In Fact: NSDL and India’s move to electronic stocks and trading

An expert suggested by the World Bank also advised that the system had worked in Scandanavian countries and in Australia.

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The plan was to bring a law to promote a depository that would hold all securities.

In mid-1995, as P J Nayak, joint secretary in the Finance Ministry in charge of the capital markets and overseas borrowings divisions, neared the end of his tenure, Finance Secretary Montek Singh Ahluwalia suggested that he stay on for a new assignment. The plan was to bring a law to promote a depository that would hold all securities such as stocks, bonds, debentures, mutual fund units, treasury bills, etc. in electronic form. Nayak agreed to do the job — but working from home in Delhi.

By then, the government had succeeded in promoting a modern stock exchange, the National Stock Exchange, and carried out systemic changes in Indian capital markets following the securities scam of 1991-92. Policymakers had recognised that reforms would be incomplete without a critical market infrastructure institution — especially in the backdrop of scores of complaints on settlement of trades or transactions due to physical share certificates getting lost or mutilated, leading to what is known as “bad delivery”. A huge controversy surrounding alleged duplicate share certificates of Reliance Industries Ltd added to concerns.

Back in February 1993, Finance Minister Manmohan Singh had, in fact, announced a plan to start a centralised depository with a national clearance and settlement system. In the 1980s, cabinet notes had been drafted about having securities in electronic form, but the legal framework was not been worked out.

By 1986, financial and investment institutions such as IDBI, SBI, etc. had promoted the Stock Holding Corporation of India (SHCIL) to maintain their huge physical holdings of securities, especially stocks. A committee had recommended that a depository be started — Stock Holding’s push for a single depository was opposed by the Sebi representative, C B Bhave. Later, in discussions with the government, SHCIL chief Chandrasekhar pursued this line, having by then invested well over Rs 100 crore in building a huge complex for holding certificates in physical form, but the Finance Ministry decided to back multiple depositories in the interest of competition. The world’s biggest capital market, the US, still had not made the transition to dematerialisation or securities in electronic form — but much of the world followed what was known as immobilisation of shares, i.e., electronic entries backed by physical certificates.

An expert suggested by the World Bank also advised that the system had worked in Scandanavian countries and in Australia. And so, work started on a legislation for depositories in India. Discussions preceding it involved Nayak, officials in Sebi led by Bhave, then an executive director, and M S Sahoo of the Finance Ministry.

In the early days of discussions with the Law Ministry, concerns were expressed over potential claims in case something went wrong. Once that was addressed and cabinet approval obtained, an ordinance was issued in September 1995. By December 1995, IDBI, UTI and the National Stock Exchange promoted the National Securities Depository Ltd or NSDL with R H Patil as chairman, and bringing on board Bhave. But the ordinance lapsed twice towards the end of the Narasimha Rao government.

When the United Front government took over in 1996, worried officials asked the new Finance Minister, P Chidambaram, to ensure that the Bill was not referred to the Select Committee of Parliament when it came up for discussion. The Left parties were vocal in opposing the proposed law, saying foreign banks would gain control over this too. Officials recall that the Minister then stood up and told the Speaker that he agreed with the concerns raised by a senior Left parliamentarian, and that he would ask the regulator, Sebi, to ensure that the shareholding of foreign banks or institutions directly or indirectly did not exceed 20%. The Bill was approved in the melee, and the Depositories Act was enacted in August 1996, providing for free transferability of shares and providing economic rights such as dividend for an investor even when a dispute was on. It also marked the end of the power enjoyed by companies to refuse transfer of shares to investors on certain grounds. Chidambaram was to later say in his 1997-98 Budget that the depository would take Indian capital markets to world standards.

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The primary promoters remained IDBI, UTI and NSE, and SBI, HDFC Bank, Citibank, Standard Chartered Bank and HSBC joined as shareholders. The regulator had to nudge companies to move towards the new system. By 1998, it was made mandatory for institutional investors to trade in shares which were dematerialised, making for a big push that was followed by a similar requirement for retail investors.

By 2000, almost all settlement of trades on stock exchanges were through the demat mode. As the numbers started rising, NSDL moved on to other projects, including one for the Income-Tax Department. The institution overcame a disagreement with Sebi in 2005-06 over depository participants and multiple applications in Initial Public Offerings, and emerged as a record-keeping agency for pension funds. By 2009, demat accounts topped 1 crore.

Last week, Finance Minister Arun Jaitley was in Mumbai at a function to mark NSDL’s crossing the milestone of 100 lakh crore in the value of securities held by it in electronic or demat form. The implementation of this significant financial sector reform has been a success — it is now widely recognised as one of the best financial markets infrastructure frameworks globally.