Dematerialization and Rematerialization of Shares

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Introduction

According to the Depositories Act, 1996, an investor has the option to hold shares either in physical or dematerialized form. Previously people used to hold shares in physical forms only in the form of share certificates but due to change in activities of the market and rise in the risk associated with physical shares it was realized that there is a need to bring technology in holding of shares and hence the concept of Demat shares was introduced.

But after the introduction of demat shares it was realized that there can be instances when people would want to reconvert there shares into physical form in case they don’t like the concept of demat shares or have difficulty in holding their shares electronically for a number of reasons and hence, the concept of rematerialization of shares came in, to give an option to people to reconvert there demat shares in physical certificate form. This article will analyse both the concepts, the procedure involved in both the conversions, the pros and cons associated with each and what is the market’s opinion on both of these conversions.

Dematerialization

The act of changing physical share certificates or other securities into electronic form and putting them in an investor’s demat account is known as dematerialisation. This system is run by a depository that has been approved by the Securities and Exchange Board of India (SEBI) to carry out the functions of a depository. According to Section 68 B of the Companies Act, amended by the Companies (Amendment) Act, 2000, any IPO undertaken by a listed company in excess of Rs. 10 crores must be issued in dematerialized form by complying with the applicable requirements of the Depositories Act, 1996. A DP is used to open the demat account. This particular system’s working is through a depository who is registered with the Securities and Exchange Board of India (SEBI) to perform the functions of a depository as regulated by SEBI.

Why need of Dematerialization

The exceptional growth in the Indian capital market over the last 15 years has resulted in an increase in stock exchange activity, transaction volumes, market intermediaries, investor population, and so on. However, with this increase in activity has come a series of problems that threaten the capital markets’ long-term survival, the most of which are due to the massive quantity of paper labour required and paper-based trading, clearing, and settlement. The century-old method of trading and settlement handled via massive amounts of paperwork made retail and institutional investors apprehensive of entering the capital market, as well as becoming a barrier to expansion and resulting in the establishment of cumbersome procedures and paperwork.

According to this article, the actual growth and transformation began in the mid-1980s, after the government’s liberalization policies. The banking industry, capital markets, securities market regulation, mutual funds, foreign investments, and government control were all targeted for financial sector reform. Finally, these institutions understood that physical certificates were causing so many investor conflicts and arbitration proceedings because the paperwork was not keeping up with the increasing development, and that a better mechanism was needed to ensure that these obstructions were removed.

As the ultimate answer to all such reforms, the Government of India decided to set up a fully automated and high-technology based model exchange that could offer screen-based trading and depositories as the ultimate answer to all such reforms and eliminate various bottlenecks in the capital market, particularly in stock exchange clearing and settlement systems.

Process of dematerialization of shares

The procedure of dematerialisation of shares is defined under Bye- Law 9.2 of National Securities Depository Limited and Business Rules 11.1 of National Securities Depository Limited. Following are the steps that need to be followed for Rematerialization of shares.

  • First and foremost, the beneficial owner of the shares (BO) must choose a depository participant (DP) that meets their needs and requirements. DPs are depository agents and co-functionaries in the dematerialization of securities processes. When a BO identifies the ideal DP, he or she must complete a Demat Account Form (DRF) and send it along with the physical certificate(s) to the depository participants for dematerialization. DP would double-check that the DRF was appropriately filled out.
  • The BO must then sign a standardised agreement with the DP, which will include the rules and regulations, fees you will be charged, and the terms and conditions of your agreement with the depository participant. The individual must submit the certificate corresponding to the securities intended to be dematerialized to the issuer after entering into such an arrangement with the depository. The participant must be informed of the details of the certificate of such securities by the BO.
  • The DP then informs the depository of the specifics of the securities to be dematerialized as well as the agreement reached between him and the beneficial owner, and transfers the certificate for the securities to the issuer together with the information and particulars of the securities.
  • When the issuer receives these certificates, they are mutilated and replaced in the records with the name of the depository, who is the registered owner of the securities. The depository and all stock exchanges where the security is listed get a certificate to that effect.
  • After that, the depository registers the beneficial owner of the dematerialized securities as the person who submitted the certificate of security. The depository also inserts the name of the participant who carried out the process and provides a notification to that participant.
  • Once the dematerialization process has been completed, the depository is responsible for maintaining all documents related to the securities that have been dematerialized.
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The demat account offers a number of benefits to the investor as well as some disadvantages too. Let’s look into what can be the said advantages and disadvantages of holding dematerialized shares.

