Working of the Depository System

Understanding the constituents is only half the picture; a student must also be able to describe how the depository system actually functions once an investor decides to hold and trade securities electronically.

Step 1 — Opening a demat account. An investor who wants to hold securities electronically approaches a Depository Participant (DP) and opens a demat (dematerialised) account, similar in concept to opening a bank account, by submitting the prescribed account-opening form and identity/address proof. This demat account becomes the electronic record of all the securities the investor (the Beneficial Owner) holds.

Step 2 — Getting securities into the account. Securities reach an investor's demat account in one of two ways:

• Dematerialisation of existing physical certificates the investor already holds (as explained in the section above); or
• Direct electronic credit of newly allotted securities — for example, shares allotted in a fresh public issue, or a bonus/rights issue — which most companies now credit straight into the applicant's demat account without ever printing a paper certificate.

Step 3 — The International Securities Identification Number (ISIN). Every security admitted into the depository system is given a unique identification code called the International Securities Identification Number (ISIN) — a standard 12-character alphanumeric code allotted to a particular security (e.g., a particular company's equity shares, or a particular debenture series) by the depository. The ISIN lets the depository, the DPs, the stock exchanges and the clearing corporation identify and process exactly the right security in every electronic transaction, without any ambiguity of the kind a paper certificate's varying formats could create.

Step 4 — Trading and settlement by book-entry. When a Beneficial Owner sells securities (typically through a stockbroker on a stock exchange), the trade is settled by the depository system through simple electronic book-entries: the seller's demat account is debited by the number of securities sold, and the buyer's demat account is credited by the same number — instructed through their respective DPs and coordinated through the clearing corporation, with the money side settled through the banking system in parallel. No certificate moves, no transfer deed is signed, and settlement is completed within a standard, short cycle rather than the weeks a paper transfer once took. …