How Central Depository System (CDS) works in Nepal ?

One of the biggest problems faced by the Nepalese Capital market has been the manual and paper based settlement system. Under this system, the clearing and settlement of transaction take place only with the use of paper work. The system of physical delivery of scrip poses many problems for the purchaser as well as the seller in the form of delayed settlements , long settlement Periods, high level of failed trade, high cost of transaction, bad deliveries etc. In many case transfer process takes much longer time than two months.

Thus, to eliminate paperwork, facilitate scrip less trading and electronic book entry of the transfer of securities, shorten settlement periods, and to improve liquidity in the stock market, it was found necessary to replace the old system of transfer and settlement with the new and modern system of depositories.

Depository system is a system whereby the transfer and settlement of scrip takes place not through the traditional method of transfer deeds and physical delivery of scrip but through the modern system of effecting transfer of ownership of securities by means of book entry on the ledgers of the depository without the physical movement of scrip. The new system, thus, eliminates paper work, facilitates automatic and transparent trading in scrip shortens the settlement period and ultimately contributes to the liquidity of investment in securities. The system is also known as “scriples trading system”.

Terms used in Depository system:

“Dematerialization” is a process by which physical certificates are converted into electronic form.

“Rematerialisation” is the process of converting securities held in a demat account in electronic form back in physical certificate form.

“Beneficial Owner” means the person who have opened their Beneficial Owner Account with Central Depository Company for depositing their securities or instruments and who have held the

securities and instruments which are capable of being deposited in de-mat form.

“Beneficial Owner Account” means De-mat Account (electronic account) opened with Central Depository Company through Depository Participant in order to deposit securities by the Beneficial Owner and which is distinguished by a unique account number.

“Central Depository Service” means taking custody of the listed securities from the concerned securities owners and performing the jobs of maintaining their securities account, performing clearing and settlement of the securities transaction including transfer of securities and other similar jobs.

“Central Depository Company” means the Securities Business person obtaining license pursuant to Regulation 7 from the Board to operate Central Depository Service.

“Depository Member” means securities business person or the body corporate having membership of Central Depository Company.

“Issuer” means any body corporate/ entity issuing securities / instruments.

“Registrar and Transfer Agent (RTA)” means any person / body corporate who on behalf of any body corporate, maintains the records of holders of securities issued by such body corporate and

deals with all matters connected with the transfer and redemption of its securities.

“Registered Owner” means a Central Depository Company whose name is entered as such in the register of the issuer.

Depository System In Nepal: CDS and Clearing Limited, a company established under the company Act is a company promoted by Nepal Stock Exchange Limited (NEPSE) in 2010 to provide centralized depository, clearing and settlement services in Nepal. The main objective of the company is to act as a central depository for various instruments (Equity, Bonds, and Warrants etc) especially to handle securities in dematerialized form. The company is inaugurated on 31st March 2011.

-SEBON granted License to CDS and Clearing Limited on 25th August 2011.

-CDS and Clearing Limited is inaugurated on 31st March 2011.

-Central Depository Software Handover on 31st March 2011

Legal Framework:

Central Depository system and clearing limited operates under Securities Act 2063, Securities services regulation 2010.

Recently CDSCL has published a “Securities central depository Bye –Law “.

Highlights of “Securities central depository Bye –Law “

• Section 3: Company listed in SEBON should apply with CDSCL for Dematerialization of its listed securities.
• Section 5: Issuer /RTA should be registered with CDSCL
• Section 10: Depository Member should apply to be registered with CDSCL after getting approval from SEBON.
• Section 12: Depository Member should have adequate infrastructure to carry out depository services.
• Section 20: Beneficial owner/ investor should apply with Depository Member registered with CDSCL to open a Demat account.
• Section 21: If a broker is not a Depository Member then it should open a clearing account with a depository member for Transaction of securities.
• Section 22: Investor should apply with its Depository member for dematerialization of its physical certificate.
• Section 23: IPO/FPO/Right Issue/Bonus issue can be done electronically
• Section 26: Pledge of share can be done electronically.
• Section 29: Transfer of ownership of securities can be done electronically.
• Section 34: CDSCL can inspect the work of Depository member.

Benefits of Depository system.

