In India if a person wants to invest or trade in the capital markets (especially in the equity segment) he must have a Demat Account. A Demat account derives the name from the term Dematerialization. Dematerialization is the process of converting physical certificates of equity shares, bonds, debentures, units of mutual fund etc. into electronic form. Now, let’s slow things down and understand how a Demat account came into being and what it is exactly. Is opening a Demat Account a very lengthy process? No, not at all. Let’s take a look at how easy it is:
Step 1: Find a Broker.
Step 2: Fill the Application Form. Investors/Traders can find download this form online. Print it out and fill it.
Step 3: Submit the form and the all the necessary documents:
- PAN Card is Mandatory
- Valid ID proof (PAN Card would suffice)
- Valid Address Proof (latest Electricity water bill/Voter ID/Aadhar Card/Drivers License/Passport)
- Bank Passbook/3-6 months bank statement (this is contingent on the type of trading account)
Account would be opened the very same day.
Earlier, before the Depository Act of 1996, majority of transaction of securities was done in physical form. This led to a whole stream of problems regarding authenticity of documents and transparency in transactions. For instance, there was no clear way of finding out if a transaction made was per say ‘fixed’ – that one party was selling and another related party was buying in order to inflate the price of shares, or that a holder of shares was in a way trying to sell only to a particular person. This is an unfair trade practice and is a bi-product or side-effect of over the counter transactions.
DIFFERENCE BETWEEN DEMAT ACCOUNT AND TRADING ACCOUNT
Each member who wants to participate in the Equity markets is mandated by SEBI to have a trading account (without which it is impossible to trade in electronic form) and a DEMAT account. These two are separate and perform separate functions.
The easiest way to understand this is the following. Think of the trading account similar to net banking account. To make any transaction buy or sell, in electronic medium, the participant must have a Trading Account. One cannot perform the function without it. The Trading account is linked to an individual’s Bank account. The funds from the Bank are brought in to the trading account (No interest is earned in the trading account). Withdrawal of funds also takes place from the trading account.
The DEMAT account on the other hand, should be thought of as the online locker of a Bank. When a security is purchased it takes T+2 days for it to reach the DEMAT account. This means if a security is purchased and sold the same day, it does not make it to the Demat Account at all. The Demat facility is extended to each Depository Participant from the two Depositories in India. I shall explain this in greater detail below.
BENEFIT OF DEMATERIALIZATION
The Dematerialization of securities or moving the securities to electronic medium was an effort towards making the Capital Market a better place for the investors. They are the backbone and the most basic strength of the market. Dematerialization, broadly serves the following:
- Brings transparency to the transactions
- Devoid of duplication or Fake Certification of Securities. Each certificate would have a unique identity
- Faster Processes
- Cheaper Processes
- No question of loss due to misplaced certificates
The capital market for an investor or trader is a place where he/she parks surplus funds for growth, security or a combination of both. On the other hand, for issuers of these securities it is a place from where they can source funds. Issuers could be government bodies (state and central), private companies, public companies or the central bank of the country i.e. in India the RBI (Reserve Bank of India). The investors provide these entities with the required funds & traders with the desired level of liquidity. Therefore, for the least the investors can expect from the market is a certain level of trust and integrity.
UNDERSTANDING THE DEMAT ACCOUNT
Now, that I have very briefly given a background as to why there was a need for electronic trading of securities, it would seem obvious as to where then would these securities be held? Is there a bank for such securities? Does each person have a place where they can hold shares, bonds, derivative contracts? Yes of course. It is called a Demat Account.
The structure of the Capital Market is not the easiest to explain to a lay man but I’ll try my best. There is the Exchange. This is the entity that is responsible for providing the technology for the sale and purchase of securities in electronic form. It has the duty to provide transparent and fare trading and investing processes. The Issuer of Securities as well the investors or traders need to be members of an Exchange. For investing/hedging or trading commodity futures or options (yet to be released in India) one needs to be a member of the two commodity exchanges. To invest in metals (precious or base metals) it is the MCX whereas to trade in agro-commodities it is necessary to be linked to the NCDEX.
Similarly, for currency derivatives or equity products one should be the member of BSE or NSE.
So does this mean people have to register themselves with the exchanges? No. There are intermediaries (Banks or Brokers) who are members of the exchange. The individuals or households that wish to invest or trade in securities need to be registered with the exchanges through these trading members. Not to mention all intermediaries need to be registered with the SEBI. Now then, who are the
Depositories? And how are they different from the Depository Participants? We will get to that below.
I know it must be getting confusing till here but I promise it will fall in place by the end of the article. I hope it is clear that Banks and Brokers are intermediaries that are linked to the Exchanges and are registered with SEBI. That is the story up until now. Let’s move forward. Just as the Exchanges provide the technological platform or the electronic medium for the transactions to take place (think of it as an electronic market place) the Depository provides the services of holding the securities in the electronic form. There are two depositories in India. The National Securities Depository Limited (NSDL) and the other is the Central Depository Service Limited (CDSL). So, does this mean we need to register ourselves (as investors/traders) with the Depositories?
No. That’s not possible. We can only register ourselves with the DP or a Depository Participant who are the intermediaries between the Depository and the Investors/Traders. So when an Individual opens a Demat Account, he does so either with a Broker or with a Bank. The Broker or the Bank is the intermediary who in turn is also a Depository Participant.