Advantages of dematerialization

  • Dematerialization of shares enables the making of transactions very easy and convenient for the shareholder. A demat account allows you to conduct transactions electronically, eliminating the need for the shareholder to be physically present at the broker’s location to complete a transaction. Furthermore, the investor can use a computer or a smartphone to access the Demat account.
  • Dematerialization of shares also ensures safety and security as it eliminates the risks associated with physical deliveries such as theft, forgery, getting lost in transit, shares under litigation, signature difference of transferor, and the like.
  • Dematerialization also makes the process of transferring of ownership of the demat account to the next of the kin very easy in case of death of demat account holder, this is done by making the legal heir the nominee of the demat account. Previously this was not possible when the shares were held in physical form since the legal heirs had to go through a lot of effort to claim their rights.
  • There is also a lot of savings that a person does when holding a demat shares. The loan interest paid on demat shares are really less as compared to physical shares. The person also doesn’t have to pay any stamp duty charges for transfer of shares.

Disadvantages of Dematerialization

  • One of the most significant downsides of dematerialization is the cost of opening and managing a Demat account. The account holder must pay an annual maintenance charge, even if the demat account only contains a single share. Also sometimes, brokers charge too much.
  • Someone who does not have a thorough understanding of computers or the digital world may find it difficult to operate demat shares. To handle a demat account, you do not need to be a technological specialist, but you do need to be tech-savvy. This difficulty can be remedied via stockbroker trade facilities, but it will cost you extra fees or lead to broker fraud or misappropriation of funds.
  • Multiple regulatory frameworks must be followed, including the Depositories Act, Regulations, and various depositories’ Bye Laws. In addition, agreements are made at various stages of the dematerialization process. These factors may cause problems for investors who want dematerialized securities transactions to be simple.

Remateralization

The process of converting electronic securities holdings into physical certificates is known as rematerialisation. It’s the inverse of the dematerialisation process, in which the investors who have previously converted their shares to electronic form have the option of converting them back to physical form once again. The digital existence of shares is cancelled during the rematerialisation process, and new physical shares are issued. Rematerialisation is commonly used to avoid paying the maintenance fee for a Demat account with only one or two shares. RTA (Registrar & Transfer Agent) assigns separate numbers to process shares during rematerialization.

Once shares are rematerialized, every transaction involving share trading takes place physically, including documentation. When shares are maintained in physical form, the company is responsible for keeping track of their accounts. To seek rematerialisation of shares, investors must fill out and submit an RRF (Remat Request Form) to the Depository Participant. After their shares have been successfully rematerialized, RTA issues them new physical certificates for their holdings.

The rematerialisation process, on the other hand, is extremely complicated and can take up to 30 days to complete. The rematerialisation process entails a set of procedures that the investor must do in order to convert his shares into physical form. 

Procedure of Rematerialisation

The procedure of rematerialisation of shares is defined under Bye- Law 9.4 of National Securities Depository Limited and Business Rules 11.2 of National Securities Depository Limited. Following are the steps that need to be followed for Rematerialization of shares.

