Dematerialization (“Demat” in short form) is the method by which a person can get his physical share certificates converted into electronic form, for the same number of holding which is credited to his demat account with a depository participant (DP).

It is a process by which the physical share certificates of an investor are taken back by the Company and an equivalent number of securities are credited in electronic form at the request of the investor. For this an investor will have to first open an account with a depository participant and then request for the dematerialization of his share certificates through the depository participant. The dematerialized holdings are credited into the account he has with the DP. This is quite similar to opening a bank account.

Dematerialization of shares is optional and an investor can still hold shares in physical form. However, to sell the shares through the stock exchanges one has to dematerialize it before he sells it and similarly, if an investor purchases shares, the delivery of the shares will be in the demat form.

Meaning of a depository

• A Depository NSDL (National Stock Depository Limited) & CSDL (Central Stock Depository Limited) is an organization like a Central Bank where at the request of a shareholder his securities are held in the electronic form through the medium of a Depository Participant.
• The depository is different from a traditional custodial service because a transfer of beneficial ownership can be done directly by a depository whereas a custodian cannot do this. The main objective of a depository is to minimize the paper work involved with the ownership, trading and transfer of securities.

Meaning of a depository participant

• A depository participant is one with whom an account has to be opened to trade in the electronic form. While the depository can be compared to a bank, a depository participant is like the branch of a bank with which you can have an account.
• A depository participant (DP) is also the account holder’s representative (agent) in the depository system providing the link between the company and the account holder.

Operations of a depository system

The depository system operates in the lines of a banking system. A bank holds funds in its accounts and transfers funds between accounts whereas a depository holds securities in accounts and transfers securities between accounts. In both systems, the transfer of funds or securities happens without the actual handling of funds or securities. Banks and the depository are accountable for the safe keeping of funds and securities respectively.

Benefits of having a demat account

1. Shares of companies can only be traded if they are dematted. SEBI has made demat mandatory on most of the traded scrip’s, and therefore electronic transaction will be the only way everyone can trade.
2. In the electronic form transfer of securities has no stamp duty whereas in the case of transfer of physical shares, stamp duty of 0.5 percent is payable on the market value of shares being transferred.
3. In the case of physical certificates, many risks such as delays, loss in transit, theft, mutilation, bad deliveries, etc. occur whereas in the electronic form these are eliminated. The depository participant on specific instructions can keep shares in the “Frozen Mode”.
4. The concept of an “odd lot” in respect of dematerialized shares stands abolished, i.e. in the demat mode, market lot becomes one share.
5. For providing credit facility against securities, dematerialized securities are preferred by banks and other financial institutions because they attract lower margin and lower rates of interest compared to physical securities.
6. Even in the electronic mode of trading, the payment mechanism (usually through a broker) between the buyer and seller continues to be as before. Also the usual brokerage charges would have to be incurred. However, after the settlement, pay in and pay out is on the same day for scripless trading which means that there is no delay in the receipt of cash.
7. Shares bought are transferred to the buyer’s name on the very next day of pay out. In case of physical shares, transfer of ownership takes 30 days or sometimes even more.
8. Courier/postal charges are done away with for sending share certificates/transfer deeds.
9. Dematerialization also has facility for freezing/locking of investor accounts, which enables the accountholder to make his account non-operational.
10. Dematerialization enables a borrower to pledge and hypothecate securities.
11. Because of its convenience both brokers and investors prefer shares in a dematerialized form.

