Demat, that stands for dematerialization, is the process of converting physical shares into electronic form. A demat account enables shareholders to perform paperless trade in shares. These electronic shares are deposited with a depository. National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL) are two registered depositories in India that govern and hold the custody of dematerialized form of shares. Both NSDL and CDSL further have agents called ‘Depository Participants (DPs)’ of their own, registered with SEBI (Securities Exchange Board of India), which act as intermediaries between depositories and investors.
Emergence of Demat
Previously, shares were traded in their physical form. Traders called out the prices of shares in Bombay Stock Exchange (BSE), India’s oldest stock exchange. Transfer price was fixed in an open outcry system similar to auction. Money was then exchanged for share certificates. Records of shareholding were manually kept and shareholders received certificates to the extent of their holding. Investors had to submit these certificates with the brokers for further trading and to the companies for getting the shares registered in their names. Every single share transaction demanded physical transfer of certificates leading to piles of work undone. Because of excessive paperwork settlements took a long time. This gave scope to forgery, fraud, fake and duplication of certificates which became unmanageable. All parties to the transaction like brokers, share holders and even the companies were infamous for fraudulent activities.
Shareholders were left in dark until they get their ownership verified by writing personally to the companies and getting their registration certified. They wouldn’t even know if they hold the original shares or fake documents. Most of the times share trading went unnoticed to the issuing companies itself. Secondary trading played an active part in the most undesirable way. It grew to be risky both for brokers and clients to find reliable counterparts. At one point, regional clearing houses were introduced to address this problem, but they failed in resolving these issues.
With the advent of computerization, the need for a better platform for share trading is felt and investor security is prioritized. NSDL was established under The Depository Act 1996 and brought in the concept of dematerialization of shares, for the first time in India. This created waves of ambiguity and enthusiasm at the same time across the country. NSDL had to travel a rough path in its initial days convincing investors, companies and banks, brokerages, etc to get included in the process. Everyone had their own doubts about the functioning of the system and waited for the first entrants to experience the setbacks. But to everyone’s surprise the concept was well imbibed into the minds clearing the way for a more constructive share trading system.
NSDL along with CDSL assisted a wide network of depository participants who made their work easy. Fake shares were uprooted, companies got their actual shareholding revealed, clients got to know authenticity of their ownership, and brokers with malpractices were eliminated. Initially depositories allowed trading in both physical and electronic forms but as this slowly lead to reduced liquidity in demat segment, SEBI stepped in to correct the situation by allowing institutional investors to buy shares in physical form but to sell only in demat form. This balanced the transactions and retained liquidity in both physical and demats segments. Settlement cycle was shortened and risk was gradually eliminated. Clearing and settlement systems were standardized.
Features of a demat account
- Investors with dematerialized shares are entitled to all the rights available to shareholders as in the case of physical shares.
- Through delivery instruction slip (DIS) and receipt instruction slip (RIP) investors can easily transfer their holdings. They can mention all the details of the transaction in these slips.
- Demat account minimizes the risk of ownership being forged and eliminates the scope for any kind of illegal activities with respect to buying and selling of shares.
- Rematerialization, i.e., converting electronic form of shares back into physical shares and dematerialization of shares can be done hassle-free through depository participants.
- Through demat accounts investors can receive all benefits offered by companies like dividends, interest, refunds, bonuses etc.
- Shares can be transferred between demat accounts by issuing instruction to the DP.
- As the shares exist in electronic form they can be accessed through multiple channels. Trading can be done over various electronic platforms like mobiles, tablets, laptops, desktops etc.
- Investors can pool all their investments like shares, mutual funds, government securities, etc into their demat account.
- SPEED e facility is an internet infrastructure provided by NSDL that allows investors to place delivery instructions to their DPs.
- Demat accounts enable its holders to pledge their securities with lenders to avail loans.
- Demat accounts expedited the share transaction rate providing quick liquidity to the investors.
- Hidden charges, stamp duty, handling charges and other miscellaneous expenses are all eliminated in demat accounts. Any charge we pay as a part of transaction will be transparent and well defined.
- Demat accounts can be opened by minors as well. Their legal guardians will be operating persons until minor attains the age of majority.
- To avoid any unexpected debit or credits in the account, investors can freeze their demat account temporarily.
Types of demat accounts:
- Regular demat account which can be operated by resident Indians.
- Repatriable demat account which is operated by non-resident Indians and allows fund transfers abroad. This needs an NRI bank account for fund transfers.
- Non-Repatriable demat account is also for NRIs but does not allow fund transfers abroad. They need to route the transfers through their NRO (non-resident ordinary) account in India.
Process of opening a demat account:
Demat account is similar to a bank account. It stores the information related to the securities in electronic form. Transactions are recorded online with debit and credit entries like money in banks. We can open an empty or zero balance demat account. Online demat accounts can also be opened with Aadhar card linked to the bank account. Same mobile number should be provided for both demat and the bank account for online opening.
- PAN Card, as a proof of identity, is a must for opening demat account.
