Meaning of Depository:
The word ‘depositary’ is defined as “the party of the institution (eg bank or trust company) receiving a deposit. One with whom anything is lodged in trust, as ‘depository’ is the place where it is put. The obligation upon the depositary is that he keeps the thing with reasonable care and upon request restores it to the depositor.” A depository holds securities (like shares, debentures, bonds, Government Securities, units etc.) of investors in electronic form. Besides holding securities, a depository also provides services related to transactions in securities. It acts as a trustee of the owner since the securities are entrusted with him in trust. He is also the agent of the owner of the securities.
According to sub-section (1A) of section 12 of the Securities and Exchange Board of India Act, 1992;"depository" means a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration under sub-section (1A) of section 12 of the Securities an Exchange Board of India Act, 1992.
A Depository facilitates holding of securities in the electronic form and enables securities transactions to be processed by book entry by a Depository Participant (DP), who is an agent of the depository, offers depository services to investors. According to SEBI guidelines, financial institutions, banks, custodians, stockbrokers, etc. are eligible to act as DPs. The investor who is known as beneficial owner (BO) has to open a demat account through any DP for dematerialisation of his holdings and transferring securities.
The depository system envisages a deposit of securities by the various investors with the depository. This would take the form of a transfer by the various investors with the depository. This would take the form of a transfer by the holder of securities in favour of depository. Once the shares are lodged with the depository, their transfer would be through book entry transfers in accounts maintained by the depository. Thus the main functions of a depository are to dematerialize the securities and enable their transaction in book entry form.
In the absence of depositories, which provide for maintenance of ownership records in a book entry form, every share transfer is required to be accomplished by physical movement of share certificates to, and registration with, the company concerned.
Registration of transfer of securities with depository.
- Every depository shall, on receipt of intimation from a participant, register the transfer of security in the name of the transferee.
- If a beneficial owner or a transferee of any security seeks to have custody of such security, the depository shall inform the issuer accordingly.
The process often involves long delays and a significant portion of transactions end up as ‘bad delivery’ due to faulty completion of paperwork. In many cases the process of transfer would take much longer than the two months stipulated in the Companies Act, and a significant proportion of transactions would end up as bad delivery due to faulty compliance of paper work. Theft, forgery, mutilation of certificates and other irregularities were rampant. In addition, the issuer has the right to refuse the transfer of a security. All this added to costs and delays in settlement, restricted liquidity and made investor grievance redressal time consuming and, at times, intractable.
The Depositories Act initially came into force as an ordinance viz. The Depositories Ordinance, 1995 promulgated on 7th January 1996. It was designed to provide a legal framework for establishment of depositories to record ownership details in book entry form. The Act also made consequential amendments in the Companies Act, 1956; the Securities and Exchange Board of India Act, 1992; the Indian Stamp Act, 1899; the Income tax Act, 1961; and the Benami Transactions (Prohibition)Act, 1988.
The Depositories Act, 1996 was enacted with the objective of ensuring free transferability of securities with speed, accuracy, and security, by making securities of public companies freely transferable subject to certain exceptions by restricting company’s right to use discretion in effecting the transfer securities and dispensing with the transfer deed and other procedural requirements under the Companies Act.
The Depositories Act, 1996 is an Act to provide for regulation of depositories in securities and for matters connected therewith or incidental thereto.
Certificate of Commencement of Business:
No depository shall act as a depository unless it obtains a certificate of commencement of business from SEBI.
The Act provides for establishment of one or more depositories. Every depository is required to be registered with the Securities and Exchange Board of India (SEBI) and will have to obtain a Certificate for commencement of business on fulfillment of such conditions as may be prescribed. The Board shall not grant it certificate under sub-section (1) unless it is satisfied that the depository has adequate systems and safeguards to prevent manipulation of records and transactions.
Investors opting to join the system will be required to be registered with one or more participants who will be the agents for the depository. Investors will have the choice of continuing with the existing securities certificates or opt for the depository mode. Under Section 3 (1) of the Act the depository is required to obtain a certificate of commencement of business from the Securities and Exchange Board of India. According to subsection 3 the Board shall not grant a certificate under sub-section (1) unless it is satisfied that the depository has adequate systems and safeguards to prevent manipulation of records and transactions.
The Depository Act provides for the establishment of depositories like the National Securities Depository Limited (NSDL) and the Central Depository Services Limited providing depository services in the electronic form for securities traded in equity and debt markets.
Every depository must have adequate mechanisms for reviewing, monitoring and evaluating the depository’s controls, systems, procedures and safeguards. It should conduct an annual inspection of these procedures and forward a copy of the inspection report to SEBI. The depository is also required to ensure that the integrity of the automatic data processing systems is maintained at all times and take all precautions necessary to ensure that the records are not lost, destroyed or tampered with. In the event of loss or destruction, sufficient back up of records should be available at a different place. Adequate measures should be taken, including insurance, to protect the interests of the beneficial owners against any risks. Every depository is required to extend all such co-operation to the beneficial owners, issuers, issuers’ agents, custodians of securities, other depositories and clearing organisations, as is necessary for the effective, prompt and accurate clearance and settlement of securities transactions and conduct of business.
