The Depository System

Almost every investor owns shares or has owned shares in their life. However, most investors wouldn’t have seen a physical share. For the most part, a share is nothing but an entry in an electronic ledger governed by a third party institution. This was not always the case. Earlier, shares used to be paper certificates that were given to investors and served as proof of ownership. The system which helps maintain records of ownership of intangible assets such as shares is called a depository system.

Digitization has affected almost every industry across the world, and the financial system is no exception. With the advent of digitization, the entire financial supply chain has been impacted. However, the depository system has seen the most prominent impact. Earlier, the depository system was operated using pen and paper-based systems. Obviously, this process was time-consuming and wasteful.

In this article, we will study about the depository system as well as how it has changed through the ages.

How the Depository System has Changed?

As mentioned above, earlier, the depository system used to be paper-based. This meant that share certificates were issued in paper form, and a depository had to keep records about the ownership of these shares in a physical register. Hence, if the ownership of shares had to be changed, the records in the register had to be changed. Since these records had legal significance, transfer deeds had to be created. This was a tedious and expensive process that was prone to errors.

However, this changed with digitization. Right now, every stock exchange appoints a depository institution. The job of this institution is to maintain an electronic record of the outstanding shares. Since the records are electronic, their movement is also electronic. Hence, paper certificates do not have to be moved, and transfer deeds do not have to be created.

The modern depository system is one of the bedrocks on which the modern financial system is standing. Countries that do not have digital depository systems see considerable fewer investments because of the relative inefficiency of the paper-based system which they use.

Participants in the Digital Depository System

The digital depository system requires the participation of at least four different members. The roles and responsibilities of these participants have been elaborated below:

  1. The Depository: The depository institution is obviously one of the participants of the depository system. The depository institution is supposed to act as the custodian of securities listed with it. This means that legally, the depository is the owner of the securities listed with it. However, it cannot liquidate the assets under its purview. Its ownership has a limited meaning. It can only transfer the assets from one person to another.

    In simpler terms, if a company A issues securities, they will list down the name of the depository as the owner of the securities. The depository will then create a separate agreement with the actual owner of shares. Therefore, if the ownership changes, the records only have to be changed by the depository. The issuing company does not have to change any records since, according to them, the shares still belong to the same party i.e., the depository.

  2. The Depository Participant: The depository is a large organization that cannot provide services to all its investors. As a result, it appoints several agents called depository participants. These agents are banks or brokering services that customers open de-mat accounts with. The role of these participants is to ensure that the records of the owners are properly maintained. These participants also have to be approved by regulators.

  3. The Beneficial Owner: The actual owner of the assets is called a beneficial owner. This is because they have all the rights and responsibilities towards the ownership of these assets. These are the real owners of the shares or debentures i.e., the people whose records are being kept by the depository participant. When the sale of security happens, only the name of the beneficial owner is changed in the records of the depository participant. This process is quick and effective.

  4. The Issuer: The issuer is the institution that is actually giving out shares and debentures. Since the issuer creates new securities, they have to select the depository institution they want to deal with. Generally, depository institutions are a part of the underwriting process itself. Therefore, while issuing the securities, the issuer has to register the securities with the depository, and only then can the depository participants start underwriting the securities.

    It needs to be understood that both listed, as well as unlisted securities, can become a part of the digital depository system. Private limited companies may not be traded on the stock exchange. However, they, too, can hold their securities in the digital form and can transfer it to other parties when required.

The bottom line is that the digital depository system has proved to be an important innovation in the financial system. A basic understanding of this system is necessary for all investors.

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The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to and the content page url.