Dematerialization of Securities: Mandatory for Unlisted Public Companies to issue shares in Demat Form

Soniya Khanna

25 Jun, 2023

MCA has exercised its powers to frame rules under Section 29(1) (b) of the Companies Act, 2013. Now, dematerialization of securities is mandatory for unlisted public companies. In simplified words, we can say that unlisted public companies are required to issue securities in demat form. Along with this, they are also required to facilitate the dematerialization of existing shares.

What is meant by the Dematerialization of Securities?

Under the dematerialization of securities, physical certificates of securities are converted into an electronic form in an equivalent number of securities of the investor.

Why the step of Dematerialization of Securities had been taken by the government?

This step of dematerialization of securities had been taken by the government in order to enhance transparency as well as to enhance investor protection.

This initiative is effective from 2^nd October 2018. Now, along with the dematerialization of existing securities, unlisted public companies also have to ensure that further issues and transfers of securities will only be in dematerialized form.

Less than a month had been given to unlisted public companies for the dematerialization of securities. For this, corporate action was required to be taken by the unlisted public companies for passing resolutions for share dematerialization. It must be ensured that articles of association are amended for the issuance of dematerialized shares.

What are the major benefits of the Dematerialization of Securities of Unlisted Public Companies?

There are numerous benefits of the Dematerialization of Securities of Unlisted Public Companies:

• Reduce the risk of duplication, fraud, loss or theft, and delays in respect of securities held in physical share certificates.
• Enhance transparency and increase investor protection.
• Prevent malpractices and issuance of backdated
• Eliminate the payment of stamp duty on share transfers.
• Now it will ease the securities transfer.
• There will be less paperwork in the transfer of securities.
• It is a more safe & convenient way of holding securities.
• Nomination Facility
• It will reduce the transaction cost
• Immediate transfer of securities

Applicability of Dematerialization of Securities

It is applicable to every unlisted public company with effect from 2^nd October 2018 with respect to the issuance of securities in dematerialized form and dematerialization of existing shares.

If we talk about the applicability of debentures and preference shares, then we have to look at the definition of securities defined under securities contract (regulations) act, 1956.

How the dematerialization of existing securities can be processed?

Dematerialization of existing securities can be processed by the unlisted public companies through the following steps:

• An application is required to be made to the depository as per the Depositories Act, 1996
• In respect of each type of security ISIN (International Security Identification Number)
• Make existing security holders aware of such facility

What will be the influence on the further issue of securities by the unlisted public companies?

Before making an offer of bonus shares, right issue, buy-back of securities and further issue of securities, every unlisted public company has to ensure that all its existing securities are in the dematerialized form according to Depositories Act, 1960.

How it will affect the security holder who wishes to transfer or subscribe to securities of unlisted public companies?

After 02^nd October 2018, every person holding a security in the unlisted public company has to apply for dematerialization of securities prior to the transfer.

If a security holder wishes to subscribe to shares of the unlisted public company, then he has to ensure that existing shares of such company are in dematerialized form.

What are the compliance requirements for unlisted public companies in respect of the Dematerialization of Securities?

The following requirements must be compiled by every unlisted public company:

• They have to make the payment of fees on time.
• They are also required to maintain the security deposit of at least 2 years’ fees according to the agreement made with the depository, registrar & share transfer agent.
• Unlisted Public Companies have to comply with the regulation, guidelines, and circulars issued by the SEBI (Securities Exchange Board of India) from time to time.
• It is also required for Unlisted Public Companies to submit an audit report half-yearly as per regulation 55A of the SEBI (Depositories and Participants) Regulations, 1996, to the registrar under whose jurisdiction the registered office of the company is situated.
• In case of any default made by the unlisted public company in complying with the requirements, then they are not eligible to offer securities, issue bonus shares or right issue of shares, buy-back of securities if the payment is not made to the depositories or registrar or share transfer agent.

Grievance Redressal

Under this, grievances are filed with IEPF (Investor Education Protection Fund) which takes action against the depository, depository participant, share transfer agent & registrars after carrying a discussion with SEBI (Securities Exchange Board of India).

What is ISIN (International Security Identification Number)?

ISIN (International Securities Identification Number) is allotted for security like fully paid-up equity, partly paid-up equity, equity with differential voting rights and dividend rights. It is a unique 12-digit alphanumeric identification number.

Why ISIN (International Security Identification Number) is mandatory?

The process of obtaining an ISIN (International Security Identification Number) is required to be undertaken by the unlisted public companies to facilitate the demat accounts opening for shareholders and the subsequent conversion of securities into dematerialized form.

Therefore, coordination and the participation of third parties are required in order to ensure compliance with the Amendment Rules within the prescribed time frame.

Who is an RTA (Registrar and Transfer Agent)?

RTA (Registrar and Transfer Agent) is an agent of the issuer. For providing services such as dematerialization, rematerialization, initial public offers (IPO) and corporate actions, RTA (Registrar and Transfer Agent) act as an intermediary between the issuer and depository.

How many types of depositories are there?

Before coming to the depositories, let’s first understand the “depository”. A depository holds the shareholder’s securities in electronic form. Such securities can be bonds, mutual fund units and government securities, which are kept by the registered Depository Participant (DP).

There are two types of depositories registered with SEBI such as:

1. National Securities Depository Limited (NSDL) and
2. Central Depository Service (India) Limited (CDSL).

A Depository Participant is the depository’s agent who is responsible for providing depository services to traders and investors.

Is it also applicable to non-resident shareholders?

Yes, in the case where there is a non-resident shareholder who does not have a PAN (Permanent Account Number) will have to apply for a PAN for the purpose of Demat account opening.

Payment Manner

In pursuant to the amendment rules, unlisted public companies would have to incur a number of additional expenses. No stamp duty is required to be paid at the time of transfer of dematerialized shares. Whereas there is a requirement to pay stamp duty for the issuance of dematerialized securities.

However, to remove the confusion and to clarify the payment manner, state and central stamp authorities would have to coordinate with each other in order to eliminate the stamp duty payment requirement on the issuance of dematerialized securities.

In principle, approval from stock exchanges is redundant or not required, as under Regulation 55A of the SEBI (Depositories and Participants) Regulations, 1996 will be applicable to unlisted public companies. As per this regulation, all the information is not required to be disclosed. MCA will soon amend the audit reporting requirements.

Is it applicable to deemed public companies?

There is no clarity on whether this amendment also applies to deemed public companies (private companies which are the subsidiaries of public companies). Therefore, they would also have to comply with the amendment rules.

On 10^th August 2018, SEBI clarified that this amendment would not restrict the holding of shares of an investor in physical form after 5^th December 2018.

After 05^th December 2018, if the investor wishes to transfer shares, then it can only be done once the dematerialization of securities is done. This step might look cumbersome, but in upcoming future, this step of dematerialization of securities will be beneficial in the public interest.