Parties to a Depository:
In a depository system, the following parties are involved
- the depository,
- the beneficial owner;
- the participant;
- the issuer.
A depository would render service connected with the recording of allotment of securities or transfer of ownership of securities in its record. The service is availed of by the beneficial owner of the securities which are eligible to be dealt with by the depository system and in respect of which the service is availed of. The beneficial ownership would be pertaining to the securities of an issuer i.e. a person making an issue of securities. Section 1(1) (j) defines ‘registered owner’ as a “depository whose name is entered as such in the name of issuer.”
The participant means a person through whom the beneficial owner of the securities would avail of the depository service and is the custodial agencies like banks, financial institutions as well as large corporate brokerage firms.
Agreement between depository and participant:
A depository shall enter into an agreement with one or more participants as its agent. Any person, through a participant, may enter into an agreement, in such form as may be specified by the bye-laws, with any depository for availing its services. The relationship and dealings between the depository and the participant will be governed by an agreement and the participant is an agent of the depository vide Section 4 (1) of the Act.
Depository Participants includes brokers, banks, insurance companies, Stock Exchange clearing cells, the Reserve Bank of India, financial institutions, institutional managers, fund mangers etc.
Section 41 of the Companies Act lays down two modes of acquiring membership of a company and in both an entry of the name of a person as a member in the register of the members of the company is a condition precedent for a person to be regarded a member of the company. However to facilitate the beneficial owner of shares, on whose behalf the depository holds the shares, to be recognized as members, Section 41 in its new subsection 3 provides that every person holding equity share capital of a company and whose name is entered as a beneficial owner in the records of a depository shall be deemed to be a member of the concerned company.
Regulation 26 of the SEBI (Depositories and Participants) Regulations, 1996 states that depositories, participants, issuers, and issuers agent, in addition to the rights and obligations laid down in the Depositories Act and the bye laws shall have the rights and obligations arising from the agreements entered into by them.
In Probir Kumar Misra v. Ramani Ramaswamy it was held that after the Depositories Act, 1996, such depositors who are holding equity share capital of the company and whose name is entered as beneficial owner are also deemed to be members of the company, thus making them members under the Act.
In the case of Northern Projects Ltd. v. Blue Coast Hotels and Resorts Ltd. it was contended that only persons holding equity shares can be members of the Company in terms of Section 41(3) of the Act. This was rejected by Court and it was stated that Sub-section (3) of Section 41 is therefore only in addition to Section 41(1) and Section 41(2) and not in derogation or substitution of the first two subsections. The word ’shareholder’ and ‘member’ is used in the same connotation under the Act and the Section covers the third category of equity shareholders who are neither subscribers as contemplated by Sub-section (1) nor whose names are entered in the register of members as contemplated under Sub-section (2) of Section 41.
Depositories to indemnify loss in certain cases.
Any loss caused to the beneficial owner due to the negligence of the depository or the participant, the depository shall indemnify such beneficial owner.
In order to protect the interests of the beneficial owners of the securities handled by the depository, section 16 of the Act seeks to require the depository to indemnify loss suffered by the beneficial owner due to the negligence of the depository or the participant. A sine qua non for claiming the compensation shall be ‘negligence’ on the part of the depository or the participant, as the case may be. Where loss due to the negligence of the participant is indemnified by the depository, the depository shall have the right to recover the same from such participant.
According to Section 18 of the Act the Board, on being satisfied that it is necessary in the public interest or in the interest of investors so to do, may, by order in writing - (a) call upon any issuer, depository, participant or beneficial owner to furnish in writing such information relating to the securities held in a depository as it may require; or (b) authorise any person to make an enquiry or inspection in relation to the affairs of the issuer, beneficial owner, depository or participant, who shall submit a report of such enquiry or inspection to it within such period as may be specified in the order. Further the Board may in the interest of investors and to prevent the affairs of depository being conducted in a manner detrimental to the investors or the securities market, it may issue such directions (a) to any depository or participant or any person associated with the securities market; or (b) to any issuer as may be appropriate in the interest of investors or the securities market.
The SEBI came out with the Security and Exchange Board of India (Depositories and Participants) Regulations, 1996 regulating various facets of law relating to depositories. The rules govern areas such as registration of depository, grant of certificate of commencement of business, registration of participants, and details regarding rights and obligations of depositories, participants, issuers, manner of registrat.
Surrender of certificate of security.
Any person who has entered into an agreement under section 5 shall surrender the certificate of security, for which he seeks to avail the services of a depository, to the issuer in such manner as may be specified by the regulations.
The issuer, on receipt of certificate of security under sub- section (1), shall cancel the certificate of security and substitute in its records the name of the depository as a registered owner in respect of that security and inform the depository accordingly.
