Gone are the days when shares were stored as physical certificates. With digitisation, the world has seen a huge transformation, and so has the stock market. The modern stock market has replaced physical share certificates with electronic ones through dematerialisation.
In this blog, let’s understand what dematerialisation is and how it works in a simple way.
What is Dematerialisation of Securities?
Dematerialisation is the process of converting physical shares into electronic form. Once the shares are converted, they are stored in a demat account. The full form of a demat account is “dematerialised account.”
A depository is responsible for storing the securities electronically on behalf of shareholders. These securities may include bonds, government securities, or mutual funds. A depository participant (DP), registered under the Depositories Act of 1996, helps investors hold these securities in electronic form. The DP provides depository services to traders and investors, acting as an intermediary between them and the depositories.
Currently, in India, two depositories registered with SEBI offer these services: NSDL (National Securities Depository Ltd.) and CDSL (Central Depository Services (India) Ltd.).
A Brief History of Dematerialisation
While we now understand the concept of dematerialisation, it’s important to know its background. After the liberalisation of India’s economy in 1991, the country began adopting technology to streamline processes. SEBI (Securities and Exchange Board of India) was formed in 1992, and in 1996, the Depositories Act was passed, introducing the concept of dematerialisation of shares. This allowed traders to manage their securities more efficiently, from anywhere and at any time.
Around the same period, the National Stock Exchange (NSE) was established, which introduced an anonymous trading system. This further increased the use of dematerialisation in the stock market. The Companies (Amendment) Act of 2000 made it mandatory for companies issuing IPOs worth ₹10 crores or more to do so in dematerialised form. This marked a major shift, with more investors opening demat accounts and transitioning to the online trading system.
The Process of Dematerialisation
The dematerialisation process involves four key parties:
- The Share Issuing Company
- Depository
- Owner or Beneficiary
- Depository Participant (DP) or Broking Firm
Let’s understand the role of each party:
The Share Issuing Company
Before issuing dematerialised shares, a company must update its Articles of Association and register itself with a depository.
The Depository
In India, the two depositories – NSDL and CDSL – assign a unique 12-digit ISIN (International Securities Identification Number) to each security. The communication between the company and depository is typically handled by Registrar and Transfer Agents (RTAs).
The Owner or Beneficiary
An investor who wants to hold shares in electronic form must open free demat Account This applies to both new and existing investors. All their transactions, such as buying and selling stocks, bonds, mutual funds, and ETFs, are recorded in this account. However, investors cannot open a demat account directly. Instead, they must use a Depository Participant (DP) or a brokerage firm to open the account on their behalf.
Depository Participants (DPs)
A DP is an agent registered with the depositories (NSDL or CDSL) that helps investors open and maintain demat accounts. They process the investor’s application, verify documents, and register the account. Examples of DPs are Motilal Oswal, Zerodha, HDFC Sky, etc
Delivery Trading
What is Delivery trading? It involves purchasing stocks with the intention of holding them for an extended period, making it a long-term investment strategy. To facilitate this, investors need a Demat account, which allows them to securely hold their shares in an electronic format, ensuring easy access for future trading or selling when market conditions are favorable.
Steps of Dematerialisation:
- The investor opens a demat account through a depository participant (DP).
- They submit their physical share certificates along with a Dematerialisation Request Form (DRF).
- The DP verifies the details in the DRF and the physical certificates.
- After verification, the physical certificates are destroyed, and the details are sent to the depository in electronic form.
- The depository confirms the dematerialisation process is complete and informs the DP.
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The converted shares are credited to the investor’s demat account, where they are held electronically.
Benefits of Dematerialisation
Paperless Transactions
Converting shares into electronic form eliminates the need for physical paperwork. All transactions, whether it’s buying or selling securities, are now digital, reducing administrative costs for companies.
Monitoring Investments
With all your securities stored in a single demat account, you can easily monitor your investments online. You can track the performance of your portfolio and make changes when necessary.
Convenience
Demat accounts make it simple to trade and manage your investments. You can access your account from anywhere and carry out transactions without needing to handle physical certificates.
Safety
Keeping your securities in a demat account eliminates the risks associated with physical share certificates, such as loss, theft, or damage.
Avail Loan Facility
Investors can also use their electronic holdings as collateral for loans. This adds to the convenience of dematerialisation.
Corporate Benefits
Dividends, interest, refunds, and other corporate benefits, such as stock splits, bonus shares, and rights shares, are credited directly to your demat account, ensuring that you receive them without delay.
Problems with Dematerialisation
High-Frequency Trading
The ability to quickly communicate and execute orders has made the market more liquid. However, it has also made the market more volatile. Investors tend to focus on short-term profits, leading to frequent trading, which sometimes creates instability.
Technological Challenges
Not all investors are comfortable with technology. Some may have slow systems or less experience with digital tools, putting them at a disadvantage compared to those who can trade more efficiently.
Conclusion
In conclusion, dematerialisation has revolutionised trading in the Indian stock market. It has made trading more accessible and convenient, removing the complications of dealing with paper certificates. Investors can now focus on building strategies and aiming for higher returns.
However, while dematerialisation offers numerous benefits, it’s important to be mindful of the challenges, such as increased volatility in the market and technological limitations. As long as you understand these potential issues, you can make the most of your demat account and enjoy the convenience of electronic trading.
For a seamless trading experience, download the HDFC Sky App, one of the best trading app in India. This app offers access to over 3,500 listed companies. Open your demat account online today and enjoy a hassle-free trading experience with simplified pricing and zero hidden charges.