The Ministry of Corporate Affairs has notified private companies to mandate the dematerialization of shares to improve transparency and record-keeping, as well as to modernize the securities market infrastructure. According to the directive, private companies that are not small have to convert physical share certificates into electronic forms.
Dematerialization Defined
Dematerialization is the conversion of share certificates and other securities into electronic records instead of holding them physically. Such records are kept in a demat account with a registered depository participant. Through dematerialization risks linked with physical documents such as loss, forgery, or damage are eliminated. Transactions on securities become convenient and secure.
Regulatory Framework
A new rule was issued by the Ministry in 2023 under the Companies (Prospectus and Allotment of Securities) Second Amendment Rules. It states that: “No private company shall, other than small companies, issue any security by way of:
(i) only in a dematerialized form, and
(ii) convert the existing securities held into electronic form.”
Provided that a small company is defined as a company whose paid-up capital does not exceed ₹4 crore and whose income does not exceed ₹40 crore.
Compliance Timeline
The time limit during which compliance is to be met is provided by the regulation under the term eighteen months beginning from the end of the financial year which ends on or after March 31, 2023. To illustrate, if a company’s financial year ends on March 31, 2023, this means it must comply with dematerialization requirements by September 30, 2024.
Stakeholder Obligations
The dematerialization requirements place obligations on individual stakeholders, not only on companies. Their collective responsibility is the following:
For Promoters, Directors, and Key Managerial Personnel
Dematerialization of the entire holdings before any public offering, rights issue, bonus issue, or buy-back of shares, of promoters, directors, and key managerial personnel.
For Security Holders
Security holders should ensure the dematerialization of their securities before transfer. Moreover, a subscription to securities offered by way of the private placement, bonus, or rights issue shall only be issued to persons whose securities were already dematerialized before such subscription.
Benefits of Dematerialisation
There are many advantages for companies and investors through dematerialization:
Increase safety: Electronic records diminish risks of physical loss, damage, or theft.
Facilitate transactions: Through demat accounts, the transfer of securities becomes smooth and fast.
Keeping records accurately: Action Corporate, such as stock splitting and dividends, is automatically maintained in the electronic records.
More transparency: Open and transparent records of ownership and transactions give Electronic systems.
Simplified Portfolio Management: An investor can consolidate several securities in one demat account.
Process of Dematerialization
To comply with the new requirements, private companies are expected to follow these steps:
- Amendment to Articles of Association
Companies should have an amendment made by special resolution to the Articles of Association allowing the issue and holding of securities in dematerialized form.
- Appointment of a Registrar and Transfer Agents
Companies should engage a registrar and transfer agent registered to handle dematerialization and associated services.
- Execute a Tripartite Agreement
The company should enter into a tripartite agreement with a depository registrar and transfer agent for the issue and upkeep of dematerialized securities.
- ISIN
An International Security Identification Number (ISIN) should be given to each kind of security. This number acts as a unique identifier for the securities in the electronic system.
- Information to the Shareholders
Companies have the responsibility of informing all existing shareholders about the requirement for demat and guiding them on converting their physical shares.
Conclusion
The dematerialization of shares by private companies will always go down as a noteworthy regulatory development of India’s corporate landscape. The transition from paper-based records to electronic will provide greater operational efficiency and lesser risk while augmenting the long-term vision for digitization in the securities market.
