What is Dematerialization and its process?

The year 1996 revolutionised the Indian stock market when the Securities and the Exchange Board of India introduced an account called Demat Account. The idea behind the introduction of the Demat account was to do away with the complex process of physical trading where investors had to be present at the stock exchanges to buy and sell securities. With a Demat account, SEBI introduced the current form of online trading, where investors can buy and sell securities online and hold their investments virtually in the Demat account. But, what about the shares investors bought before 1996 which are held in the form of physical share certificates?

That is where the process of dematerialization introduced by SEBI helps investors to convert their physical shares into electronic form through a Demat account. The process of dematerialization is vital to ensure you can trade in the shares you hold as physical certificates by converting them into virtual shares. This blog highlights what is dematerialization and the entire dematerialization process.

What is a Demat Account?

It is important to understand the concept of the Demat account before learning the process of dematerialization as you can only dematerialize your physical shares by opening a Demat account. ‘Demat’ refers to dematerialization, a process by which physical securities are converted into electronic format. Therefore, a trader can use a Demat account to hold, transfer, and transact securities without the hassles of dealing with physical securities. As a result, trading has become a safer, quicker, and much more efficient method of storing securities and executing trades.

A Demat account helps manage your equity, bonds, and mutual fund investments. It is similar to a bank account. The only difference is that instead of holding money in a bank account, a Demat holds securities – shares, bonds, or debentures. You don’t need to carry physical shares with you when you have a Demat account.

Dematerialization Process

Before the introduction of digital trading, people held physical share certificates. However, SEBI has made it mandatory that physical share certificates should be converted to virtual shares through the dematerialization process. Dematerialization is the process of converting your physical shares into electronic form. This consists of four primary parties: depository, issuer, beneficial owner and depository participant.

There are two depositories in India— National Securities Depository Limited and Central Securities Depository Limited. The issuer is the company that floats the shares, whereas the depository participant is a SEBI-registered entity that acts as an intermediary between the investor and the depository. Investors avail of depository services only through depository agents. Dematerialization is comparable to keeping your money in a bank account. In Demat form, your physical share certificates are replaced by electronic book entries; purchases of shares are reflected as credits in your Demat account, and sales are reflected as debits. Before you learn what is dematerialization process, here are some rules of the dematerialization process:

• In the process of dematerialization, a company revises its Article of Association through a special resolution in the general meeting, allowing it to issue shares in electronic form.
• Private companies, then, have to register with both NSDL and CDSL. The depositories have their own set of criteria for registration, and the issuer has to comply with them.
• Post-registration, the depositories provide a unique ISIN for each of the shares. An ISIN is a 12-digit code used to identify different securities such as shares, bonds, etc.
• The companies get access to depository services only through an intermediary. If the issuer wants to transfer the dematerialized shares, it has to arrange for Demat connectivity from depositories.

Features of Dematerialization

The dematerialization process involves numerous investor-oriented features which allow investors to trade effectively and make informed financial decisions. The dematerialization process converts the physical shares into the electronic form to ensure an investor can trade in the shares using an online Demat account. Through dematerialization, investors can safely transact as the depository institutions cross-check the transactions. Furthermore, as the dematerialization process includes the opening of the Demat account, it allows investors the ease of trading and other unique features such as stock analysis, data charts, financial reports, etc.

Importance and Benefits of Dematerialization

Numerous investors still hold physical share certificates they bought before 1996. However, SEBI has made it mandatory to follow the process of dematerialization to convert the physical shares into electronic form. These include:

• Safety: Dematerialization eliminates the chances of shares being lost, forged or misplaced, increasing the safety of the holding. They are stored in secure depositories, which has made theft a thing of the past.
• Convenience: Thanks to the electronic nature of dematerialized shares, the problems related to their storage and maintenance have been eliminated. You won’t have to deal with lost or damaged certificates anymore.
• Accessibility: All the records of shares are stored electronically and online. This allows you to access dematerialized shares from almost anywhere and anytime using the internet.
• Cost-efficiency: Electronic trading doesn’t require cumbersome paperwork, which reduces a lot of expenses.
• Flexibility: Dematerialization led to increased flexibility and therefore improved access for small investors. Now, one can buy/sell even a single share without any restriction on the numbers.

