NISM Series VI Depository Operations – Part 1: Indian Capital Market & Need for a Depository System

Quick Summary: This is Part 1 of our 7-part NISM Series VI short notes series for passnism.in. This post covers the Indian Capital Market structure, key legislations governing securities markets, and the need, features, and legal framework of India's depository system — all written in simple language for fast exam revision.

What is the Indian Capital Market?

Securities markets act as channels that connect savers with investors. They separate the act of saving money from the act of investing it. Because of this separation, the growth of savings and investments in an economy depends not on individual capacity but on the economy's overall potential.

A financial market has four key participants:

Investors (buyers of securities)
Borrowers (sellers of securities)
Intermediaries
Regulatory bodies

Structure of the Financial Market

The financial market is broadly split into two segments:

Money Market – Deals in short-term borrowing and lending. It has two sub-segments: Organised Money Market and Unorganised Money Market (which includes money lenders and indigenous bankers).
Capital Market – Deals in long-term securities. It has two sub-segments: Primary Market and Secondary Market.

Primary Market vs Secondary Market

The Primary Market is where companies raise fresh capital from investors through Initial Public Offers (IPOs), rights issues, or offers for sale of equity or debt instruments.

The Secondary Market provides liquidity to securities already issued. It allows investors to buy and sell securities on stock exchanges. An active secondary market supports primary market growth and overall capital formation in the economy.

Laws Governing the Securities Market in India

Four major legislations regulate securities market transactions in India:

1. Securities and Exchange Board of India (SEBI) Act, 1992

This act gives SEBI three core statutory responsibilities:

Protecting the interests of investors in the securities market
Promoting the development of the securities market
Regulating the securities market

SEBI has full authority and independence to regulate and develop an orderly securities market.

2. Securities Contracts (Regulation) Act, 1956

This act controls virtually every aspect of securities trading and the functioning of stock exchanges. Its primary goal is to prevent undesirable transactions in securities.

3. Depositories Act, 1996

This act provided the legal foundation for establishing depositories in India. Its three objectives are:

Making securities freely transferable (with limited exceptions)
Enabling dematerialisation of securities
Maintaining ownership records in book entry form

4. Companies Act, 2013

This act governs the issue, allotment, and transfer of securities and company management. It mandates standard disclosures in public issues, especially in areas of company management, project details, and management's perception of risk factors.

Who Regulates the Securities Market?

Regulation is shared among four bodies:

Securities and Exchange Board of India (SEBI)
Reserve Bank of India (RBI)
Department of Economic Affairs (DEA), Ministry of Finance
Ministry of Corporate Affairs (MCA)

Why Was a Depository System Needed in India?

Before the Depositories Act, 1996, India's stock exchange settlement system was highly inefficient and risky. The old physical system had the following problems:

High number of bad deliveries
Mutilation and damage of share certificates
Slow transfer of ownership
Theft and forgery of certificates
Lengthy registration process with the issuer company
Delays in settlement that restricted liquidity
Time-consuming investor grievance redressal

To solve these problems, the Depositories Act, 1996 was passed. It established depositories with the objective of ensuring free, fast, accurate, and secure transfer of securities.

Key Features of the Depository System in India 1. Multi-Depository System

The Depositories Act, 1996 allows multiple entities to provide depository services. India currently has two depositories: NSDL (National Securities Depository Limited) and CDSL (Central Depository Services Limited).

2. Dematerialisation

Dematerialisation (or demat) is the process of converting physical share certificates into electronic form. The physical certificates are destroyed and an equivalent number of securities are credited to the investor's demat account.

3. Depository Services Through Depository Participants (DPs)

Depositories do not directly interact with investors. They offer services through agents called Depository Participants (DPs). The appointment of DPs is regulated by SEBI.

4. Fungibility

In the depository system, securities in demat form are not identified by certificate numbers. All securities of the same class are identical and interchangeable with each other. This property is called fungibility.

5. Registered Owner vs Beneficial Owner

In the depository system, the ownership of dematerialised securities is vested in the security holder. The depository appears as the registered owner in company records, but the actual rights, duties, and liabilities belong to the beneficial owner — the investor.

