing valuable insight leading to the
successful completion of my assignment.
I also extend my gratitude to my Project Guide Mr. AYUSH RAJ, Teaching Associate of Law,
who assisted me in compiling the project.
I would also like to thank all the faculty members of H.P. National Law University (Shimla) for
their critical advice and guidance without which this project would not have been possible.
Last but not the least I place a deep sense of gratitude to my family members and my friends who
have been constant source of inspiration during the preparation of this project work.

NAME – KUNAL MEHTO

1020161716

B.A. LL.B. (HONS.)

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INTRODUCTION

Securities market is an economic institute within which take place sale and purchases
transactions of securities between subjects of economy on the base of demand and supply. Also
we can say that securities market is a system of interconnection between all participants
(professional and nonprofessional) that provides effective conditions: to buy and sell securities,
and also

 To attract new capital by means of issuance new security (securitization of debt),

 To transfer real asset into financial asset,
 To invest money for short or long term periods with the aim of deriving profit.

India has adopted the Depository System for securities trading in which book entry is done
electronically and no paper is involved. The physical form of securities is extinguished and
shares or securities are held in an electronic form. Before the introduction of the depository
system through the Depository Act, 1996, the process of sale, purchase and transfer of securities
was a huge problem, and there was no safety at all. The depository system envisages a deposit of
securities by the various investors with the depository. This would take the form of a transfer by
the various investors with the depository. This would take the form of a transfer by the holder of
securities in favour of depository. Once the shares are lodged with the depository, their transfer
would be through book entry transfers in accounts maintained by the depository. Thus the main
functions of a depository are to dematerialize the securities and enable their transaction in book
entry form.

DEPOSITORIES: DEFINITION, ROLE AND FUNCTION:

According to Black’s Law dictionary the word “depositary” is defined as “the party of the
institution receiving a deposit. One with whom anything is lodged in trust, as „depository‟ is the
place where it is put. The obligation upon the depositary is that he keeps the thing with
reasonable care and upon request restores it to the depositor.” A depository holds securities
(like shares, debentures, bonds, Government Securities, units etc.) of investors in electronic
form. Besides holding securities, a depository also provides services related to transactions in
securities. It acts as a trustee of the owner since the securities are entrusted with him in trust. He
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is also the agent of the owner of the securities. As per the Bank for International Settlements
(BIS), depository is “a facility for holding securities transaction to be processed by book entry.
Physical Securities may be immobilized by the depository or the securities may be
dematerialized (so that they exist only as electronic records).” A Depository facilitates holding
of securities in the electronic form and enables securities transactions to be processed by book
entry by a Depository Participant (DP), who as an agent of the depository, offers depository
services to investors. According to SEBI guidelines, financial institutions, banks, custodians,
stockbrokers, etc. are eligible to act as DPs. The investor who is known as beneficial owner (BO)
has to open a demat account through any DP for dematerialisation of his holdings and
transferring securities. In the absence of depositories, which provide for maintenance of
ownership records in a book entry form, every share transfer is required to be accomplished by
physical movement of share certificates to, and registration with, the company concerned. The
process often involves long delays and a significant portion of transactions end up as „bad
delivery‟ due to faulty completion of paperwork. In many cases the process of transfer would
take much longer than the two months stipulated in the Companies Act, and a significant
proportion of transactions would end up as bad delivery due to faulty compliance of paper work.
Theft, forgery, mutilation of certificates and other irregularities were rampant. In addition, the
issuer has the right to refuse the transfer of a security. All this added to costs and delays in
settlement, restricted liquidity and made investor grievance redressal time consuming and, at
times, intractable. To obviate these problems, the Depositories Act, 1996 was enacted with the
objective of ensuring free transferability of securities with speed, accuracy, and security, by

a. Making securities of public companies freely transferable subject to certain exceptions by

restricting company’s right to use discretion in effecting the transfer securities and
dispensing with the transfer deed and other procedural requirements under the Companies
Act.
b. Dematerializing the securities in the depository mode
c. Providing for maintenance of ownership records in a book entry form.
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DEPOSITORY SYSTEM IN INDIA:

India has adopted the Depository System for securities trading in which book entry is done
electronically and no paper is involved. The physical form of securities is extinguished and
shares or securities are held in an electronic form. Before the introduction of the depository
system through the Depository Act, 1996, the process of sale, purchase and transfer of securities
was a huge problem, and there was no safety at all.

