Dematerialisation: Costs, insurance and other issues  

Mar 15, 2004

Although high dematerialisation costs may have retarded the growth of India's investor population, things are beginning to change. (March 15,2004)

Dematerialisation: Costs, insurance and other issues

Sucheta Dalal

After years of ineffectual complaints, things are beginning to change on the dematerialisation front; and some of the credit must go to the Initial Public Offerings (IPOs) by nationalised banks and Public Sector Undertakings (PSUs). If nothing else, they helped establish that Indian investors have been effectively shut out of the capital market. For over a decade, India’s investor population has either remained static or shrunk.

When last surveyed, the total number of investors was estimated at less than two crore and they included persons who held shares in a single company. In terms of the number of depository accounts, the picture was even more dismal. Just 40 lakh demat accounts (and they included multiple accounts), accounted for over 99 per cent of secondary market trading.

The remaining investors stayed away from the capital market. Investors blamed this on extortionately high charges levied by Depository Participants (DPs) and the National Share Depository Ltd. (NSDL); but the NSDL has always maintained that investors, who are not active traders, are well advised to hold physical shares instead of paying high custody charges. However, that is a problem. Not having a DP account discourages investors and that is unacceptable in a healthy capital market. It also diminishes their chance of booking profits at the best possible price.

The dematerialisation process takes almost two months to complete, and unless investors are exceptionally lucky (as they were at the end of 2003), the bull run would end before they get the timing right and also dematerialise their shares in preparation for selling them. The recent spurt in demat accounts shows that investors can be attracted back to the capital market. Nearly 13 lakh new accounts have been opened by the NSDL alone in the last few months alone, CDSL reports a few lakh more. And although a big chunk of investors have merely wanted to take advantage of the bull run to sell shares, many have also been tempted to invest in the fortuitous string of blue chip PSU offers.

It is now up to the government to encourage these investors to become active players by making the depository charges affordable. Reducing custody charges and transaction costs for small shareholders, by transferring the cost burden to companies (who are its biggest beneficiaries of dematerialisation) would be a big incentive. Investor groups have long pointed out that that investors’ ability to change DPs must not be hampered through usurious exit charges. The very notion of open competition, that the NSDL (which has a nearly monopoly in the depository business) advocates, is defeated by high exit charge and it forces investors to remain with a DP despite poor service or high charges.

Fortunately, some significant new developments could change the situation. Firstly, NSDL has announced a slight reduction in some of its charges last week. Secondly, the Central Depository Services Ltd. (CDSL) is now getting its act together, and may provide investors with a good alternative to the NSDL. As a part of this effort CDSL extended its ‘Easi’ (Electronic access to securities information) service to the more exciting ‘Easiest” (Electronic Access to Securities Information and Execution of Secured Transactions) service last week. Easi is an information dissemination system that allowed investors to check transactions online, while ‘Easiest’ allows them to transact through the Net. Investors and clearing members can now use it to transfer and deliver shares to their broker pool accounts They can even transfer securities directly to the clearing corporation for pay-in. This facility is currently available only with the CDSL system and will help mitigate investor complaints about lack of information from DPs. It will also end the problem of investors being made to sign over blank delivery instruction slips to brokers to counter practical constraints such as the geographical distance from the DP’s office. Even NSE brokers are enthusiastic about ‘Easiest’ and say that the registration fee of Rs. 50,000 is fair and affordable.

Clearly, CDSL’s attempts to grow its minuscule market share are paying off. Its demat accounts have jumped 148 per cent and it has received over 31 new DP registrations. Its strategy of keeping fees affordable should also help it to attract a new class of DPs. For instance, UCO Bank, Indian Overseas Bank, Vijaya Bank and Union Bank of India would be ideal candidates to provide DP services in the North-Eastern and southern regions. Many of their own investors are located in these regions and the bulk of them have sought physical allotment of shares for want of depository facilities. These banks have issued anywhere between 40 to 74 per cent of their shares in physical form at the request of investors who are all potential DP clients.

The availability of a comprehensive cover against fraud is another positive factor. A meeting of investor groups at Ahmedabad, at the end of February, was surprised to learn that CDSL enjoys a distinct advantage. It has an insurance cover of Rs 50 crore, with under 10 per cent of the dematerialisation market; while NSDL has an Rs 25 crore cover despite being a near monopoly. The Securities and Exchange Board of India (SEBI) must ensure that both depositories use the insurance cover effectively on behalf of investors. The terms and conditions for availing insurance must to be disclosed to investors and publicised through the depository websites (CDSL has already promised to do so). SEBI must also insist that both depositories use the insurance cover to recompense investors in all cases of outright fraud, rather than push them into long drawn and expensive arbitration.

Also, SEBI must quickly implement its internal report recommending a big reduction in demat costs in the interest of growing India’s investor base. If the government plans to use the public offer route more aggressively for disinvesting PSU shares next year, then the growth of our investor population will have to keep pace with the economy. That will be a true indicator of India Shining.