The recommendation of the Financial Sector Legislative Reforms Commission (FSLRC) to hold all financial products in electronic form with depositories would be a truly significant financial reform measure.

The Draft Law or Indian Financial Code, which is part of the FSLRC’s second report, states that “every person subscribing to financial products, other than securities, must have the option either to receive such financial products in physical form or in de-materialised form with a depository”.

The definition of financial products, in turn, includes, apart from securities, insurance contracts, deposits, credit arrangements, retirement benefit plans, small savings instruments or “any other instrument” that may be prescribed from time to time.

Although the above recommendation is discreet, it can lead to huge savings and convenience for the investing community, besides enhancing transparency and providing reliable data for policy formation and regulation of markets.

Eliminating multiplicity

If all financial products are held in a unified demat account, the following advantages are imminent:

Investors will not be required to open multiple accounts falling under different jurisdictions. It saves them annual maintenance charges (AMC) that work out to roughly Rs 200 for each product. Thus, if an investor has, say, insurance policies, corporate fixed deposits (FD) and National Pension Scheme (NPS) membership along with securities, he would end up paying Rs 800 every year under four different jurisdictions – as against Rs 200 plus if they were all held under a single demat account. It translates into a saving of Rs 1,200 crore for two crore investors (who are already now in the depository system) in the form of AMC for four products. In addition, the ease and convenience of viewing one’s holdings and execution of transactions is immeasurable.

As investors’ statements of accounts are available with the depository participants (DP), the possibility of his successors not being able to claim the assets against these accounts will be rare.

In the event of the demise of the investor, the demat account maintained with the DP will furnish all the assets the deceased was holding. There have been reports of nearly Rs 1,700 crore of unclaimed deposits lying with banks and an equal sum of matured insurance policies without claimants. Such instances can be minimised with a unified demat account.

The huge competitive distribution network of the DPs can make the marketing of even new products such as NPS economically viable. One way to ensure the demographic dividend that India today has does not become a liability for its future generations is to bring the country’s young workforce under NPS, leveraging the existing nationwide network of 15,000-plus service centres of DPs. It will also hasten the process of financial inclusion.

The synergies in developing the IT systems and reduced costs through more efficient sharing of infrastructure will be substantial for a unified depository. The benefits of these can be passed on to the customer in the form of lower tariffs.

Replicating experiment

Depositories are regulated by the Securities and Exchange Board of India (SEBI), which, over time, has strengthened the framework for mitigating risks and enhancing transparency and accountability. The market regulator has ensured that the depositories are well-capitalised and promoted only by financial institutions of repute and standing. Further, competition between depositories has ensured that the cost of offering depository services in India is among the lowest in the world.

The depository experiment in India has shortened the settlement cycle by moving from the old account period to a T+2 rolling settlement regime (T+2). In the process, it has eliminated the risk of bad paper as well as default, in turn, reducing the cost of trading.

The FSLRC report is now apparently seeking to replicate the above success story, seen in securities, in other financial products as well. But since different financial products fall under the jurisdictions of different regulators, including the Reserve Bank of India (RBI), it requires deep understanding and high level of co-ordination among them to have a unified depository system.

It is not clear whether the term “deposits” under the definition of “financial product” in the Draft Law covers bank FDs. This is because the banking sector is to remain under the RBI, which is not envisaged to be a part of the proposed new Unified Financial Agency. If the records of FDs of banks are also shared with the depository system for consolidation of account statements, it will certainly lighten the burden of keeping track of FD receipts and their maturity periods.

It may not be out of place here to also make a mention of the National Academic Depository Bill, now pending before Parliament, for keeping academic records in demat form. It, in a way, recognises depositories as the natural choice for protecting ‘Saraswati’ with as much care as ‘Lakshmi’!

The road ahead

Currently, risk mitigation measures with regard to depositories and DPs are based on marketability and transferability of assets. While products such as deposits, insurance policies and NPS plans are per se non-transferable, the technology/IT systems developed for the same can still ensure compliance with such requirements. The ATM network of banks can be permitted for viewing and transacting in DP accounts using the existing smart cards of investors. Also, the DPs offering services of multiple products may be subjected to higher net worth requirements.

There is also the issue of transparency. Many companies have raised deposits from public, but there is no public record available as to how much has been repaid and the amounts outstanding. Some have even resorted to private placement of debentures. If it is made mandatory to hold such assets in demat, an easy MIS can be generated for effective policy formulation. Moreover, offenders can be brought to book before matters snowball into intractable situations, as is being seen in some cases.

The implementation of the FSLRC’s recommendation pertaining to the role of depositories may not require a complete overhaul of the existing legislative framework. The Depositories Act, 1996 merely states that securities as defined by the SEBI are to be only held in a demat account. SEBI, as is expected, has defined securities in SEBI (Depository & Depository Participant) Regulation, 1996 to cover only those products regulated by it, such as shares, debentures, units of mutual funds, etc. with freedom to notify any other security at any time.

Further, SEBI regulation 7C prohibits depositories from carrying on any other activity unless it is incidental to depository activity.

If only these two amendments are carried out in the SEBI regulations to operationalise the unified depository system – and other financial sector regulators are generous to accept (both in letter and spirit) the jurisdiction of SEBI over the unified depository services framework, including the role of depositories and DPs for dealing in other financial products – the proposed FSLRC reform will bring in a sea change in the way financial sector operations pan out in the country.

We will not be surprised to see, in the near future, the holders of other class of assets (moveable or immovable) also hanker for their ownership record being kept in electronic form with depositories.

(The author is MD & CEO of Central Depository Services India Ltd. Views are personal.)

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