A depository, just like a bank, is a financial institution that keeps your financial securities in a dematerialized form so that they can be transacted as and when required.
There are two depositories in India: CDSL or Central Depository Services Limited, and NSDL or National Securities Depository Limited.
There is no direct communication or interaction between the Demat account holder and the depositories. Hence, the depository participants come into the picture.
What is Depository Participant?
Depository participants act as a bridge between the Demat account holders and the depositories, that is, CDSL and NSDL. It serves as an agent of the depository as well as of the client and is regulated by SEBI (Securities and Exchange Board of India).
Need of Depository and Depository Participants
Traditional stock trading was done through paperwork where the buyers and the sellers had to keep a check on the confirmation of the orders placed for buying and selling of shares.
In such a scenario, there was a high risk of theft, loss, as well as of damage of the important papers.
All these risks were eliminated by the establishment of a central depository service as it reduced the need of physical activities required at the time of share trading.
With depository services in place, individuals can now hold and transfer their shares through electronic modes. The entire process of buying, selling, and transferring of shares from one party to another has now become secure and safe.
Also, it has allowed faster processing of the transactions along with a reduction in the dependency on physical paperwork that was required earlier.
Depository participants serve numerous investors at the same time in trading over several stocks and in managing their investment portfolios.
Who can be depository participants?
Any financial institution/entity that meets the eligibility criteria as per the norms set by SEBI for providing Demat services can act as a Depository Participant. This includes:
- State Financial Corporations
- Public Financial Institutions
- Stock Brokers
- Non-banking Financial Corporations
- Registrar and Transfer Agents
A DP is responsible for the execution and final transfer of shares and other financial securities between the investors and the depositories.
Functions of a Depository Participant
- A depository participant allows investors and traders to interact with the electronic trading system functioning in the country. A DP, on behalf of the investors, converts the physical securities held by him into electronic format. A DP also allows the conversion of balance securities from an electronic format to a physical format in the BO account.
- DPs maintain electronic records of the holdings of investors and traders. They also assist in trade settlement of the underlying securities which are then delivered to the linked BO account.
- Depository Participants also enable settlement of the transactions that are carried out beyond the stock exchange.
- When an investor buys a financial security through a DP the entity is required to provide electronic credits of the securities that have been allotted through an IPO by the issuer of the security.
How do Depository Participants work?
Depository participants act as a link between the investors and the depositories. In order to avail the services of Depository participants, the investors need to have a Demat Account.
A Demat Account is opened just like a bank account mostly with the help of a broker. There are prescribed Demat account opening forms that are available with the Depository Participants that need to be filled in. There are standard agreements that need to be signed between the client and the DP mentioning in detail the rights and obligations of each party.
Involvement of the Stock Broker
Since the number of investors in the country is in thousands, it becomes difficult to bring them in one location. This is where the stock brokers and brokerage firms come into play. Stock brokers are individuals or entities that are registered the stock exchanges and act as a bridge between the investors and the stock exchanges. Whenever an investor places an order for buying the shares of a company at a given price, the request is processed through a broker at an exchange that has multiple parties involved in it.
The purchase order is forwarded by your broker to the stock exchange. At the stock exchange, the buy or the purchase order is matched with the sell order for the same amount. Once the seller and the buyer agree at the price the order is executed and is confirmed.
Settlement of the trade order
Once the order is finalized, the details of the order are confirmed by the exchange, and it is the exchange that ensures that no default in the transaction takes place. Once the order is confirmed, the ownership of the shares is then transferred. This transfer of ownership is known as a settlement.
Demat Account was introduced as a solution to electronically hold the financial securities and to prevent the cumbersome physical handling of securities. While the Demat account holds the securities in an electronic format, it is the trading account that facilitates buying and selling of these securities. Depository participants act as a link between the client and the depository making the entire stock trading a hassle-free process for all the parties involved.