DepositoriesPrepared by –

Krunal Kuwadia – 40

On the simplest level, depository is used to refer to any place where something is deposited for storage or security purposes.

More specifically, it can refer to a company, bank or an institution that holds and facilitates the exchange of securities.

Or a depository can refer to a depository institution that is allowed to accept monetary deposits from customers.

According to Investopedia, Central security depositories allow brokers and other financial companies to deposit securities where book entry and other services can be performed, like clearance, settlement and securities borrowing and lending.

Concept

An American depositary receipt (ADR) is a negotiable security that represents securities of a non-US company that trades in the US financial markets.

Securities of a foreign company that are represented by an ADR are called American depositary shares (ADSs).

Shares of many non-US companies trade on US stock exchanges through ADRs. ADRs are denominated and pay dividends in US dollars and may be traded like regular shares of stock. Over-the-counter ADRs may only trade in extended hours.

The first ADR was introduced by J.P. Morgan in 1927 for the British retailer Selfridges.

ADR

ADRs are one type of depositary receipt (DR), which are any negotiable securities that represent securities of companies that are foreign to the market on which the DR trades.

DRs enable domestic investors to buy securities of foreign companies without the accompanying risks or inconveniences of cross-border and cross-currency transactions.

Each ADR is issued by a domestic custodian bank when the underlying shares are deposited in a foreign depositary bank, usually by a broker who has purchased the shares in the open market local to the foreign company.

An ADR can represent a fraction of a share, a single share, or multiple shares of a foreign security.

The holder of a DR has the right to obtain the underlying foreign security that the DR represents, but investors usually find it more convenient to own the DR.

The price of a DR generally tracks the price of the foreign security in its home market, adjusted for the ratio of DRs to foreign company shares.

In the case of companies domiciled in the United Kingdom, creation of ADRs attracts a 1.5% stamp duty reserve tax (SDRT) charge by the UK government.

Depositary banks have various responsibilities to DR holders and to the issuing foreign company the DR represents.

Working of ADR

One can either source new ADRs by depositing the corresponding domestic shares of the company with the depositary bank that administers the ADR program or, instead, one can obtain existing ADRs in the secondary market.

The latter can be achieved either by purchasing the ADRs on a US stock exchange or via purchasing the underlying domestic shares of the company on their primary exchange and then swapping them for ADRs; these swaps are called crossbook swaps and on many occasions account for the bulk of ADR secondary trading.

This is especially true in the case of trading in ADRs of UK companies where creation of new ADRs attracts a 1.5% stamp duty reserve tax (SDRT) charge by the UK government; sourcing existing ADRs in the secondary market (either via crossbook swaps or on exchange) instead is not subject to SDRT.

Sourcing of ADR

Level I ADR Level II ADR Level III ADR Regulation Q ADR SEC Rule 144A ADR

Types of ADR

These are not listed on any US exchange and can be traded only in the over-the-counter (OTC) market.

These ADRs are not subject to very stringent regulations from the SEC.

They represent shares of foreign companies that do not qualify for a US exchange listing or choose not to list on the exchange.

Investors can buy unsponsored OTC ADRs, which can be issued by more than one bank.

Sponsored OTC ADRs are generally confined to being issued by one sponsoring bank.

They are also more structured than unsponsored ones.

Level I ADR

These are typically listed on the NASDAQ or the NYSE and are subject to stricter SEC regulations which all listed companies need to comply with.

Level II ADR

Some ADRs may be offered through a public issue by the sponsoring bank.

The foreign company can raise substantial funds from the American markets with these ADRs.

Publicly issued ADRs require the most stringent adherence to SEC rules.

Level III ADR

The other way to restrict the trading of depositary shares to US public investors is to issue them under the terms of SEC Regulation S.

This regulation means that the shares are not, and will not be registered with any United States securities regulation authority.

Regulation S shares cannot be held or traded by any “U.S. person” as defined by SEC Regulation S rules.

The shares are registered and issued to offshore, non-US residents.

Regulation S ADRs can be merged into a Level 1 program after the restriction period has expired, and the foreign issuer elects to do this.

Regulation S ADR

Some foreign companies will set up an ADR program under SEC Rule 144A.

This provision makes the issuance of shares a private placement.

Shares of companies registered under Rule 144-A are restricted stock and may only be issued to or traded by Qualified Institutional Buyers (QIBs).

US public shareholders are generally not permitted to invest in these ADR programs, and most are held exclusively through the Depository Trust & Clearing Corporation, so there is often very little information on these companies.

Characteristics include:◦ It is an secured security.◦ A fixed rate of interest is paid.◦ Can be converted into multiple shares.

SEC Rule 144 A

A global depository receipt or global depositary receipt (GDR) is a certificate issued by a depository bank, which purchases shares of foreign companies and deposits it on the account. GDRs represent ownership of an underlying number of shares.

Global depository receipts facilitate trade of shares, and are commonly used to invest in companies from developing or emerging markets.

