Introduction to Depository

Introduction to Depository (Part 1)

Definition: A depository is an organization that holds and transfers securities in electronic form, providing a facility for investors to hold and transfer securities in dematerialized form and in book-entry form.
Need for a Depository System: The earlier settlement system in India was inefficient and risky, characterized by bad deliveries, mutilation of share certificates, slow transfer of securities, theft, forgery, and other irregularities, highlighting the need for a depository system.

Key Features of the Depository System in India

Multi-Depository System: The Depositories Act, 1996 provides for a multi-depository system, allowing various entities to provide depository services.
Dematerialisation: The model adopted in India provides for dematerialization of securities, where securities issued in physical form are destroyed and an equivalent number of securities are credited into the security holder's beneficial owner's account.
Depository Participants (DPs): DPs are agents of the depository, providing depository services to security holders, and their appointment is subject to conditions prescribed under SEBI (Depositories and Participants) Regulations, 2018.
Fungibility: In the depository system, securities in dematerialized form are not identified by distinctive numbers and certificate numbers, making them interchangeable.
Registered Owner/ Beneficial Owner: The depository is recorded as a Registered Owner in the books of the Issuer, while the security holder is recorded as the Beneficial Owner (BO) in the records of the depository.

Institutional Structure of the Depository System in India

Depositories: Depositories are companies formed and registered under the Companies Act, 1956, and granted a certificate of registration under the SEBI Act, 1992.
Stock Exchanges: Stock exchanges facilitate the buying and selling of securities.
Clearing Corporations: Clearing corporations facilitate the settlement of securities transactions.
Depository Participants (DPs): DPs provide depository services to security holders.
Issuers: Issuers are companies that issue securities.
Registrars and Transfer Agents (RT&As): RT&As maintain the records of securities holders.

Legal Framework

The Depositories Act, 1996: This act enables the setting up of multiple depositories in India and regulates their operations.
SEBI (Depositories and Participants) Regulations, 2018: These regulations govern the operations of depositories and depository participants.
Bye-laws of Depository: The bye-laws of the depository govern its operations and the relationship between the depository and its participants.
Prevention of Money Laundering Act, 2002: This act regulates money laundering activities in India.

Depository Participant

Definition: A Depository Participant (DP) is an agent of the depository, registered with SEBI under section 12(1A) of the SEBI Act 1992.
Role: DPs provide depository-related services to investors and act as intermediaries between the depository and the investors.
Eligibility Criteria: A DP must be registered with SEBI and satisfy the eligibility criteria prescribed under the SEBI Act 1996 and the SEBI (Depository and Participants) Regulations 2018.

Introduction to Depository (Part 2)

Certificate of Registration: SEBI may grant a certificate of registration to a company to act as a depository, subject to certain conditions.
Commencement of Business: A depository can only function after obtaining a certificate of commencement of business from SEBI, which is granted if the depository has adequate systems and safeguards to prevent manipulation of records and transactions.

Key Conditions for Commencement of Business

The depository must have a net worth of not less than Rs. 100 crores.
The Bye-Laws of the depository must be approved by the SEBI Board.
The depository's automatic data processing systems must be protected against unauthorised access, alteration, destruction, disclosure, or dissemination of records and data.
The depository must have a secure network for electronic communication with participants, issuers, and issuers' agents.
The depository must establish standard transmission and encryption formats for electronic communication of data.
The depository must have controlled access to its premises, facilities, and electronic data communication network.
The depository must have a detailed operational manual explaining its functioning, including the interface and method of transmission of information.
The depository must have adequate procedures and facilities to protect its records against loss or destruction.
The depository must have insurance to indemnify beneficial owners for any loss caused by the depository's wrongful act, negligence, or default.

Rights and Obligations of Depositories

Every depository must have adequate mechanisms for reviewing, monitoring, and evaluating its controls, systems, procedures, and safeguards.
The depository must conduct an annual inspection of its procedures and forward a copy of the inspection report to SEBI.
The depository must maintain the integrity of its automatic data processing systems and take precautions to prevent loss, destruction, or tampering of records.
The depository must take adequate measures, including insurance, to protect the interests of beneficial owners against various types of risks.
The depository must extend cooperation to beneficial owners, issuers, and issuer's agents, custodians of securities, other depositories, and clearing organisations for effective clearance and settlement of securities transactions.

Bye-Laws and Records

A depository must make Bye-Laws governing its operations, which must be approved by SEBI.
The depository must maintain records of securities dematerialised and rematerialised, transfers, holdings of beneficial owners, and other relevant information for a minimum period of eight years.
The depository must also comply with the provisions of the Companies Act for maintaining certain registers, such as the Register of Members, Register of Debenture holders, and Index of Members.

Functions of a Depository

Facilitating account opening, modification, and closure: An investor must open an account with a depository participant to avail depository services.
Facilitating dematerialisation: The depository converts securities held in physical form into holdings in book entry form.
Facilitating account transfer: The depository gives effect to transfers resulting from the settlement of trades and other transactions between beneficial owners.
Facilitating transfer and registration: The depository accelerates the transfer process by registering ownership of shares in its name.
Corporate actions: The depository may handle corporate actions, such as providing information to the issuer or distributing corporate benefits.
Facilitating pledge and hypothecation: The depository allows securities held with it to be used as collateral to secure loans and other credits.

Introduction to Depository (Part 3)

Pledging/Hypothecating Securities: Pledging or hypothecating securities makes the process simple and cost-effective. The securities are transferred to a segregated or collateral account through book entries in the records of NSDL, but in the case of CDSL, the securities remain in the depository account of the BO (Pledgor/Hypothecator).
Linkages with Clearing System: The clearing system ascertains pay-in (sell) or pay-out (buy) of brokers, and the depository delivers securities to the clearing system from selling brokers and to buying brokers from the clearing system. This requires electronic linkages between depositories and the clearing system.
Additional Functions: Depositories perform various functions, including:
- Providing nomination and transmission facilities to investors
- IPO-related facilities
- Other services

Review Questions

The introduction of the depository system in India led to a decrease in theft, forgery, and mutilation of certificates.
- Correct answer: (b) False
Before demat of securities, the evidence of change of ownership was:
- Correct answer: (a) Endorsement of physical security
Depositories provide information to the issuer about persons entitled to receive corporate benefits but do not distribute these benefits.
- Correct answer: (a) True
A Depository Participant must be registered with:
- Correct answer: (c) SEBI