What Is Dematerialization?

Over the past few years, the world of finance has transitioned to a paperless and digital environment. For example, there has been a significant change in transactions as the world moves from cash to digital methods like credit cards and UPI. Moreover, even the way of investing and holding on to securities has become digital.

What Is Dematerialization?

Dematerialization is one such process through which physical share certificates are converted into an electronic format and stored safely in a centralised repository. Dematerialization has made investing and trading seamless and convenient. In this blog, we will go over the process of dematerialization, how to do it, and its benefits.

Why is Dematerialization Done?

Before the digital era, investing or trading of shares was completely physical. Once the shares were purchased, the investor needed physical share certificates, which acted as proof of ownership. However, there were numerous challenges when it came to handling the physical share certificates. There were significant risks of fraud, theft, or even misplacing the share certificates.

Additionally, the process of settling transactions with physical certificates was more complicated and time consuming. The Securities and Exchange Board of India (SEBI) had a vision to transform the trading environment into a digital environment. To support this vision, the dematerialization of physical shares into an electronic format was necessary. Dematerialization facilitated a smooth, seamless, and secure environment for investing and trading.

How Dematerialization Works

Let’s take a look at how the dematerialization process works by understanding what a Demat account is and the role of a depository participant (DP).

Demat Account: A demat (dematerialized) account is an account which holds securities in an electronic format. An investor opens a Demat account with a registered depository participant.

Depository Participant: A depository participant is an intermediary that acts as a link between investors and a depository like the NSDL or CDSL.  The depositories play a crucial role in the storage of securities in an electronic format.

Read more: Difference Between CDSL and NSDL

Process of Dematerialization

• To dematerialize shares, an investor needs to open a demat account with a registered DP.
• For the conversion of physical shares into an electronic format, the investor is required to fill out a dematerialization request form (DRF). The form can be obtained from the DP and submitted with the original share certificates.
• The DP then forwards the share certificates and dematerialization request to the company and registrar and transfer agents (RTA).
• Once the DP confirms the process of dematerialization of the shares, the physical shares are immobilised and can no longer be traded physically.
• The depository then verifies and confirms the completion of the dematerialization process to the DP, and the shares and securities are displayed digitally in the investor’s Demat account.

History of Dematerialization

Dematerialization is a crucial factor in today’s safe and convenient investing environment. Let’s take a look at how the process of dematerialization was introduced.

Steps towards dematerialization of securities started in the 1990s. The liberation of the Indian economy in 1991 brought about significant reforms in the country’s financial landscape. In 1992, the Securities and Exchange Board of India (SEBI) was formed. Being a regulatory body, SEBI played a crucial role in introducing and integrating dematerialization.

In 1996, dematerialization was introduced under the Depositories Act. In the same year,  the National Securities Depository Limited (NSDL) was formed, while the Central Depository Services Limited (CDSL) was formed in 1999. The two depositories play an integral role in the storage and trading of securities in an electronic format.

Over time, companies were required to issue shares in a dematerialized format, ensuring a smooth transition to an effective digital format. Now, in order to invest or trade shares, a demat account is mandatory.

Benefits of Dematerialization

Dematerialization offers several benefits to investors as well as market participants. Some of the key benefits include:

Eliminates Fraud and Forgery

Since dematerialized shares are stored in a secure electronic format, there is little to no scope for these share certificates to be forged or stolen through fraudulent means.

No Need for Physical Storage

With shares and securities being stored in a centralised repository in an electronic format, there is no need for physical share certificates. Further, it eliminates the risk of theft or misplacing the share certificates. It also reduces paperwork and transaction costs.

Faster Settlement Cycles

Settlement of transactions and trades is fast and efficient since all processes are done digitally. This allows quicker credit and debit of securities from a demat account.

Efficient Monitoring and Management

Dematerialization helps investors to efficiently and easily monitor their investments. One can view their holdings digitally and easily buy or sell securities.

Things to Consider with Dematerialization

Although dematerialization offers significant advantages, there might be several challenges with the process such as:

• The process of dematerialization gets rejected due to incorrect information or inaccurate share certificates.
• The processing and verification of securities can be time-consuming.
• There is involvement and dependency on intermediaries like RTAs and DPs, which can pose a challenge.
• Several older investors are not aware of dematerialization, and they might find it challenging to convert physical shares to a digital format.

Dematerialization vs. Rematerialization

Rematerialization refers to the process of converting dematerialized shares into a physical format. Investors often opt for rematerialization to avoid paying demat account maintenance charges. Here’s how the process differs from dematerialization:

Role of NSDL and CDSL

The National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL) play an indispensable role in today’s era of investing and trading. Both depositories offer services of storing shares in an electronic format and facilitate safe and smooth trading of securities.

The NSDL was formed in 1996 and has a greater market share. It has around 3.5 crore demat accounts and 278 depository participants associated with it. Meanwhile, the CDSL was founded in 1999 and has over 15 crore demat accounts registered with it. Around 599 depository participants are registered with CDSL.

Conclusion

If one wants to invest or trade in shares, a demat account is a must. The process of dematerialization has not only helps create a safer and more convenient system for investors but also helps depositories and depository bodies to ensure a secure and efficient environment.