Procedure to demat shares

1. The process begins with the opening of an account with a depository participant. This is similar to the opening of a bank account. An account has to be opened with a depository participant (DP) by filling up an Account Opening Form and signing a “Participant-Client Agreement”.
2. The applicant is then given a unique client ID number, which must be quoted in all correspondence with the DP. The client (registered owner) has to submit a request to the DP in the Dematerialization Request Form for dematerialization, along with the certificates of securities to be dematerialized. Before submission, the client has to deface the certificates by writing "SURRENDERED FOR DEMATERIALIZATION".
3. The DP verifies that the form is duly filled in and the number of certificates, number of securities and the security type (equity, debenture etc.) are as given in the DRF. Once the form and security count is in order, the DP will issue an acknowledgement slip duly signed and stamped, to the client.
4. The DP will scrutinize the form and the certificates. This scrutiny involves:
   1. Verification of client's signature on the dematerialization request with the specimen signature (the signature on the account opening form). If the signature differs, the DP should ensure the identity of the client.
   2. Compare the names on DRF and certificates with the client account.
   3. Paid up status.
   4. ISIN.
   5. Pari Passu status.
   6. Lock-in status.
   7. Distinctive numbers.
5. In case the securities are not in order they are returned to the client and acknowledgment is obtained. The DP will reject the request and return the DRF and certificates in case:
6. A single DRF is used to dematerialize securities of more than one company.
7. The certificates are mutilated, or they are defaced in such a way that the material information is not readable. It may advise the client to send the certificates to the Issuer/R&T agent and get new securities issued in lieu thereof.
8. Part of the certificates pertaining to a single DRF is partly paid-up; the DP will reject the request and return the DRF along with the certificates. The DP may advise the client to send separate requests for the fully paid-up and partly paid-up securities.
9. Part of the certificates pertaining to a single DRF is locked-in; the DP will reject the request and return the DRF along with the certificates to the client. The DP may advise the client to send a separate request for the locked-in certificates. Also, certificates locked-in for different reasons should not be submitted together with a single DRF.
10. The DP will verify the nature of the security, its pari passu status with reference to the list of ISIN codes available with it. The allotment of ISIN must be verified at a second level. Wrong allocation may result in avoidable losses to the clients. The ISIN is entered in the space provided for it in the dematerialization request form.
11. In case the securities are in order, the details of the request as mentioned in the form are entered in the DPM (software provided by NSDL to the DP) and a dematerialization request number (DRN) will be generated by the system.
12. The DRN so generated is entered in the space provided for the purpose in the dematerialization request form.
13. A person other than the person who entered the data is expected to verify details recorded for the DRN.
14. The request is then released and forwarded electronically by the DP to DM (Depository Module, NSDL's software system) by DPM.
15. The DM forwards the request to the Issuer/R&T agent electronically.
16. The DP will fill the relevant portion viz., the authorization portion of the demat request form. The DP will punch the certificates on the company name so that it does not destroy any material information on the certificate. The DP will then dispatch the certificates along with the request form and a covering letter to the Issuer/R&T agent.
17. The Issuer/R&T agent confirms acceptance of the request for dematerialization in his system DPM (SHR) and the same will be forwarded to the DM. The DM will electronically authorize the creation of appropriate credit balances in the client's account.
18. The DPM will credit the client's account automatically. The DP must inform the client of the changes in the client's account following the confirmation of the request.
19. The issuer/R&T may reject dematerialization request in some cases. The issuer or its R&T Agent will send an objection memo to the DP, with or without DRF and security certificates depending upon the reason for rejection.
20. The DP has to remove reasons for objection within 15 days of receiving the objection memo. If the DP fails to remove the objections within 15 days, the issuer or its R&T Agent may reject the request and return DRF and accompanying certificates to the DP. The DP, if the client so requires, may generate a new dematerialization request and send the securities again to the issuer or its R&T Agent. No fresh request can be generated until the issuer or its R&T Agent has rejected the earlier request and informed NSDL and the DP about it.

Precautions

1. Holdings in those securities that have not yet been admitted for dematerialization by NSDL cannot be dematerialized. List of securities admitted for dematerialization should be verified before defacing the securities.
2. Holdings in street name cannot be dematerialized. A new procedure for transfer and demat to be done together has been conceptualized. The combination and sequence of names of holders as printed on the physical certificate should be identical with the names initiating the dematerialization request.
3. Separate dematerialization requests will have to be filled for locked-in and free holdings.
4. Separate dematerialization requests will have to be filled for holdings locked-in for different reasons.
5. Separate dematerialization requests will have to be filled for fully paid up and partly paid-up holdings.
6. Separate dematerialization requests will have to be filled for holdings in the different ISINs of a company.

Other

1. Dematted shares can be converted back into physical shares.
2. Dematerialization of shares can be canceled automatically. This takes place if a company is declared bankrupt in the so-called liquidation path or if a bankruptcy court dismisses a bankruptcy petition due to there being insufficient assets to cover the costs of proceedings. In both cases, share dematerialization is deemed canceled upon the lapse of six months from the date on which the court decision becomes final and non-appealable.
3. One may open accounts with several DPs.