6. Free Transferability of Shares

Transfer of shares held in demat form takes place freely through an electronic book-entry system, without any physical movement of documents.

Institutions That Support the Depository System

The following institutions work together to keep the depository system running smoothly:

Depositories – NSDL and CDSL
Stock Exchanges – BSE, NSE, etc.
Clearing Corporations / Clearing Houses
Depository Participants (DPs)
Issuers – Companies that issue securities
Registrars and Transfer Agents (RT&As)

What is a Depository? (Legal Definition)

As per the Depositories Act, a depository is defined as:

A company formed and registered under the Companies Act, 1956, which has been granted a certificate of registration under sub-section (IA) of section 12 of the SEBI Act, 1992.

The principal function of a depository is to provide investors a facility to hold and transfer securities in dematerialised and book-entry form. When securities are transferred, the transferor's depository account is debited and the transferee's account is credited.

Difference Between a Depository and a Bank

Bank	Depository
Holds funds in accounts	Holds securities in accounts
Transfers funds between accounts	Transfers securities between accounts
Transfers funds without handling cash physically	Transfers securities without handling physical certificates
Provides safekeeping of money	Provides safekeeping of securities
Either joint holder can sign instructions	All joint holders must sign instructions
Minimum balance is required	No minimum balance required
Interest earned on deposits	Interest earned only through the Stock Lending Scheme
Bank can use deposited funds	Depository cannot move balances without account holder's authorisation

Depositories Act, 1996 – Key Highlights

Only a company registered under the Companies Act, 2013 and sponsored by specified institutions can set up a depository in India.
A depository can provide any service connected with recording of allotment of securities or transfer of ownership.
A Depository Participant (DP) is an agent of the depository. The relationship between DPs and the depository is governed by a formal agreement under the Depositories Act.
A depository can deal in securities only after obtaining a certificate of registration from SEBI.

Eligibility Criteria for Setting Up a Depository

A depository company must have a minimum net worth of Rs. 100 crore.
The sponsor(s) must hold at least 51% of the equity capital of the depository company.
If a stock exchange is a sponsor, it cannot hold more than 24% of the paid-up equity share capital of the depository.
No single depository participant can hold more than 15% of the equity capital of the depository at any time.

Records a Depository Must Maintain (Minimum 5 Years)

As per SEBI regulations, every depository must maintain the following records for at least 5 years:

Records of securities dematerialised and rematerialised
Names of transferors, transferees, and dates of transfer
A register and index of beneficial owners
Daily holdings details of beneficial owners
Records of instructions received and sent to participants, issuers, agents, and owners
Records of approval, notice, entry, and cancellation of pledge or hypothecation
Details of securities declared eligible for dematerialisation
Any other records specified by SEBI

Core Functions of a Depository

Account Opening – Investors open demat accounts through DPs registered with a depository.
Dematerialisation – Converting physical securities into electronic book-entry form.
Account Transfer – Recording entries in beneficial owner accounts for trade settlement.
Transfer and Registration – Effecting ownership transfers through book entries, as per instructions from beneficial owners.
Corporate Actions – Distributing benefits like dividends and bonus shares to eligible beneficial owners.
Pledge and Hypothecation – Securities can be pledged or hypothecated as collateral for loans, recorded as book entries.
Linkages to Clearing System – Facilitating actual delivery and receipt of securities in the clearing and settlement process.

Quick Revision Points for NISM Series VI Exam

Capital market = Primary Market + Secondary Market
Depositories Act, 1996 was passed to solve problems of the physical settlement system
India follows a multi-depository model (NSDL and CDSL)
Depository acts like a bank but for securities, not money
Minimum net worth of a depository = Rs. 100 crore
Sponsor must hold at least 51% equity; no single DP can hold more than 15%
Records to be maintained for minimum 5 years
Depository can operate only after SEBI registration

Up Next: Part 2 – Depository Participant: Roles, Rules, and Registration

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