The Indian securities market has undergone a radical change after the introduction of the Depositories Act, 1996. This Act established a reliable electronic means of recording and transferring securities, putting an end to the outmoded paper-based system, with its delays, susceptibility to theft, forgery and physical damage. By providing a legal framework for dematerialisation and introducing depositories, the Act led to a reduction in paperwork, brought about greater transparency in the securities market, and facilitated greater supervision by enforcing agencies.
This blog dissects the main features of the Depositories Act and its implications for India’s financial system.
Background and Need for the Depositories Act
Pre-Depositories Act, the Indian capital market largely worked on paper- It had its own shortcomings. Shares were physically issued and transferred, creating all problems of bad delivery, loss in transit, and fake securities. There were problems of forgery and theft.
After the economic liberalisation of the early 1990s and the increasing role of foreign institutional investors (FIIs), a transparent, efficient, and safe trading system was deemed necessary. To alleviate this, the Government of India introduced the Depositories Act (1996), allowing the book-entry form of electronic securities.
Some of the Principal Objectives of the Depositories Act are
The main objectives of the Depositories Act include:
- Help with the dematerialisation of securities.
- The legal framework of the depository’s operations.
- Simplify the method of ownership transfer of securities.
- Minimum paperwork and Least Documentation.
- Strengthening transparency and investor trust in the securities market.
Through the establishment of a structure for demat and electronic settlements, the Act sought to increase the operational efficiency of stock exchanges and market intermediaries.
Relevant Definitions under the Depositories Act
Though the basics of the actor remain constant, it becomes imperative to know the important definitions as provided in the Act in order to comprehend the statutory provisions.
- Depository: A depository is an institution where the securities of an investor are held in electronic form. It is a holder of securities and it enables security transfer between accounts.
- Owner: A person in whose name the security is registered with a depository.
- Depository Participant (DP): The role of a DP is to demat securities and offer various depository-related services to clients. DPs are agents of the depository, similar to distributors being agents of mutual funds.
- Issuer: A company or institution that distributes securities (i.e., shares or debentures).
These definitions serve as the foundation for the statutory relationships and transactions that are implemented by the Act.
Structure and Framework of the Depositories Act
The Act consists of 12 sections and covers the powers, duties, and rights of the depository, issuer, beneficial owner, and the depository participant. It was enacted and is expected to have a symbiotic relationship with the Companies Act, 2013, the Securities Contracts (Regulation) Act, 1956, and the guidelines of the Securities and Exchange Board of India (SEBI).
Salient Features of the Depositories Act
1. Section 3 – Registration of Depositories
There can be no depository without having a certificate of registration from SEBI. The depository shall conform to such eligibility criteria and other norms as may be prescribed by the regulator.
India has two operational depositories currently:
- (NSDL) National Securities Depository Limited
- Central Depository Services (India) Limited (CDSL)
Both of them are regulated by SEBI and offer depository services to Investors spread across the country.
2. Section 4 – Contract between Depository and Participant
It shall be compulsory for a depository to provide its services through depository participants only. Investors deal with the DP to open a demat account, transfer securities, and use other services related to the demat account.
3. Section 6 - Dematerialization of Securities
This section allows investors to hold securities in dematerialised (demat) form, under which physical certificates are transformed into electronic form. These securities, after demat, are held (automatically, without the need for periodic account statements or other reporting) by the DP.
4. Article 8 – Rights of the Beneficial Owner
The beneficial owner has all the rights and obligations associated with the securities, including collecting any dividends, exercising votes, and transferring ownership. The depository just works as a keeper of the beneficiary owner’s record.
5. Section 10 – Investigation and Inspection by SEBI
The Market Regulator has the right to inspect the records of the depository, DP or any other person associated to check if the norms are being followed or not. If any contravention is identified, SEBI may levy a penalty, suspend registration, or initiate other actions.
Role of SEBI under the Depositories Act
“SEBI, as the securities market watchdog, is the nodal point for the implementation of the provisions of the Depositories Act. The SEBI has laid down various regulations under this Act, namely:
- SEBI (Depositories and Participants) Regulations, 1996
- SEBI (ICDR) Regulations
- SEBI (Listing Obligations and Disclosure Requirements) Regulations
These rules prescribe the manner of registration, operation & duties of depositories as well as DPs.
Effect of the Depositories Act on the Indian Securities Market
Depositories Act: The law that changed the way shares do business in India. Major impacts include:
- Minimization of Fraud and Misrepresentation: The situation of fake/duplicate share certificates has come down drastically with the advent of the dematerialization of securities.
- Faster Settlement of Trades: Settlement time frames have been reduced, with securities now being transferred either on T-day or T+1/T+2 days. Consequently, market liquidity will also be boosted.
- Improved Investor Confidence: The confidence of small and big investors, domestic as well as foreign, in the system has been raised a lot by the secure and transparent trading platform.
- Enhanced Market Efficiency: The huge reduction in paperwork and the removal of stamp duty on the transfer of demat securities have also meant that the system is cost-effective.
Recognition by the Courts and Interpretation of the Law
Even Indian Courts have realized the significance of the Depositories Act. In the matter of SEBI v. National Securities Depository Ltd., the Bombay High Court upheld SEBI’s power to regulate depositories and declared investor protection to be the crux of the Act.
In NSDL v. SEBI, the court tempered these fears by stating that depositories hold beneficial owners in trust and any violation of such trust would invite stringent regulatory intervention.
Challenges and Prospects
The Indian capital market has been significantly infused by the Depositories Act; however, certain hitches are still there:
- More investor awareness about the rights and duties of demat account holders is required.
- Concerns over the security of electronic holding systems deserve and need ongoing attention.
- SEBI, Stock Exchanges, and Depositories need to coordinate well to handle large volumes of transactions and follow the changes in the regulations.
SEBI is focused on reforming depository regulations, besides ensuring that the safeguards in the Indian securities market continue to be robust and an investor-friendly interface.
Conclusion
The impact of the Depositories Act, 1996. The implementation of the Depositories Act, 1996, has brought about a paradigm shift in India’s capital market, removing risks associated with paper and facilitating the dematerialization of securities, making share transfers much easier and faster. The Act is still being used and works very well, thanks to the full support of SEBI and adequate checks and balances to protect investors in the current financial services landscape.
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