1. No risks associated with physical certificates such as loss of share certificate, fake securities. Etc
2. No bad Delivery.
3. Faster settlement cycles.
4. Low transaction cost for purchase and sale of securities compared to physical mode.
5. Increase liquidity of securities
6. Reduction of paper work
7. Allotment of IPO,Bonus,Rights shares etc in electronic form

Facilities offered by depository system:

1. Dematerialisation
2. Rematerialisation
3. Electronic settlement of trades in stock exchange
4. Pledging /hypothecation of dematerialized securities.
5. Electronic credit of securities alloted in public, rights,bonus issue.
6. Freezing of De-mat account so that the debts from the dematerialization are not permitted

Major Players in Depositary System

1. Depositary (CDS)
2. Depository Member(DM)
3. The Beneficial Owner /Investor(BO)
4. Registrar and Transfer Agent (RTA)

• Depository(CDS): A “Depository” is a provider of facility for holding and/or transacting securities in, book entry form. Physical securities can be converted in to book entry form i.e. electronic form by way of immobilization or dematerialization. (So that they exist only as electronic records). Example: Central Depository System and clearing Limited.
• Depository Member (DM): A “Depository Member” (DP) is an agent of the depository (CDS), who is authorized to offer depository services to investors. According to CDS Service Regulation –Rule-20 A Depository Members shall be a Bank or Financial Institution, Stock Broker, Registrar and Transfer Agent, custodian or such other entity as from time to time.
• Beneficial owner/Investor (BO): When physical shares are converted in to electronic form, the depository becomes ‘Registered owner” in the books of the company and investors name is removed from books of the company. Depository is holding shares in its records on behalf of the investors who have opened a demat account with the depository. Hence all benefits are given to the actual investor who is called as a “Beneficial Owner” (BO) of the securities.
• Registrar and Transfer Agent (RTA): “Registrar and Transfer Agent (RTA)” means any person / body corporate who on behalf of any body corporate, maintains the records of holders of securities issued by such body corporate and deals with all matters connected with the transfer and redemption of its securities.

Beneficiary Account (DEMAT Account):

A beneficiary account is an account opened by the investor or a broker with a Depository Member( DM ) of his choice,to hold shares in dematerialized form and undertake scrip less trading. The investor must open a demat account with a Depository Member (DM) .Opening a demat account with a DP is similar to opening an account with bank. The selection of DP is to be done by the investor based on fee payable ,proximity,service levels,etc.

Once a demat account is opened , the investor must sign and agreement with the DM. The investor will be alloted and account no. Known as client identity. The client identity number along with the DM identity number forms a unique combination. Both these numbers should be quoted in all the future dealing with Depositories/DM/RTA/Company

An investor can close a demat account by giving and application in prescribed form. In case there is an balance in the demat account sought to be closed, the following steps are necessary

1. Rematerialisation of all securities standing to the credit of the demat account at the time of making the application for the closure.
2. Transferring the balance to the credit of another demat account , with the same Depository Member or with a different Member.

How to know securities balance in Demat account ?

The investor /Benificial owner (BO) is provided with a transaction statement by his Depository member at regular intervals. Based on that the investor will know his security Balances.

Dematerialization (Dmat):

“Dematerialization” is a process by which physical certificates are converted into electronic form. The Investor must approach his Dm for dematerialization . only the share of those company that has established connectivity withh CDSCL are available for dematerialization.

PROCESS OF DEMATERIALIZATION:

1. Investor must submit request form along with physical share certificate toDepository Member( DM).
2. DM will check whether security is available for Dmat. Investor must deface the share certificate by stamping “ surrendered for dematerialization” (CDSCL by –laws )
3. DM enters the Demat request in their system to be sent to the depository.
4. DM dispatches the physical certificates to the RTA/company.
5. Depository records the details of the system and forwards the request to Registar and transfer agent or issuer i.e. the company whose shares are brought to be dematerialized.
6. RTA Company on receiving the physical documents verifies request and check them. Once the RTA/company finds that shares are in order, dematerialization of the concerned securities is electronically confirmed to the depository.
7. Depository creates the dematerialized securities to the beneficiary account of the investor and inumates the DP electronically. The DP issues a statement of transaction to the client.

Rematerialisation (Remat):

Rematerialisation is the process of converting securities held in a demat account in electronic form back in physical certificate form.

The investor must fill up a remat form and give it to the Depository Member .The DM will forward the request to the CDSCL after varifying that the share holder has necessary balance . CDSCL in turn will intimate the RTA/Company will print the certificate and dispatch the same to the investor.

