By Dhanendra Kumar
India has been the world leader in digitisation and transformative financial inclusion. Its rapid economic advancement has resulted in spectacular growth in Indian market capitalisation, which, at its market cap of $3.7 trillion, is now the fifth biggest stock market in the world. Earlier, participation in equity markets required extensive and complex manual paperwork with transactions and agreements, which has now been eased with dematerialisation, which is defined as the process of converting physical shares into electronic format.
To reduce delay in receipt of securities, process a large number of applications in IPOs, store share certificates, and prevent frauds and thefts, dematerialisation was adopted. The Depositories Act of 1996 was introduced to govern dematerialisation. There are two depositories in India—Central Depository Services (India) Limited & National Securities Depository Limited. There are broadly three sets of companies that may potentially dematerialise their securities—listed companies regulated by Securities and Exchange Board of India (Sebi) and the ministry of corporate affairs (MCA), unlisted public companies, and unlisted private companies, both regulated by MCA.
For listed companies, Sebi has been consistently amending the requirement pertaining to furthering the dematerialisation of physical securities. It restricted any transfer of shares in physical form effective April 1, 2019, while clarifying that it did not prohibit shareholders from holding shares in physical form. Sebi disallowed listed companies from transfer of physical securities. These changes were made to curb fraud and manipulation risk in physical transfer of securities, as there used to be several instances of fraud due to tampering etc.
Given the convenience and security in demat transactions, a need was felt to make it mandatory for unlisted companies to dematerialise their shares also. Consultations were held with stakeholders—corporates, industry associations, regulatory bodies and government authorities, MCA, and the ministry of finance. Thereafter, MCA issued a notification dated September 10, 2018, stipulating that all unlisted public companies would henceforth issue securities only in dematerialised form with effect from October 2, 2018.
Despite all its benefits, it was not mandatory for the unlisted public companies to convert shares into the dematerialised form. This was largely due to opposition from industry associations fearing additional expenses for the companies. However, in view of various benefits, through an amendment, it was then required for securities holders of an unlisted public company to convert all such securities in dematerialised form effective October 2, 2018. This helped in the transition of around 30,000-40,000 unlisted public companies, though that was only around 10% of the total number.
Unlisted private companies constitute the largest number of registered companies. Rule 9A of Companies (Prospectus and Allotment of Securities) Rules, 2014 applies only to an unlisted public company. While a private company is not required to, they can also facilitate dematerialisation of their shares. There is, however, one exception—a private company which is a subsidiary of public company. It will be considered a deemed unlisted public company and therefore required to convert its shares into demat form for any new issuance or transfer of securities. It is estimated that there are more than a million active Unlisted Private Companies out of more than two million companies as on October 31, 2021.
There are numerous benefits of dematerialisation. These include avoidance of risk of loss of physical documents in storage or transit, saving time and procedural and legal costs like stamp duty, avoiding tedious paperwork, enabling the tracking of transactions, and monitoring the performance of investments. With data of the beneficial ownership of shares, it can curb fraud. It also helps in weeding out shell companies, curbing malpractices like benami transactions, improving monitoring of securities-led collaterals and subsequent frauds, and aiding effective tax collection and formalisation of the securities market. Companies are benefitted largely as it improves corporate governance and reduces expenditure on manual compliance and procedural formalities in the earlier regime. It also promotes investments, FDI, FPIs, and helps investor’s certificates, bonus/rights shares, and eliminates risks. With digital connectivity penetrating in tier-2/3 towns and rural areas, it can also help in the mobilisation of larger investments and savings. More than 50 crore Indians have accounts under the Pradhan Mantri Jan Dhan Yojna (PMJDY) in the globally acclaimed Jandhan-Aadhar-Mobile (JAM) trinity, accounting for over `2 trillion in deposits during the last nine years. Over 55.5% of PMJDY account holders are women, a pivotal achievement in financial and gender inclusion.
It would be in the interest of efficiency, transparency and speedy economic growth if it is made mandatory for all unlisted companies to dematerialise their shareholding in a phased manner, along with the simplification of procedures, which will improve efficiency and reduce costs. It will help the government and regulators in supervising and monitoring the entire securities market and tax administration better. In fact, this may be one of the biggest financial reforms for creating a transparent and efficient system.
With inputs from Aditya Trivedi, associate, COMPAD
Dhanendra Kumar, Chairman, Competition Advisory Services LLP. Views are personal.