  • The rematerialisation process begins with the investor requesting that his shares be rematerialized. He must fill out a Remat Request form (RRF) and submit it to the depository participant (DP). This form is used to notify the depository participant of the rematerialization of shares.
  • The next step is the verification of RRF. After receiving the RRF from the investor, the Depository participant validates it by verifying the client’s signature, whether the form is properly filled out or not etc. He examines the form in detail and, if everything is proper and then he gives an acknowledgement slip, which is stamped and signed.
  • After this the DP electronically informs the Depository of client’s rematerialisation request after successful verification and fulfilment of all processes. The DP does this by inputting the request in his software known as DPM.
  • DPM also generates an RRN (Rematerialisation Request Number). For this reason, the RRN produced in this manner is entered into the field provided in the rematerialisation request form. A person other than the person who submitted the data should verify the details reported for the RRN. The DP then sends the request to the DM (Depository Module — the Depository’s software system). If the DP discovers that the client’s account does not have sufficient funds, the request will be denied. The DP will inform the customer that their request will not be fulfilled.
  • The DM electronically sends the request to the Issuer/R&T agency. The DP will complete the request form’s authorization section. The request form will subsequently be sent to the Issuer/R&T agent by the Depository. The depository will deliver all essential data and paperwork together with such a request.
  • On receiving the rematerialisation request from the depository, the issuer authorises and checks all details and has the authority to raise concern regarding the processing of request. Depending on the nature of the objection, the Issuer/ R&T agent may reject the request or process it partially and send an objection letter to the DP, requesting correction for the remaining portions.
  • The Issuer/R&T Agent accepts the rematerialisation request once all information has been reviewed and determined to be valid. He will submit the Depository confirmation of such a request. The Issuer/R&T Agent will now start the printing process for the client’s new physical certificates.
  • Following the successful processing of the rematerialisation request and the printing of new certificates, the Issuer sends these certificates to the investor. The Registrar and Transfer Agent use these certificates to assign unique numbers to shares.
  • When the depository receives confirmation of the request, it will update the client’s accounts. It will download all of the data that has been sent to the Depository Participant. He will update DP on the status of the request. The DP will now notify the investor of his request for rematerialization. The entire rematerialization process takes up to 30 days in this manner.
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Advantages of Rematerialization

  • Rematerialization of shares saves us from paying the maintenance fee for a Demat account, generally in a demat account even if we only hold only one or two shares still we have to pay the annual maintenance charge which is very burdensome for people.
  • The dematerialized shares are sometimes prone to cyber scams, dematerialization of transaction and communication facilities generally provide a direct connection between criminals without any physical contact in a more flexible way, but when we hold shares in rematerialized form they are safe from such cyber scams.
  • In case of holding rematerialized shares even if the person is not tech savvy he can easily operate his shares.
  • Many a times investors  hold infrastructure bonds has [1] 

Disadvantages of Rematerialization

  • When we hold shares in physical form we need to pay a stamp duty on transfer of securities which is not the case when we hold them in dematerialized form.
  • Holding shares in physical form makes it prone to the risk of losing them due to theft, fire, flood etc. One has to keep the share certificate with

Opinion on Rematerialization Process

Despite the fact that investors can hold their shares in either physical or electronic form, the fact that rematerialization has occurred indicates that there is insufficient liquidity in the new system for investors. This is the reason that many think that the process of dematerialization must be made a one way process so that investors can’t opt for rematerialization once they have converted their shares in demat form, as in this case rematerialization will act as a setback to concept of dematerialization but many also think that the investor must be offered the choice of rematerialization in the early phases as if the investor is dissatisfied with the depository system, there will exist an escape path of rematerialization for him.[2]  Let’s look into some of the opinions of various famous personalities of the market.

According to the National Securities Depository Limited managing director CB Bhave’s unfazed opinion ‘the investors have the option of rematerialization under the legislation. When a request for remat is submitted, we are unable to query the investor about the rationale for the request.’

JM Share & Stock Brokers’ head of equities dealing, Ashith Kampani, is of adamant opinion about making dematerialisation a one-way process: ‘If investors are given the choice of dematerialisation, the depository idea is likely to take longer to catch on.’ Rematerialisation would be preferred by more investors due to illiquidity. But then the system would be never able to achieve liquidity if existing investors leave the depository.’

To popularise dematerialisation, Ajay Pancholi, manager, operations, ICICI Brokerage Services, believes that a patient approach is required. According to him the dematerialisation process should never be made a one-way process. The ability to rematerialize will entice retail investors to experiment with the depository system

Also, some people are of the opinion that dematerialization should not be made a one way process from the start itself but once the dematerialised section has adequate liquidity, the whole process should be rendered a one-way process.

Conclusion

We can conclude that the market has a split opinion on whether the option of rematerialization should be removed once an investor’s holdings have been dematerialized. But according to the author both Dematerialization and rematerialization have their own advantages and disadvantages as discussed in this article and it should be totally at the discretion of the shareholder whether he wants to hold his shares in demat form or in physical form.


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