Rematerialization process in figure :

Electronic Settlement of the Trades :

Procedure for selling dematerialization securities in the stock exchanges is similar to the procedure for selling physical securities Instead of delivering physical securities to the broker,the investor must instruct his/her DM to debit his/her demat account with the number of securities sold by him/her and credit broker’s clearing account.

Procedure for selling securities is given below:

1. Investor gives instruction to DM to debit his account and credit the brokers (clearing account pool ) account.
2. After receiving the sales order from investor . the Depository member should make sure whether the Demat account of the investor contains enough securities for transaction.
3. The Depository Member enters the order from the investor to the CDSCL system.
4. If the transaction takes place the Investor’s broker transfers the securities to CDSCL for clearing purpose.
5. The broker receives payment from the CDSCL.
6. The investor receives payment from the broker for the sale in the same manner payment is received for a sale in the physical mode.

Procedure for purchase of Dematerialized shares :

The procedure of buying dematerialized securities in stock exchange is similar to the procedure for buying in physical securities.Investor may give a one time standing instruction to receive credits into his/her account or may give separate instruction each time in the prescribed format.

The transaction relating to purchase of securities are summarized below .

1. Investor purchases securiteis in any of the stock exchange connected to Depository (CDSCL ) through a broker.
2. Broker receives payment from investor.
3. Broker arranges payment to CDSCL.
4. Broker receives credit of securities in clearing account .
5. Broker gives instruction to DM to debit clearing account and credit client’s account.
6. Investor receives shares in his account.
7. The investor should ensure that the broker transfer the securities purchased to his account ,before the book closure. If the securities remain in the clearing account of the broker, the company may give corporate benefits to the broker. Therefore the investor has to collect benefits from the broker.

Electronic Public offering process(IPO/FPO):

This is another function of Depository system . In Depository system the public offering can be made electronically . The alloted shares are directly credited to the benificial owner’s Demat A/c. But the applicant should have a Demat account with any Depository member For this purpose.

• Electronic Public Offering Process (IPO/FPO)

1. Application is made by BO To RTA for IPO.
2. Issuer/RTA Request CDSCL to varify Bo’s Identification
3. CDSCL send the verification report to Issuer/RTA
4. Issuer/RTA sends the allotment information to CDSCL on behaf of application .
5. CDSCL credit the Benificial owner with the alloted securities.
6. CDSCl notify the Depository member about the allotment .

Direct credit of non cash corporate benefits:

Non corporate benefits can be like Right share, bonus share etc. When any non cash corporate benefits are announced for a particular security, the depository will give the details of all clients having electronic holdings in that security as of record date to the RTA/Company. Non-cash benefits will be distributed through depository by crediting the entitled quantity of shares into shareholder’s Demat account.

In the public/right issue application form of depository eligible companies, there will be a provision for the investor to indicate the manner in which he wants the securities alloted to him. Even in the case of bonus issue the investor is given an option for getting the shares alloted in physical or electronic form.

CDSCL does not deal with Cash corporate benefits like Cash dividend .

Pledging of Dematerialized securities:

Pledging of dematerialized securities is easier and more advantageous as compared to pledging physical securities. The procedure is .

1. Both borrower (pledger) as well as the lender (pledgee) must have Demat Account.
2. The pledger must initiate the pledge by submitting to his Depository member the details of the securities to be pledged in a standard format.
3. The pledge should confirm the request through his DM.

Once this is done the securities are pledged. All financial transactions between the pledger and the pledgee are handled outside the depository system.

After the borrower has repaid the loan, the borrower can request for a closure of pledge by instructing his DM in a prescribed format. The lender on receiviing the repayment will instruct his DM confirmed the closure of the pledge.

Electronic Linkage in Central Depository system and clearing limited.

The figure depicts the electronic connectivity of CDSCL with its business partners- DPS, issuer companies/ R&T agents and stock exchanges/clearing corporations.

Connectivity between CDSCL and business partners can be through V-SAT (Very Small Aperture Terminal) or leased line.

No two business partners have direct linkage to each other in the CDSCL system.

DP has database (Account details) of its investors clients This helps DP to service clients effectively.CDSCL also has this database. Every transaction is recorded in CDSCL database as well as DP database. Both these database are reconciled on a daily basis.