Prices of global depositary receipt are often close to values of related shares, but they are traded and settled independently of the underlying share.

Several international banks issue GDRs, such as JPMorgan Chase, Citigroup, Deutsche Bank, The Bank of New York Mellon.

GDRs are often listed in the Frankfurt Stock Exchange, Luxembourg Stock Exchange and in the London Stock Exchange, where they are traded on the International Order Book (IOB).

Normally 1 GDR = 10 Shares, but not always. It is a negotiable instrument which is denominated in some freely convertible

currency. It is a negotiable certificate denominated in US dollars which represents a

non-US Company's publicly traded local equity.

GDR

It is an unsecured security. A fixed rate of interest is paid on it. It may be converted into number of shares. Interest and redemption price is public in

foreign agency. It is listed and traded in the share market.

Characteristics

A European Depositary Receipt (EDR) represents ownership in the shares of a non-European company that trades in European financial markets.

The stock of many non-European companies trade on European stock exchanges like London Stock Exchange through the use of EDRs.

EDRs enable European investors to buy shares in foreign companies without the hazards or inconveniences of cross-border & cross-currency transactions.

EDRs carry prices in Euro, pay dividends in Euro, and can be traded like the shares of European-based companies.

EDR

An Indian Depository Receipt (IDR) is a financial instrument denominated in Indian Rupees in the form of a depository receipt created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India) against the underlying equity of issuing company to enable foreign companies to raise funds from the Indian securities Markets.

IDR

The foreign company IDRs will deposit shares to an Indian depository.

The depository would issue receipts to investors in India against these shares.

The benefit of the underlying shares (like bonus, dividends etc.) would accrue to the depository receipt holders in India.

The Ministry of Corporate Affairs of the Government of India, in exercise of powers available with it under section 642 read with section 605A had prescribed the Companies (Issue of Indian Depository Receipts) Rules, 2004 (IDR Rules) vide notification number GSR 131(E) dated February 23, 2004.

Standard Chartered PLC became the first global company to file for an issue of Indian depository receipts in India

IDR

Fungibility means that all the holdings of a particular security are identical & inter-changeable & they have no unique characteristic such as distinctive number, certificate no., folio no. etc.

To have a better understanding of the concept of fungibility, we can take an example of a currency note.

Just as Rs.100 note can be interchangeable with any other note of Rs. 100 or denomination of smaller notes with the value of Rs. 100, similarly securities of a company can be interchanged with any other security of the same company, as the distinctive number of the security does not matter.

Fungibility

In India, a Depository Participant (DP) is described as an agent of the depository.

They are the intermediaries between the depository and the investors.

The relationship between the DPs and the depository is governed by an agreement made between the two under the Depositories Act.

In a strictly legal sense, a DP is an entity who is registered as such with SEBI under the sub section 1A of Section 12 of the SEBI Act.

As per the provisions of this Act, a DP can offer depository-related services only after obtaining a certificate of registration from SEBI.

Depository Participant

Depository interacts with its clients / investors through its agents, called Depository Participants normally known as DPs.

For any investor/ client, to avail the services provided by the Depository, has to open Depository account, known as Demat A/c, with any of the DPs.

A demat account is opened on the same lines as that of a Bank Account. Prescribed Account opening forms are available with the DP, needs to be

filled in. Standard Agreements are to be signed by the Client and the DP, which

details the rights and obligations of both parties. Along with the form the client requires to attach Photographs of Account

holder, attested copies of proof of residence and proof of identity needs to be submitted along with the account opening form.

In case of Corporate clients, additional attachments required are - true copy of the resolution for Demat a/c opening along with signatories to operate the account and true copy of the Memorandum and Articles of Association is to be attached.

Process Flow

Dematerialisation (usually known as demat) is converting physical certificates to electronic form

Rematerialisation, known as remat, is reverse of demat, i.e. getting physical certificates from the electronic securities

Transfer of securities, change of beneficial ownership

Settlement of trades done on exchange connected to the Depository

Advantages

In India, shares and securities are held electronically in a Dematerialized account, instead of the investor taking physical possession of certificates.

A Dematerialized account is opened by the investor while registering with an investment broker.

The Dematerialized account number is quoted for all transactions to enable electronic settlements of trades to take place.

Every shareholder will have a Dematerialized account for the purpose of transacting shares.

Access to the Dematerialized account requires an internet password and a transaction password.

Transfers or purchases of securities can then be initiated. Purchases and sales of securities on the Dematerialized account

are automatically made once transactions are confirmed and completed.

Demat Concept

Easy and convenient way to hold securities. Immediate transfer of securities. No stamp duty on transfer of securities. Safer than paper-shares (earlier risks associated with physical certificates such

as bad delivery, fake securities, delays, thefts etc. are mostly eliminated). Reduced paperwork for transfer of securities. Reduced transaction cost. No "odd lot" problem: even one share can be sold. Change in address recorded with a DP gets registered with all companies in

which investor holds securities eliminating the need to correspond with each of them separately.

