There was a time when shares were stored in the form of physical certificates, but that time has passed. With the advent of digitisation, the way the stock market operates has changed dramatically. In today’s stock market, physical share certificates have been replaced with electronic ones through a process known as dematerialisation.
Let’s explore what dematerialisation means and how it works in simple terms.
What is Dematerialisation of Securities?
Dematerialisation is the process of converting physical share certificates into electronic form. These converted shares are stored in a demat account. The full form of a demat account is “dematerialised account.”
A depository is responsible for keeping the shareholder’s securities in electronic form. A depository participant (DP), registered under the Depositories Act of 1996, manages these securities, which may include bonds, government securities, or mutual funds. A DP acts as a middleman between the investor and the depository.
In India, there are two main depositories: NSDL (National Securities Depository Ltd.) and CDSL (Central Depository Services (India) Ltd.), both of which are regulated by SEBI.
A Brief History of Dematerialisation
To fully appreciate dematerialisation, it’s important to understand where it all began. Prior to the 1990s, the Indian stock market operated on a paper-based system. This meant that investors had to store physical share certificates, which not only posed security risks but also created inefficiencies in trading.
After India’s economy was liberalised in 1991, technology started playing a bigger role in modernising various sectors, including the financial markets. In 1992, SEBI (Securities and Exchange Board of India) was formed as a regulatory authority to bring transparency and efficiency to the stock market. A major milestone came in 1996, when SEBI introduced the Depositories Act, paving the way for the dematerialisation of shares.
Around the same time, the National Stock Exchange (NSE) was established. This new electronic exchange introduced an anonymous trading system, which increased the use of dematerialisation of shares.
In 2000, the Companies (Amendment) Act mandated that companies offering Initial Public Offerings (IPOs) worth ten crores or more must issue shares in dematerialised form. This marked another major shift as more investors began opening demat accounts and adopting the digital trading system.
The Process of Dematerialisation
The dematerialisation process is a coordinated effort that involves four key participants:
- The Share Issuing Company
- Depository
- Owner or Beneficiary
- Depository Participant (DP) or Broking Firm
Let’s understand the role of each party:
The Share Issuing Company
Before a company can issue dematerialised shares, it must first revise its Articles of Association. This document contains the rules governing the company’s operations. Once these rules are updated, the company must register itself with a depository.
The Depository
In India, there are two depositories – NSDL and CDSL – responsible for the safekeeping of securities. Each share or security issued by the company is assigned a unique 12-digit ISIN (International Securities Identification Number), which helps identify it in the market. The communication between the company and the depository is usually handled by Registrar and Transfer Agents (RTAs).
The Investor or Beneficiary
Investors who wish to hold shares in electronic form must open free demat Account Whether you are a new or existing investor, all your transactions, such as buying and selling stocks, bonds, ETFs, and mutual funds, will be recorded in this account. However, investors cannot open a demat account directly with a depository.Instead, they must use a Depository Participant (DP) or a brokerage firm to open the account on their behalf.
Depository Participants (DPs)
A depository participant (DP) acts as an agent registered with the depositories (NSDL or CDSL). DPs help investors open and maintain their demat accounts. They process the investor’s application, verify the necessary documents, and register the account. DPs serve as the main point of contact for all dematerialisation-related services.
Delivery Trading
What is Delivery trading? It involves purchasing stocks with the intention of holding them for an extended period, making it a long-term investment strategy. To facilitate this, investors need a Demat account, which allows them to securely hold their shares in an electronic format, ensuring easy access for future trading or selling when market conditions are favorable.
Steps of Dematerialisation
- Open a demat account through a depository participant (DP).
- Submit the physical share certificates along with a Dematerialisation Request Form (DRF).
- The DP verifies the certificates and the details provided in the DRF.
- Once verified, the physical share certificates are destroyed, and the information is forwarded to the depository electronically.
- The depository updates its records and confirms the dematerialisation process is complete.
- The demat account is credited with the electronic shares, which can now be traded online.
Benefits of Dematerialisation
No Paperwork
One of the biggest advantages of dematerialisation is that it eliminates the need for physical paperwork. Since all transactions happen electronically, the risk of losing physical certificates or misplacing important documents is completely avoided. Additionally, companies can cut down on the administrative costs associated with issuing and managing physical certificates.
Monitoring Investments
With a demat account, investors can track their investments with ease. All their securities, whether they are stocks, bonds, mutual funds, or ETFs, are stored in one place. Investors can log in to their demat accounts online and monitor the performance of their portfolio, making it easier to make informed investment decisions.
Convenience
With dematerialisation, investors no longer need to deal with the hassle of storing, transferring, or verifying physical certificates. They can carry out all their trading transactions electronically from the comfort of their home or office. This convenience has made it easier for retail investors to participate in the stock market.
Safety
Holding securities in a demat account is far safer than storing physical certificates. Electronic shares are immune to risks such as theft, loss, or damage. Investors no longer have to worry about their certificates being lost in transit or damaged due to unforeseen circumstances.
Loan Facility
One lesser-known benefit of holding securities in a demat account is that they can be used as collateral for loans. Banks and financial institutions offer loans against shares, which means that investors can leverage their dematerialised holdings to access funds when needed.
Corporate Benefits
When your shares are dematerialised, receiving corporate benefits becomes a seamless process. Dividends, interest payments, stock splits, bonus shares, and rights issues are automatically credited to your demat account, ensuring that you receive them promptly without having to deal with paperwork.
Drawbacks of Dematerialisation
While dematerialisation has brought many benefits, it also presents some challenges:
High-Frequency Trading
The ease and speed of electronic transactions have led to an increase in high-frequency trading, which has made the stock market more liquid. However, this has also introduced volatility, as investors often focus more on short-term gains. This frequent buying and selling can sometimes destabilise market conditions.
Technology-Related Issues
Not all investors are comfortable with using technology for trading. Some may lack the necessary technical skills or have slower internet connections, which can put them at a disadvantage. Investors who are not tech-savvy may find it difficult to trade as efficiently as those who are more familiar with digital platforms.
Conclusion
In summary, dematerialisation has completely transformed how shares are traded in the Indian stock market. It has eliminated the inefficiencies of handling physical certificates and made trading much more secure and convenient. By opening a demat account, investors can manage their investments with ease, monitor their portfolio online, and trade from anywhere.
However, while dematerialisation offers numerous benefits, it’s important to be mindful of the challenges, such as market volatility and technological barriers. Investors who understand these issues and prepare accordingly can make the most of the digital trading system and succeed in today’s financial markets.
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