Unlocking India's Digital Share Revolution: Demat Shares Explained

Post liberalization of the Indian economy in 1991, the Indian Government established Securities and Exchange Board of India (SEBI) as the regulator for the securities markets in 1992. SEBI began to bring about reforms in the securities market. One major reform carried out by SEBI was the Dematerialization of securities.  

Demat or Dematerialisation is the process by which shareholders can convert their physical shares certificates in a company into electronic form. These electronic securities are held and maintained by a couple of central organizations registered and regulated by SEBI. These organizations function as a central accounting and record keeping office in respect of the securities admitted by issuer companies.  

While Demat shares have become a norm and mandatory for any listed company to be traded on any stock exchange in India, how about unlisted public limited and private limited companies? In this blog, we will delve into the world of demat shares, understand the various players and intermediaries involved to open and maintain demat shares. Further we will also understand what companies (both public and private) must do to convert their shares into demat form.  

Depositories and Depository Participants.

In the year 1996, Indian government enacted the Depository Act to further the modernization of the Indian economy, and this had the backing of law for dematerialization. A depository is an organization which holds securities (like shares, debentures, bonds, government securities, mutual fund units, etc.) of investors in electronic form at the request of the investors. It also provides services related to transactions in securities. As the registered owner of the shares, the depository maintains the shares in its records and ensures their proper transfer and settlement. A depository facilitates holding securities of investors in the electronic form and enables securities transactions to be processed. At present two depositories viz. National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL) are registered with SEBI. NSDL led the dematerialisation of securities, which pioneered dematerialisation in India. Subsequently, CDSL was established, and it became the second Depository to be recognized and licensed by SEBI. A depository is like a bank for shares. Just as we keep money in a savings account with a bank, we can keep our investments in shares in a demat account kept with a depository. As the bank helps us in transferring money from our account to another person’s account, depository helps us in transfer of shares from one demat account to another.  

However, investors and companies cannot directly transact and trade with depositories, they must interact via intermediaries known as Depository Participants (DPs). As bank extends its services through its branches to customers, depository extends its services through its network of agents, known as DP. A DP is an agent of the depository through which it interfaces with the investors, companies and provide depository services. A DP can be a financial institution, bank, broker, or any other entity eligible as per SEBI guidelines. As of July 13, 2023, a total of 934 DPs (288 NSDL, 646 CDSL) are registered with SEBI.  

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Recommended Reading: Demystifying Unlisted Shares: Everything You Need to Know

Issuers and Beneficial Owners

Companies which issue any kind of security are known as 'Issuer' in the depository system. Securities include shares, debentures, bonds, government securities, mutual fund units and a few other types of instruments. Both listed and unlisted companies can be admitted into the depository system. Depositories function as the central accounting and record keeping office in respect of the securities admitted by issuers.

While issuers issue the shares in the depository system, the investors or shareholders are the owners and called the Beneficial Owners (BOs), the true owner who ultimately owns or controls the securities held in a depository. Any BO can access these digital shares by opening a Depository Account. Depository Account is just like a bank account, kept with a depository. A bank account is used to keep and transact money, depository account is used to keep and transact securities. Depository account is popularly called Demat account.  

Opening a demat account is fairly straight forward these days. One would have to approach any of the DPs, who will help you complete the formalities. It starts with filling out a form, submitting a PAN card and proof of address. In addition, one has to provide the details of bank account. After Demat account is opened, DP provides the DP ID and the client ID, a copy of Client Master Report (often also known as Client Master List or CML) containing demat account related details, tariff sheet and ‘Rights & Obligations of Beneficial Owner and Depository Participant’. Combination of DP ID and Client ID makes it the unique Demat account number in the Depository system. The first eight digits of your demat account number are usually the DP ID, while the final eight digits are the account holder’s client ID. This is also known as BO ID or Beneficiary Owner ID in the case of CDSL. In the context of CDSL, the Beneficiary Owner ID is a 16-digit numeric character, although in the case of NSDL, the demat account number begins with “IN” and is accompanied by a 14-digit numeric code.