Key Features of the Depository System in India:

1. Multi-Depository System: The depository model adopted in India provides for a competitive
multi-depository system. There can be various entities providing depository services. A
depository should be a company formed under the Company Act, 1956 and should have been
granted a certificate of registration under the Securities and Exchange Board of India Act, 1992.
Presently, there are two depositories registered with SEBI, namely:

 National Securities Depository Limited (NSDL), and

 Central Depository Service Limited (CDSL)

At present there are two depositories in India, National Securities Depository Limited (NSDL)
and Central Depository Services (CDS). NSDL is the first Indian depository; it was inaugurated
in November 1996. NSDL was set up with an initial capital of US$28mn, promoted by Industrial
Development Bank of India (IDBI), Unit Trust of India (UTI) and National Stock Exchange of
India Ltd. (NSEIL). Later, State Bank of India (SBI) also became a shareholder. The other
depository is Central Depository Services (CDS). It is still in the process of linking with the
stock exchanges. It has registered around 20 DPs and has signed up with 40 companies. It had
received a certificate of commencement of business from SEBI on February 8, 1999. These
depositories have appointed different Depository Participants (DP) for them. An investor can
open an account with any of the depositories‟ DP. But transfers arising out of trades on the stock
exchanges can take place only amongst account-holders with NSDL’s DPs. This is because only
NSDL is linked to the stock exchanges (nine of them including the main ones-National Stock
Exchange and Bombay Stock Exchange). In order to facilitate transfers between investors having
accounts in the two existing depositories in the country the Securities and Exchange Board of
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India has asked all stock exchanges to link up with the depositories. SEBI has also directed the
companies‟ registrar and transfer agents to effect change of registered ownership in its books
within two hours of receiving a transfer request from the depositories. Once connected to both
the depositories the stock exchanges have also to ensure that inter-depository transfers take place
smoothly. It also involves the two depositories connecting with each other. The NSDL and CDS
have signed an agreement for inter-depository connectivity.

2. Depository services through depository participants: The depositories can provide their
services to investors through their agents called depository participants. These agents are
appointed subject to the conditions prescribed under Securities and Exchange Board of
(Depositories and Participants) Regulations, 1996 and other applicable conditions. NSDL carries
out its activities through various functionaries called business partners who include Depository
Participants (DPs), Issuing corporates and their Registrars and Transfer Agents, Clearing
corporations/ Clearing Houses etc. NSDL is electronically linked to each of these business
partners via a satellite link through Very Small Aperture Terminals (VSATs). The entire
integrated system (including the VSAT linkups and the software at NSDL and each business
partner’s end) has been named as the “NEST” [National Electronic Settlement & Transfer]
system. The investor interacts with the depository through a depository participant of NSDL. A
DP can be a bank, financial institution, a custodian or a broker. Just as one opens a bank account
in order to avail of the services of a bank, an investor opens a depository account with a
depository participant in order to avail of depository facilities.

3. Dematerialisation: The model adopted in India provides for dematerialisation of securities.

This is a significant step in the direction of achieving a completely paper-free securities market.
Dematerialization is a process by which physical certificates of an investor are converted into
electronic form and credited to the account of the depository participant. Indian investor
community has undergone sea changes in the past few years. India now has a very large investor
population and ever increasing volumes of trades. However, this continuous growth in activities
has also increased problems associated with stock trading. Most of these problems arise due to
the intrinsic nature of paper based trading and settlement like theft or loss of share certificates.
This system requires handling of huge volumes of paper leading to increased costs and
inefficiencies. Risk exposure of the investor also increases due to this trading in paper.
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Some of these risks are:

 Delay in transfer of shares.

 Possibility of forgery on various documents leading to bad deliveries, legal disputes etc.
 Possibility of theft of share certificates.
 Prevalence of fake certificates in the market.
 Mutilation or loss of share certificates in transit.
 The physical form of holding and trading in securities also acts as a bottleneck for
broking community in capital market operations.

The introduction of NSE and BOLT has increased the reach of capital market manifolds. The
increase in number of investors participating in the capital market has increased the possibility of
being hit by a bad delivery. The cost and time spent by the brokers for rectification of these bad
deliveries tends to be higher with the geographical spread of the clients. The increase in trade
volumes lead to exponential rise in the back office operations thus limiting the growth potential
of the broking members. The inconvenience faced by investors (in areas that are far flung and
away from the main metros) in settlement of trade also limits the opportunity for such investors,
especially in participating in auction trading. This has made the investors as well as broker wary
of Indian capital market. In this scenario dematerialized trading is certainly a welcome move.

Dematerialization or Demat is a process whereby your securities like shares, debentures etc, are
converted into electronic data and stored in computers by a Depository. Securities registered in
your name are surrendered to depository participant (DP) and these are sent to the respective
companies who will cancel them after “Dematerialization” and credit your depository account
with the DP. The securities on Dematerialization appear as balances in your depository account.
These balances are transferable like physical shares. If at a later date, you wish to have these “
demat securities converted back into paper certificates; the Depository helps you to do this.

4. Fungibility: The securities held in dematerialized form do not bear any notable feature like
distinctive number, folio number or certificate number. Once shares get dematerialized, they lose
their identity in terms of share certificate distinctive numbers and folio numbers. Thus all
securities in the same class are identical and interchangeable. For example, all equity shares in
the class of fully paid up shares are interchangeable.
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5. Registered Owner/ Beneficial Owner: In the depository system, the ownership of securities
dematerialized is bifurcated between Registered Owner and Beneficial Owner. According to the
Depositories Act, Registered Owner means a depository whose name is entered as such in the
register of the issuer. A Beneficial Owner means a person whose name is recorded as such with
the depository. Though the securities are registered in the name of the depository actually
holding them, the rights, benefits and liabilities in respect of the securities held by the depository
remain with the beneficial owner. For the securities dematerialized, NSDL/CDSL is the
Registered Owner in the books of the issuer; but ownership rights and liabilities rest with
Beneficial Owner. All the rights, duties and liabilities underlying the security are on the
beneficial owner of the security.