Transmission of securities is done by DP, eliminating the need for notifying companies.

Automatic credit into demat account for shares arising out of bonus/split, consolidation/merger, etc.

A single demat account can hold investments in both equity and debt instruments.

Traders can work from anywhere (e.g. even from home).

Advantages of Demat

The depository system helps in reducing the cost of new issues due to lower printing and distribution costs.

It increases the efficiency of the registrars and transfer agents and the secretarial department of a company.

It provides better facilities for communication and timely service to shareholders and investors.

Advantages to the Company

The depository system reduces risks involved in holding physical certificates, e.g., loss, theft, mutilation, forgery, etc.

It ensures transfer settlements and reduces delay in registration of shares.

It ensures faster communication to investors. It helps avoid bad delivery problems due to

signature differences, etc. It ensures faster payment on sale of shares. No stamp duty is paid on transfer of shares. It provides more acceptability and liquidity of

securities.

Advantages to the Investor

It reduces risks of delayed settlement. It ensures greater profit due to increase in

volume of trading. It eliminates chances of forgery or bad

delivery. It increases overall trading and profitability. It increases confidence in their investors.

Advantages to broker

To enable the creation of depositories to facilitate dematerialised trading in India, the central government promulgated the Depository Ordinance, 1995 which was followed by the Depositories Act, 1996.

Government Initiatives

Every depository will be required to be registered with SEBI.

Investors will have choice of continuing with the existing share certificates or opt for the depository mode.

Investors opting to join the depository mode are required to register with the agents of the depositories. These will be custodial agencies like banks, financial institutions, and large brokerage firms.

While the depositories will be the registered owner in the register of the company, the investor will enjoy the economic benefits as well as the voting rights on the share concerned.

Highlights of Depositories Act, 1996

Shares in the depository mode will be fungible. Investors having entered the depository mode can

leave the system and can get share certificate from the company as registered owners in the books of the company.

Ownership changes in the depository system will be made automatically on the basis of delivery against payment. Further, there will be no stamp duty on transfer of ownership.

Any loss caused to the beneficial owners due to the negligence of the depository or the participant will be indemnified by the depository.

Highlights of Depositories Act, 1996

There are 2 institutions providing Demat A/c in India:

NSDL CDSL

Institutions providing Demat in India

NSDL, the first and largest depository in India, established in August 1996 and promoted by institutions of national stature responsible for economic development of the country has since established a national infrastructure of international standards that handles most of the securities held and settled in dematerialised form in the Indian capital market.

Although India had a vibrant capital market which is more than a century old, the paper-based settlement of trades caused substantial problems like bad delivery and delayed transfer of title till recently.

The enactment of Depositories Act in August 1996 paved the way for establishment of NSDL, the first depository in India.

This depository promoted by institutions of national stature responsible for economic development of the country has since established a national infrastructure of international standard that handles most of the trading and settlement in dematerialised form in Indian capital market.

National Securities Depository Limited

Under the provisions of the Depositories Act, NSDL provides various services to investors and other participants in the capital market like, clearing members, stock exchanges, banks and issuers of securities.

These include basic facilities like account maintenance, dematerialisation, rematerialisation, settlement of trades through market transfers, off market transfers & inter-depository transfers and distribution of non-cash corporate actions.

The depository system, which links the issuers, depository participants (DPs), NSDL and Clearing Corporation/ Clearing house of stock exchanges, facilitates holding of securities in dematerialised form and effects transfers by means of account transfers.

Functions of NSDL

Depository is a facility for holding securities electronically in which securities transactions are processed by book entry.

In addition to the core services of electronic custody and trade settlement services, NSDL provides special services like pledge, hypothecation of securities, automatic delivery of securities to clearing corporations, distribution of cash and non-cash corporate benefits (Bonus, Rights, IPOs etc.), stock lending, demat of NSC and demat of warehouse receipts.

NSDL has also set-up a facility that enables brokers to deliver contract notes to custodians and/or fund managers electronically. This facility called STEADY (Securities Trading - information Easy Access and DeliverY) was launched by NSDL on November 30, 2002.

STEADY is a means of transmitting digitally signed trade information with encryption across market participants electronically, through Internet.

Functions of NSDL

CDSL is the second Indian central securities depository based in Mumbai.

CDSL is promoted by Bombay Stock Exchange Limited (BSE) jointly with State Bank of India, Bank of India, Bank of Baroda, HDFC Bank, Standard Chartered Bank and Union Bank of India.

Central Depository Services Limited

The main function of CDSL is the holding securities either in certificated or uncertificated (dematerialized) form, to enable book entry transfer of securities.

Functions of CDSL

They are two demat 'storage' providers which are majorly owned by Govt.

They store shares that investors buy and tag it against that investor.

A DP is a depositary participant (basically a broker) who buys shares as adviced by an investor.

Take an example: You are an investor. You buy shares via ICICI (who acts as DP) and deposits with NSDL (ICICI's storage partner).

Working of NSDL and CDSL