Mention the National Securities Depository Ltd (NSDL) to the average Indian and it will probably elicit a blank stare. After all, a maximum of two crore Indians own shares, and just over a quarter that number hold them in an electronic (or dematerialised form) account.
But the NSDL is fast growing into a giant electronic database and custodial organisation that could end up being the repository of an array of highly confidential information, both personal and financial.
The NSDL is a sort of bank that holds and transfers financial instruments through electronic accounts. Its stated aim is to ensure ‘‘the safety and soundness of Indian marketplaces by developing settlement solutions that increase efficiency, minimise risk and reduce costs’’. Nine years ago, NSDL was set up under the regulatory framework of the Securities and Exchange Board of India (Sebi) through the Depositories Act of 1996; but it has grown far beyond its original domain and the regulatory structure that governs it.
Sebi’s decision to mandate compulsory dematerialisation for secondary market transactions had allowed NSDL to establish one of the fastest records of dematerialisation of equity in the world. It has since expanded operations until its total assets under management are a giant Rs 14,00,000 crore. These include Rs 3,50,000 crore worth of corporate bonds and Rs 4,500 crore of government securities Some time ago, NSDL began converting National Savings Certificates (NSCs) and Kisan Vikas Patras (KVPs) to electronic form.
Today this database stands at Rs 500 crore. It is also looking at dematerialising Fixed Deposit Receipts and Reserve Bank of India relief bonds. The SMILE task force, set up by Sebi had also proposed the possibility of electronic ownership of mutual fund units.
A couple of years ago, the Finance Ministry commissioned NSDL to set up a massive and ambitious Tax Information Network (TIN) that will convert the paper records of over 1.6 crore tax payers into electronic form. It will then maintain a dynamic database for the Tax Department by receiving and updating information on Tax Deducted at Source (TDS) on behalf of taxpayers. Eventually, the database will allow all tax-related matters to be viewed and transacted through this network by providing passwords to individual and corporate taxpayers. The size of this task can be gauged by the fact, that a large company today creates a small truckload of paper in connection with TDS certificates alone. All this will vanish and be converted into electronic form.
When the multi-commodity stock exchanges came into existence, they too turned to the NSDL to dematerialise Warehousing Receipts. Then Sebi asked NSDL to create the controversial database of Market Participants (MAPIN) with Unique Identification Numbers and biometric fingerprinting. And finally, National Association of Software and Service Companies (Nasscom) is talking to NSDL to set up an employee database for the Information Technology industry after verifying employee credentials. Incidentally, the Central Depository Services (India) Ltd, set up by the Bombay Stock Exchange (BSE), has also been dematerialising many of the instruments that form a part of NSDL’s portfolio. But NSDL is not only the overwhelming market leader, but the reputation that it has established for integrity, security and leadership has been the biggest factor in growing its operations.
But clearly, there are regulatory issues. NSDL has far outgrown the regulatory ambit of Sebi. Although Sebi specifically clears various instruments dematerialised by NSDL, many of them are not even under Sebi’s regulatory jurisdiction and it is unclear who regulates these other areas.
For instance, NSCs and KVPs are strictly not securities as per the law. Similarly, the Forward Markets Commission (FMC) regulates commodity exchanges and NSDL is certainly not governed by its regulation; yet it dematerialises Warehousing Receipts.
Although Sebi conducts an annual inspection of the NSDL, its power to permit the dematerialisation of many instruments handled by NSDL is hazy. As for the Tax Information Network, it is the direct responsibility of the Finance Ministry and Sebi’s inspection does not cover that business.
Evidently, neither the government nor Sebi has applied its mind to the question of regulating and supervising NSDL, which have grown far beyond its original mandate. This was possible only because of the excellent leadership and integrity provided by its Managing Director C.B. Bhave and his background as a former regulator and bureaucrat.
NSDL now plans to shift some of its activities to a 100 per cent subsidiary called NSDL Database Management Ltd. Bhave says the Nasscom database work will be taken up through the subsidiary after necessary clearances. The Tax network may be similarly transferred to the subsidiary, but only when it is independently viable.
Is this good enough? Today there is no clarity about depository regulation and no clear accountability in case of systemic risk or fraud; moreover the organisation is already too big to risk any failure.
The government cannot choose to wake up when there is a problem. If, in 1996, it felt the need for a separate legislation for NSDL with specific supervision by the capital market regulator, then it cannot by and allow NSDL to expand in several directions that are all beyond the ambit of its original Act and regulation. More importantly, CDSL cannot be prancing through all the doors that are opened by up NSDL. At the same time, it would be a grave mistake to curb or restrict NSDL’s growth, at least under the current leadership. While its activities can be split into separate companies, it is clear that some of the newer businesses are subsidised and supported by the core depository infrastructure paid for by stock investors.
What is needed most urgently is for the Finance Ministry to take responsibility and create a new legislation and regulatory structure for the organisation that NSDL has become. Ideally, the depository function should be spun off to a subsidiary, which alone would be regulated by Sebi under the Depositories Act. While new legislation is written up for the unique database company that NSDL is today, the government must also look at whether there is need to create competition for NSDL under the revamped regulatory structure. As good as it is, the NSDL is already ‘‘too big to fail’’ and should not operate under regulatory ambiguity.