6. Free Transferability of shares: Transfer of shares held in dematerialized form takes place
freely through electronic book-entry system.

SEBI (Depositories and Participants) Regulations, 1996: SEBI had circulated a consultative
paper on the framework of the draft regulations for depositories and participants in October
1995. Extensive discussion were then held with the stock exchanges, market participants and
investors on this issue. In addition to the views expressed at these meetings, SEBI also had the
benefit of written comments on the Consultative Paper submitted by chambers of commerce and
industry, market participants and investors. Based on the above, the SEBI (Depositories and
Participants) Regulations, 1996 were notified in May 1996. These regulations provide for the
following:

1. Registration of depositories and participants under the SEBI Act

2. Grant of certificate of commencement of business upon satisfaction that adequate safeguards

and systems to prevent manipulation of records and transactions have been put in place, as
required by the Depositories Act.

3. The eligibility criteria for admission of securities to a depository

4. The specific rights and obligations of depositories, participants and issuers in addition to those
specified in the Depositories Act

5. Periodic reports to and inspections and enquiries by SEBI

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6. Penal action and procedure in case of default In addition, the regulations contain the following
provisions:

a. the minimum capital of the company that is to be registered as depository, has been set at
Rs. 100 crore
b. the eligibility criteria for the sponsors of a depository, who have been restricted to
financial institutions, custodians, non-banking finance companies and stock brokers with
a minimum net worth of Rs. 50 lakh and subject to a ceiling of 25 times their net worth
on the value of the portfolios for which they act as participant
c. provisions for the indemnification of beneficial owners including insurance cover for the
depository and participants
d. the adequacy of safeguards and procedures that are to be put in place before
commencement of business is allowed to the depository

the internal and external controls and audit mechanisms that are to be instituted by the
depository in order to ensure the integrity of data processing systems and the adequacy of
systems and procedures to prevent systemic failure, manipulation or loss of records.

CONCLUSION

Advantages of the Depository System

The advantages of dematerialization of securities are as follows:

 Share certificates, on dematerialization, are cancelled and the same will not be sent back
to the investor. The shares, represented by dematerialized share certificates are fungible
and, therefore, certificate numbers and distinctive numbers are cancelled and become
non-operative.
 It enables processing of share trading and transfers electronically without involving
share certificates and transfer deeds, thus eliminating the paper work involved in scrip-
based trading and share transfer system.
 Transfer of dematerialized securities is immediate and unlike in the case of physical
transfer where the change of ownership has to be informed to the company in order to be
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registered as such, in case of transfer in dematerialized form, beneficial ownership will

be transferred as soon as the shares are transferred from one account to another.
 The investor is also relieved of problems like bad delivery, fake certificates, shares under
litigation, signature difference of transferor and the like.
 There is no need to fill a transfer form for transfer of shares and affix share transfer
stamps.
 There is saving in time and cost on account of elimination of posting of certificates.
 The threat of loss of certificates or fraudulent interception of certificates in transit that
causes anxiety to the investors, are eliminated.

Disadvantages

Problems of the Depository System

Some disadvantages were about the depository system were known beforehand. But since the
advantages outweighed the shortcomings of dematerialisation, the depository system was given
the go-ahead.

 Lack of control: Trading in securities may become uncontrolled in case of

dematerialized securities.
 Need for greater supervision: It is incumbent upon the capital market regulator to keep a
close watch on the trading in dematerialized securities and see to it that trading does not
act as a detriment to investors. The role of key market players in case of dematerialized
securities, such as stock brokers, needs to be supervised as they have the capability of
manipulating the market.
 Complexity of the system: Multiple regulatory frameworks have to be confirmed to,
including the Depositories Act, Regulations and the various Bye Laws of various
depositories. Additionally, agreements are entered at various levels in the process of
dematerialization. These may cause anxiety to the investor desirous of simplicity in
terms of transactions in dematerialized securities.
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Besides the above mentioned disadvantages, some other problems with the system have been
discovered subsequently. With new regulations people are finding more and more loopholes in
the system. Some examples of the malpractices and fraudulent activities that take place are:

 Current regulations prohibit multiple bids or applications by a single person. But

investors open multiple demat accounts and make multiple applications to subscribe to
IPOs in the hope of getting allotment of shares.
 Some listed companies had obtained duplicate shares after the originals were pledged
with banks and then sold the duplicates in the secondary market to make a profit.
 Promoters of some companies dematerialised shares in excess of the company’s issued
capital.
 Certain investors pledged shares with banks and got the same shares reissued as
duplicates.
 There is an undue delay in the settlement of complaints by investors against depository
participants. This is because there is no single body that is in charge of ensuring full
compliance by these companies.