Ultimate Study Notes: NISM Series VI Depository Operations – Chapter III (Part 2)

1. Operational and Financial Obligations of Depository Participants (DPs)

Beyond the basic duties of account holding, Depository Participants (DPs) must adhere to rigorous financial, administrative, and data integrity regulations to ensure the depository network remains safe and functional.

A. Daily Reconciliation of Records

• The Reconciliation Mandate: DPs must reconcile their internal records with those of the central depository on a daily basis.
• System Automation: To prevent discrepancies and human error, the depository system automatically conducts this reconciliation at the End of Day (EOD).

B. Periodic Submission of Returns

• Multi-Regulatory Reporting: DPs are required to submit periodic returns regarding their business transactions and operations.
• Recipients: These returns must be submitted to both the Securities and Exchange Board of India (SEBI) and every depository in which the DP holds a membership.
• Format Compliance: Reports must strictly follow the format prescribed by SEBI or outlined in the specific depository's Bye-Laws.

C. Indemnity Clauses

• Risk Allocation: DPs are legally bound to indemnify their parent depository.
• Scope of Protection: This indemnity covers the depository, its officers, and its employees against all costs, fees, expenses, taxes, liabilities, actual losses, and damages incurred due to the DP's operational actions or omissions.

D. Strict Prohibition of Assignment

• Non-Delegation Rule: A DP is prohibited from assigning, delegating, or transferring its registered depository functions to any third party.
• Exception: Delegation is only permitted if the DP obtains prior formal approval from the depository where it is registered.

E. Insurance Policies

• Risk Mitigation: DPs are legally required to maintain appropriate insurance coverage.
• Coverage Scope: The policy must insure the business against potential financial losses arising from operational business risks and system failures.

F. Mandatory Record Retention Period

• Temporal Requirement: DPs must systematically preserve all service records, transaction logs, application forms, and relevant documents for a minimum period of 5 years.

G. Electronic Data Integrity and Backups

• System Integrity: DPs that maintain client records in an electronic format are obligated to guarantee the security and processing integrity of their data systems.
• Preventative Protocols: DPs must implement robust safeguards to ensure client records are not lost, accidentally destroyed, or tampered with.

2. Suspension, Cancellation, and Voluntary Termination of DP Operations

A DP’s authority to operate can be terminated either through regulatory action by SEBI or via voluntary exit.

SEBI Regulatory Action

The certificate of registration granted to a DP is subject to suspension or cancellation by SEBI if the participant violates pre-specified regulations.

Voluntary Termination by the DP

• Notice Period: If a DP wishes to voluntarily exit the depository network, it must provide a formal written notice of not less than 30 days to the depository.
• Operational Cessation: Upon receiving the termination notice, the depository may immediately stop providing services to or acting on behalf of that DP.
• Depository Notification Timeline: Within 7 days of initiating termination actions, the depository must notify:
  1. The surrendering DP.
  2. Other registered participants.
  3. The direct clients (BOs) of the surrendering DP.
  4. The Securities and Exchange Board of India (SEBI).

3. Clearing Corporations: Trade Clearing & Settlement

A Clearing Corporation (CC) or Clearing House (CH) is the specialized financial entity responsible for clearing and settling trades executed by clearing members on a recognized stock exchange.

• Role in Depository System: Clearing Corporations are admitted into the depository system specifically to manage the electronic clearing and settlement of traded book-entry securities.
• User Admission Status: A recognized Clearing Corporation is admitted as a user of the depository.
• Formal Agreement: To operate within the depository framework, the Clearing Corporation must execute a formal agreement with the depository, in accordance with the depository’s Bye-Laws.

4. Issuers and Registrars & Transfer Agents (RT&As)

The Depositories Act, 1996 grants investors the flexibility to hold their securities in either physical paper form or in electronic book-entry form within a depository.

Connecting the Issuer to the Depository

An Issuer (the company or entity issuing the security) can offer dematerialisation facilities to its investors by executing a tripartite agreement with the depository and its designated Registrar and Transfer Agent (RT&A).

