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Physically storing share certificates increases the danger of certificate forgeries/fraudulent activities, significant share certificate loss, and certificate transfer delays. Dematerialisation removes the above described inconveniences by enabling clients to transform their paper certificates into an electronic format.
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What is Dematerialization?
Dematerialization is the process of converting physical securities, such as share certificates and bonds, into an electronic format, which is then stored in a Demat Account. This eliminates the risks associated with physical securities, such as loss, theft, or damage.
A depository is responsible for holding electronic securities, which are managed through a Depository Participant (DP). These securities can include shares, mutual fund units, and government bonds. In India, dematerialization is governed by the Depositories Act of 1996.
There are two major depositories in India:
- NSDL (National Securities Depository Ltd.)
- CDSL (Central Depository Services (India) Ltd.)
Both are registered with SEBI and ensure the safe and seamless transfer of securities. Dematerialization enhances trading efficiency, reduces paperwork, and promotes transparency in financial transactions, making it a crucial part of modern investing.
What is the History of Dematerialization?
The Securities and Exchange Board of India (SEBI) was established in 1992 to oversee the capital markets following the 1991 deregulation of the Indian economy. Through the Depositories Act of 1996, SEBI in turn played a key role in establishing the dematerialisation of securities process. Additionally, it became mandatory to release initial public offerings (IPOs) of at least Rs 10 crore in dematerialized form exclusively under the Companies (Amendment) Act, 2000. You currently need a Demat account to trade shares.
Benefits of Dematerialization
The dematerialization of securities has several advantages. Here are a few of them:
1. Promises Convenience: You can easily manage your shares and transactions from any location, such a computer or smartphone, as it does not require the investor to be physically present. You become the legitimate owner of your shares when securities are converted into electronic equities. Certificates do not have to be sent to the company's registrant after this.
2. Lower Expenses: There is no stamp duty applied to your electronic securities. Nominal holding fees are assessed. You can purchase a single security or securities in odd lots. The time needed to complete a transaction is decreased as a result of the removal of paperwork. Because less paper is used, the procedure also becomes more environmentally beneficial.
3. Nominees must be included: This will enable the investor to give the nominee the authority to manage the account while he or she is away.
4-Protects Transactions: Electronic methods are used to credit and transfer securities. As a result, errors, fraud, and theft—risks associated with paper securities—are avoided.
5. Assist in loan approval: Bonds and debentures that are already in existence can be pledged as security for a loan, frequently at a reduced interest rate as the instruments gain liquidity.
6. Lowers Transaction Costs for All Stakeholders: Because the depository makes sure that entitlements are credited to the investor's account directly, transaction costs are significantly decreased. Paperless tracking and recording of securities results in minimum expenditures. It increases participation, liquidity, and profits by freeing up stakeholders to concentrate on strategy rather than administrative tasks.
7. Speed e-facility allows you to electronically transmit instruction slips to the depository participant. Fast transfers have advantages such as share bonuses, interest, dividends, stock splits, and refunds. Additionally, it makes the market more liquid.
8. Temporary Freeze: You can also put your Demat account on hold for a specific amount of time. This feature is only available, though, if your account contains a specific quantity of shares.
9. Share Transfer: It is now simpler and more transparent to transfer shares using a Demat account. To transfer your shares to your depository's participants, all you need to provide is a properly signed Delivery Instruction Slip (DIS).
10. Simple and Fast Communication: Investors are more confident when they don't have to go to brokers or other offices to provide information or place orders. Delays are less likely.
11. Greater Market Participation: Promotes more trade volume and market liquidity.
What are the problems faced with Dematerialization?
1. High frequency share trading: Markets are now more liquid but also more volatile due to easier orders and communication. As a result, investors frequently prioritise short-term earnings over long-term returns.
2. Technological challenge: People with slow computers or those with limited computer abilities are at a disadvantage against those with superior computer skills and software.
Here are some additional details to consider before beginning the process of dematerialising shares, in addition to the benefits of dematerialisation mentioned above.
3. Dematerialization of shares by a firm: By entering into a contract with depositories such as NSDL and an existing Registrar and Transfer Agent (RTA), any private limited company can issue Demat shares.
4. The RTA is in charge of finalising the crediting and transfer of shares and serves as a go-between for the business and the NSDL. Each share of the company will be assigned an International Securities Identification Number (ISIN) by the NSDL following its admission to the depository system.
Conclusion
Securities must be dematerialized to protect them from annoyances like theft and fraud. It expedites the exchange of shares between parties and lowers associated expenses.