- Recent passport size photograph, proof of residence and bank account details are required.
- With this necessary proofs, the client should fill up the demat account opening form and submit to the respective depository participants in person. DPs can be banks, brokerage firms and other financial institutions.
- Along with the account opening form, the account holder or holders in case of joint operation need to sign standard contract agreements which clearly specify the concerned rules and regulations.
- Upon signing the documents, client is provided with the copy of the agreements and schedule of charges involved with that particular DP.
- Few DPs may charge a fixed fee for both opening and annual maintenance of demat account which the client has to pay. Some may offer it for free. Brokerage charges are levied once the trading starts based on volume of trade and number of transactions.
- Investors can open multiple demat accounts with one or more DPs.
- Investors should choose nominees for their demat account. On the event of the account holder’s death, ownership will be transferred to the nominee.
- Day traders (who buy and sell securities on the same trading day) can sign a power of attorney (POA), at the time of demat opening. This enables the stock broker to conduct transactions on his behalf. POA empowers the broker to debit the account when you trade. This eliminates the need to submit DIS every time you place an order. However this may at times be risky if the brokers try to misuse it. Investors can revoke this at any time and is not mandatory.
- Once the application is accepted, a 16 digit demat account number is allotted to the client of which first 8 digits are depository id and other 8 digits are client id.
How to operate a demat account?
STEP 1: The first step in operating a demat account is to open a trading account, which is also offered by the DPs. Trading account is where the actual trading of shares takes place while demat is like a bank account which records stock of shares the investor holds. As he starts trading, shares sold are taken from demat and shares purchased are credited to it. Demat is like a safety deposit locker for the shares he holds.
STEP 2: A trading account can be opened online and buy/sell orders can be placed from anywhere. Stock brokers act as intermediaries in routing these orders through stock exchanges.
STEP 3: After selecting the stock broker, investors can submit the duly filled account opening form for trading account and provide all the mandatory documents (KYC-Know your customer) to the brokerage firm. They will be allotted the trading account with unique identification number.
STEP 4: Now the bank account, trading and demat accounts should be linked for easy transactions. Without this link, investors may have to update their demat account after every single trade they perform. Some DPs also offer a 3-in-1 account which fulfills all the requirements.
- Cash flow takes place from buyer’s bank account to seller’s bank account through buyer’s trading account.
- Shares flow takes place from seller’s demat account to buyer’s demat account.
STEP 5: Initiate the trade by placing buy or sell orders through the online trading account or by phone if the brokerage firm allows. Demat account will be credited with shares in case of buy order or vice versa. Bank account will be debited or credited according to buy/ sell order. Settlements will be done on T+2 that is second working day from the day of trading.
Investors have to maintain margin money in their accounts before starting trading. There are three types of margin:
- Initial Margin: This is a minimum amount to be maintained in the account to start trading.
- Maintenance Margin: Over the entire period of holding the demat account; investor has to maintain this money in the account and keep replenishing it on any shortfall.
- Variance Margin: It is the difference between initial and maintenance margin. In case of excess the money is given back to the investor.
Mr. Albert places a buy order for 100 shares of ABC Company Ltd for ₹ 300 each through his trading account. His broker executes the order the moment share price hits ₹ 300. His demat will be credited on T+ 2 day with balance of 100 shares from ABC Company and bank account will be debited immediately with ₹ 30,000. Every buy or sell order is valid for a certain time period and within this if the price doesn’t match up to the trader’s quote, the order will be cancelled.
When Mr. Albert places a sell order of 100 shares of ABC Company for ₹ 500 each, the broker executes it as soon as the share price reaches ₹500. His demat account reflects immediately with the new shares. And on the T+2nd day his bank account will be credited with the proceeds after deducting the taxes and other charges.
- Investors can choose to have any one of demat and trading accounts. But they cannot trade the shares with any one of them. With only demat account, they can buy shares from an IPO and hold for longer periods. But to sell them they need a trading account. And they can open only trading account when they do not wish to hold the stocks like for example, trade in futures and options.
- Dormant or inoperative demat accounts should be closed by applying for the same to the depository participant. Unused delivery slips should be returned and dues should stand cleared. It is suggested that investors do not keep their account dormant for long periods as they give chance to frauds or misuse.
Advantages of a demat account:
- Risk of fraudulent share transactions has been almost eliminated with the advent of demat account. Shares are held safely and securely.
- There is no specified quantity of shares to be traded. Trading odd lots or a single security was not possible in physical shares. Demat account has enabled that.
- It is easy to maintain, manage and keep a record of share holding.
- Regular trading doesn’t call for a transfer deed like in case of physical shares.
- All the costs associated with physical shares, such as stamp duty, handling charges, etc are eliminated.
- Share trading has becomes hassle free, less time consuming and settlements take place smoothly without delays.
- With the dawn of dematerialization, quality of share trade improved manifold inviting foreign investors and their capital to India.
- Digital platform of demat account offers all investment options to the investors. With a single click they can invest in various asset classes like shares, mutual funds, gold, ETFs etc.