• Prerequisite Connectivity: To offer demat facilities, the Issuer must establish electronic connectivity with the depository.
• Connectivity Routes: The Issuer can connect directly to the depository or route its connection through a registered Registrar & Transfer Agent (RT&A) that already possesses active connectivity.

Securities Eligible for Dematerialisation

Under the SEBI (Depositories & Participants) Regulations, 1996, a wide range of securities can be held in dematerialised form:

• Shares, scrips, stocks, bonds, debentures, or debenture stock.
• Marketable securities of a similar nature issued by any incorporated company or body corporate.
• Units of Mutual Funds (MFs), Venture Capital Funds (VCFs), and Infrastructure Investment Trusts (InvITs).
• Rights under collective investment schemes (CISs).
• Commercial Paper (CP) and Certificates of Deposit (CD).
• Securitised debt and other money market instruments.
• Government Securities (G-Secs).
• Unlisted securities.

5. Operational Role of Issuers/RT&As in Core Transactions

A. The Dematerialisation Workflow

1. Submission: The investor completes a Dematerialisation Request Form (DRF) and submits it to the DP along with the physical certificates.
2. Verification: The DP verifies the DRF for completeness and enters the request into the electronic system, which generates a unique Dematerialisation Request Number (DRN).
3. Physical Document Handling: The DP defaces and mutilates the physical certificates (marking them "surrendered for dematerialisation") and mails them along with the DRF to the Issuer or RT&A.
4. Daily Electronic Intimation: On a daily basis, the depository electronically forwards all recorded demat requests to the respective Issuer or RT&A.
5. Final Verification and Credit: The Issuer/RT&A is required to confirm or reject a demat request within 15 days of receiving the physical shares. If valid, they authorize an electronic credit in favor of the client. The depository then credits the client's demat account.

B. Regulatory Grounds for Rejection of Demat Requests

The Issuer or RT&A can reject an incoming demat request under the following circumstances:

• The submitted security certificates are reported stolen.
• The security certificates are determined to be fake.
• An active injunction or order from a court or competent statutory authority prohibits the transfer of the securities.
• Duplicate certificates have already been issued for those exact securities with the same distinctive numbers.

C. The Rematerialisation Process

Investors can choose to convert their electronic holdings back into physical paper certificates at any time.

• The RRF Document: The beneficial owner initiates the process by submitting a Remat Request Form (RRF) to the depository through their DP.
• Processing: The depository debits the electronic balance in the client’s BO account, and the Issuer prints and dispatches physical paper certificates for the equivalent balance.

D. Corporate Actions and Benefit Distribution

Issuers and RT&As coordinate closely with depositories to handle corporate events, which are broadly classified into Cash Corporate Actions (such as dividends and interest) and Non-Cash Corporate Actions (such as bonus issues, stock splits, mergers, and rights issues).

• Determining Eligibility: The Issuer declares a Record Date (or a Book Closure period) to identify eligible beneficial owners.
• Data Provision: At the close of the cut-off date, the depository provides the Issuer or its RT&A with a detailed list of beneficial owners, including their tax status and bank account numbers.
• Distribution:
  • Monetary Benefits: The Issuer or its RT&A distributes dividends, interest, or other cash benefits directly to the beneficial owners using the bank details provided by the depository.
  • Non-Monetary Benefits: For stock benefits (like bonus shares), the Issuer/RT&A coordinates the electronic credit of new securities directly into the BOs' demat accounts.

6. Key Takeaways and Terms (Part 2)

Key Takeaways

1. Mandatory Daily Reconciliation: The depository system automatically executes record reconciliation with DPs at the end of every business day (EOD).
2. Five-Year Retention Policy: DPs must systematically preserve all account transaction records and physical application documents for at least 5 years.
3. Strict 30-Day Notice for Exit: A DP cannot suddenly halt operations; they must submit a formal written notice at least 30 days prior to voluntary termination.
4. 15-Day Demat Turnaround: The Issuer or its RT&A must complete the physical verification and confirm or reject any demat request within a strict window of 15 days from receipt.
5. Direct Monetary Payouts: Dividends and interest payments are not routed through the DP; the Issuer/RT&A pays these funds directly to the investor's registered bank account.

Important Terms