A depository shall, on receipt of information under sub-section (2), enter the name of the person referred to in sub-section (1) in its records, as the beneficial owner.
“ With respect to goods and Securities, those of which any unit is by nature or usage of trade, the equivalent of any other like unit….Where the subject of obligation is a thing if a given class, the thing is said to be fungible; i.e. the delivery of any object which answers to the generic description which will satisfy the terms of the obligation.”
Section 9 (1) All securities held by a depository shall be dematerialised and shall be in a fungible form.
Options to receive security certificate or hold securities with depository:
Every person subscribing to securities offered by an issuer shall have the option either to receive the security certificates or hold securities with a depository.
Furnishing of information and records by depository and issuer.
Every depository shall furnish to the issuer information about the transfer of securities in the name of beneficial owners at intervals
Power of Board to call for information and enquiry.
The Board, on being satisfied that it is necessary in the public interest or
in the interest of investors so to do, may, by order in writing,call upon any issuer, depository, participant or beneficial owner to furnish in writing such information relating to the securities held in a depository as it may require; or authorise any person to make an enquiry or inspection in relation to the affairs of the issuer, beneficial owner, depository or participant, who shall submit a report of such enquiry or inspection to it within such period as may be specified in the order.
Penalty for delay in dematerialisation or issue of certificate of securities.
If any issuer or its agent or any person, who is registered as an intermediary under the provisions of section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992), fails to dematerialise or issue the certificate of securities on opting out of a depository by the investors, within the time specified under this Act or regulations or bye-laws made thereunder or abets in delaying the process of dematerialisation or issue the certificate of securities on opting out of a depository of securities, such issuer or its agent or intermediary shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore rupees, whichever is less.
Penalty for failure to reconcile records.
If a depository or participant or any issuer or its agent or any person, who is registered as an intermediary under the provisions of section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992), fails to reconcile the records of dematerialised securities with all the securities issued by the issuer as specified in the regulations, such depository or participant or issuer or its agent or intermediary shall be liable to a penalty of one lakh rupees for each day during which such failure continues or one crore rupees, whichever is less.
Benefits of Depository:
The depository system gives a less risky settlement with implementation of collateral bases payment systems and greater profits from increased trading volume which are made possible by NCDS systems with reduced operational costs per transaction and reduced risk. There is an improved cash flow from not having funds tied up for long periods. Further forgery and counterfeit have been eliminated with attendant reduction in settlement risk from bad deliveries. The system has led to an opportunity for development of retail brokerage business and for development of more sophisticated custodial services which can be offered to the smaller investor. There are now standardised communications between NCDS, registrars and other intermediaries. Also, there is an ability to arrange pledges without movement of physical scrip and further increase overall level of trading activity, liquidity and profits.
Although India had a vibrant capital market which is more than a century old, the paper-based settlement of trades caused substantial problems like bad delivery and delayed transfer of title till recently. The enactment of Depositories Act in August 1996 paved the way for establishment of NSDL, the first depository in India. This depository promoted by institutions of national stature responsible for economic development of the country has since established a national infrastructure of international standard that handles most of the trading and settlement in dematerialised form in Indian capital market. The procedure relating to depositories is mainly governed by the regulations and bye laws that are framed by the SEBI and the depositories under the power provided by the Depositories Act.
There are immense benefits to the public by reduction of risks associated with loss, mutilation, theft and forgery of physical scrip. Further there is an elimination of financial loss owing to loss of physical scrip and greater liquidity from speedier settlements and reduction in delays in registration. There will be greater opportunities for investment offered by new instrument and services that can be provided only when NCDS is implemented and faster receipt of benefits and rights resulting from corporate actions. There is also an improved protection of shareholder’s rights resulting from more time communications from the issuer and reduced transaction costs through greater efficiency.
The system provides Up-to-date knowledge of shareholder’s names and addresses. And there will be savings in costs of new issues from reduction in printing and distribution costs. It may also lead to increased efficiency of registrar and transfer agent functions and better facilities for communication with shareholders, conveying benefits of corporate actions and information notices. Furthermore there will be an improved ability to attract international investors without having to incur the expenditure of issuance in overseas markets.
Immobilisation of securities is done by storing or lodging the physical security certificates with an organisation that acts as a custodian - a securities depository. All subsequent transactions in such immobilised securities take place through book entries. The actual owners have the right to withdraw the physical securities from the custodial agent whenever required by them.
Rule 28- The following securities shall be eligible for being held in dematerialized form in a depository:-
- shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate;
- units of mutual funds, rights under collective investment schemes and venture capital funds, commercial paper, certificates of deposit, securitized debt, money market instruments
The Depository Act which provides for the establishment of depositories like NSDL and CDSL to curb the irregularities in the capital market and protect the interests of the investors and paved a way for an orderly conduct of the financial markets through the free transferability of securities with speed, accuracy and transparency.