Traditionally, settlement system on Indian stock exchanges gave rise to settlement risk due to the time that elapsed before trades were settled by physical movement of certificates. There were two aspects: First relating to settlement of trade in stock exchanges by delivery of shares by the seller and payment by the buyer. The stock exchange aggregated trades over a period of time and carried out net settlement through the physical delivery of securities. The process of physically moving the securities from the seller to his broker to Clearing Corporation to the buyer’s broker and finally to the buyer took time with the risk of delay somewhere along the chain. The second aspect related to transfer of shares in favour of the purchaser by the issuer. This system of transfer of ownership was grossly inefficient as every transfer involved the physical movement of paper securities to the issuer for registration, with the change of ownership being evidenced by an endorsement on the security certificate. In many cases the process of transfer took much longer than the two months as stipulated in the Companies Act, and a significant proportion of transactions wound up as bad delivery due to faulty compliance of paper work. Theft, mutilation of certificates and other irregularities were rampant, and in addition the issuer had the right to refuse the transfer of a security. Thus the buyer did not get good title of the securities after parting with good money. All this added to the costs and delays in settlement, restricted liquidity and made investor grievance redressal time-consuming and at times intractable.
To obviate these problems, the Depositories Act, 1996 was passed to provide for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security by :
(a) Making securities of public limited companies freely transferable subject to certain exceptions;
(b) Dematerializing the securities in the depository mode; and
(c) Providing for maintenance of ownership records in a book entry form.
In order to streamline both the stages of settlement process, the Depositories Act envisages transfer of ownership of securities electronically by book entry without making the securities move from person to person. The Act has made the securities of all public limited companies freely transferable by restricting the company’s right to use discretion in effecting the transfer of securities, and dispensing with the transfer deed and other procedural requirements under the Companies Act.
A depository holds securities in dematerialised form. It maintains ownership records of securities and effects transfer of ownership through book entry. By fiction of law, it is the registered owner of the securities held with it with the limited purpose of effecting transfer of ownership at the behest of the owner. The name of the depository appears in the records of the issuer as registered owner of securities. The name of actual owner appears in the records of the depository as beneficial owner. The beneficial owner has all the rights and liabilities associated with the securities. The owner of securities intending to avail of depository services opens an account with a depository through a depository participant (DP). The securities are transferred from one account to another through book entry only on the instructions of the beneficial owner.
In order to promote dematerialisation of securities, NSE joined hands with leading financial institutions to establish the National Securities Depository Ltd. (NSDL), the first depository in the country, with the objective of enhancing the efficiency in settlement systems as also to reduce the menace of fake/forged and stolen securities. This has ushered in an era of dematerialised trading and settlement.
SEBI has made dematerialised settlement mandatory in an ever-increasing number of securities in a phased manner, thus bringing about an increase in the proportion of shares delivered in dematerialised form. There is an increasing preference to settle trades, particularly in high value securities, in demat form. Such high level of demat settlement reassures success of rolling settlement.
CDSL was set up in February, 1999 to provide depository services. All leading stock exchanges like the National Stock Exchange, Calcutta Stock Exchange, Delhi Stock Exchange, The Stock Exchange, Ahmedabad, etc have established connectivity with CDSL.
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