How does the Dematerialization of Securities happen?

The process of dematerialization is as follows:

• To initiate the process of dematerialization, you need to open a demat account through a depository participant.
• Complete a dematerialization request form and submit it to the depository participant with the physical certificates. On all the security certificates, mention ‘Surrendered for Dematerialization.’
• After the form and certificates are submitted, the DP verifies the details and forwards the form to the company and the registrars through the depository.
• Post-approval, the physical certificates are destroyed, and the exact amount of electronic shares is credited to the Demat account.
• The shares are credited to the investor’s Demat account after receiving confirmation from the depository.
• The entire process takes 15-30 days.

Process of Dematerialization

The process of dematerialization Includes two steps. The first is opening a Demat account, and the next is to request the dematerialization of shares. Here is how you can complete the two steps:

1. Open a Demat Account

• Step 1: Visit your preferred DP’s website and open a Demat and trading account quickly and effortlessly.
• Step 2: Click on their website’s ‘Open a Demat and trading account’ link.
• Step 3: Fill in the application form.
• Step 4: Upload scanned copies of all the necessary documents for Know Your Customer (KYC).
• Step 5: Sign the agreement with the DP along with the charges. This agreement contains the duties and responsibilities of the depository participant and the account holder. Therefore, it is important to read them thoroughly before putting your signature.
• Step 6: Once all the relevant documents are submitted, your application will be processed by the DP.
• Step 7: After your demat and trading account application is successfully approved, you will receive a unique user ID and password to access your trading account and a demat account number.

2. Raise a Request for Dematerialization of Shares

Once you open a Demat account, you must request to convert your physical share certificates into the dematerialized format. You can follow the steps mentioned below to raise a dematerialization request with your DP:

• Step 1: Contact your DP for a Dematerialization Request Form (DRF).
• Step 2: Complete and sign the DRF with all the required details. Then, submit the duly completed form and physical share certificates to your DP. It is important to mention ‘Surrendered for Dematerialization’ on each physical share certificate.
• Step 3: Your DP will process your request after receiving the DRF and the surrendered physical share certificates.
• Step 4: Your DP will send the dematerialization request to the concerned company’s appointed Registrar and Share Transfer Agent (RTA).
• Step 5: Once the dematerialization request is approved, your physical share certificates get destroyed, and your Demat account gets credited with the relevant number of shares.

Problems with Dematerialization

Although dematerialization has transformed how securities are held and traded, it has problems. Some of the major problems associated with dematerialization include:

• Technical Problems: One of the most critical problems is dependence on technology. Any technical fault or system failure will delay the transfer of securities, affect the settlement of trades, and potentially lead to losses for the investor. Moreover, not all investors have a reliable internet connection or other infrastructural facilities to maintain their Demat accounts.
• Security Concerns: Although dematerialization is intended to reduce the risks of physical certificates being lost, stolen, or forged, it opens up new security risks. Cybersecurity threats like hacking and phishing attacks can compromise investors’ accounts, leading to unauthorized transactions or loss of funds. The depositories must ensure robust security protocols to protect sensitive financial data.
• Account Maintenance Charges: Demat accounts have maintenance charges, which burden small investors or those with minimal holdings. The charges vary from one depository participant to another, which creates confusion and dissatisfaction among investors. For infrequent traders, the cost of maintaining an account might outweigh the benefits.
• Lack of Awareness: Many retail investors, particularly those new to the market, face challenges in understanding the intricacies of dematerialization. They may struggle with issues like opening a Demat account, transferring securities, or tracking their holdings, leading to confusion and errors in trading.
• Regulatory Challenges: In some cases, the regulatory framework surrounding dematerialization might not be as transparent or robust, leaving investors vulnerable to malpractices and fraud. The evolving nature of securities markets requires constant monitoring and updates to the regulations to safeguard investor interests.

Conclusion

Dematerialization of shares is an important step in securing your investments and ensuring that you can trade them easily and quickly using an online trading app. Now that you know what dematerialization is, you can open a Demat account and raise a dematerialization request to convert your physical shares into electronic form.