For example, in case of CDSL, BO ID or Beneficiary Owner ID is 1234567891234567, the DP ID is 12345678, and client ID is 91234567. In the case of NSDL, if Demat account number is IN12355687654321, the DP ID is IN123556 and the client ID of the Demat account holder is 87654321.

How do Unlisted Public Limited get to issue Digital Shares (Demat Shares)

As per Companies (Prospectus and Allotment of Securities) Third Amendment Rules, 2018, that has come into force on the  2nd day of October, 2018, every unlisted public company has to issue the securities only in dematerialized form; and  facilitate dematerialization of all its existing securities in accordance with provisions of the Depositories Act, 1996 and regulations made there under. And every unlisted public company making any offer for issue of any securities or buyback of securities or issue of bonus shares or rights offer shall ensure that before making such offer, entire holding of securities of its promoters, directors, key managerial personnel has been dematerialized in accordance with provisions of the Depositories Act, 1996 and regulations made there under.  

Before the admission of any security into the depository system, it is necessary for the issuer to establish an electronic connectivity with depository either directly or through a registrar and transfer agent (RTA), who has already established connectivity with depository. All leading RTAs have already established electronic connectivity. The procedure and charges to obtain direct connectivity by an issuer are similar to that for an RTA. Any issuer wishing to offer demat facility has to register as an issuer by filling up the application form for Issuer and Securities admission, and provide the necessary documentation required (refer to the links for a detailed list of documents at CDSL and NSDL) including the agreement between the Issuer, Depository and/or RTA (as the case may be) and show proof of payment towards Application Processing Fee, Annual Custodial Charges & Security Deposit (refer to these links for the detailed fee and tariff structure for CSDL and NSDL).

Upon admitting itself to any depositories, of all its existing securities by making necessary application to a depository and securing the International Security Identification Number (ISIN) for each type of security, issuer must inform all its existing security holders about such facility. ISIN is a unique identification number allotted for each security in the depository system by SEBI. While any new issuance of shares happens in dematerialized form, all existing physical shares must be dematerialized. In order to dematerialize certificates, one needs to open a demat account with any of the registered DPs with the said depositories. Once the demat account has been opened, one must fill up a ‘Dematerialization Request Form’ in prescribed form and submit it to DP along with the security certificates. DP will forward the demat request to the concerned issuer company or its RTA for further processing. Once the request is confirmed by the concerned issuer company or its RTA, it results in credit of electronic securities in the demat account of the respective investor.

This process of getting admitted to depositories is same for both unlisted public and private companies. ‍

Conclusion

In conclusion, the introduction of Demat shares in India post-liberalization in 1991 marked a significant milestone in the country's financial landscape. The Securities and Exchange Board of India (SEBI) played a pivotal role in driving this transformation, making it mandatory for listed companies to adopt Demat shares. However, unlisted public limited companies were also brought into the fold through regulatory amendments in 2018, mandating the issuance of securities only in dematerialized form.

Depositories like NSDL and CDSL serve as the backbone of the Demat system, holding electronic securities and facilitating seamless transactions. These depositories have a network of Depository Participants (DPs), acting as intermediaries for investors and companies, ensuring smooth interaction within the Demat ecosystem. The Demat account, often referred to as the Depository Account, functions like a bank account for securities, enabling investors to access their digital holdings. Opening a Demat account has become a straightforward process, requiring a PAN card, proof of address, and bank account details. Unlisted public and /or private companies seeking to issue digital shares must establish electronic connectivity with depositories, either directly or through a registrar and transfer agent (RTA). The Dematerialization Request Form and the ISIN issuance process are crucial steps in transitioning physical shares into electronic form.

Demat shares have revolutionized India's securities market, providing efficiency, security, and accessibility to both investors and issuers, thereby contributing to the modernization of the Indian economy.