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Dematerialisation mandate impacts 1.6 million companies: 60% of India Inc transitions to Demat securities from October 1

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As of October 1, a significant directive impacting 60% of Indian companies came into effect, with nearly 1.6 million companies now required to issue securities in Dematerialised (Demat) form. This government mandate, part of the amendment to the Companies (Prospectus and Allotment of Securities) Rules, 2014, aims to enhance transparency and simplify transactions. However, the transition to Demat form also poses challenges, particularly for private company boards concerning share transfer and shareholder tracking.

The primary motivation behind this mandate is to improve transparency and reduce risks associated with paper-based securities. Before this amendment, around 60% of the corporate ecosystem operated using paper securities, which are prone to manipulation, delays in transfer and transmission, and complications in the Know Your Customer (KYC) process. Such issues have led to legal disputes and resource wastage. By mandating Demat shares, the government seeks to bring more accountability and streamline processes. Securities in Demat form undergo periodic KYC checks, making it easier to trace shareholders and ensure compliance. Additionally, the standardised process for share transfers and transmissions simplifies transactions and eliminates the delays associated with paper-based share certificates.

Key benefits for shareholders and the corporate ecosystem

The Demat system offers several benefits for shareholders and companies alike:
Transparency: Demat shares allow easy identification of shareholders, reducing the risk of fraudulent transactions.

Ease of fundraising: Companies with Dematerialised securities can raise funds more quickly and efficiently, as the Demat process simplifies the transfer and pledge of shares.

Enhanced business environment: The Demat mandate aligns with India’s goal of improving its business climate and rankings on global platforms like the Financial Action Task Force (FATF), which combats money laundering.

Challenges for Private companies

Despite its benefits, the new mandate presents several challenges, particularly for private companies. One of the main concerns is that Demat shares become freely transferable. Traditionally, the board of directors must approve any transfer of shares in a private company to ensure compliance with the Companies Act, which restricts the number of public shareholders to a maximum of 200. When shares are held in paper form, share transfer deeds are submitted for approval. However, in Demat form, shares can be transferred between accounts without the board’s knowledge, making it harder to monitor and control.

Depositories like NSDL and CDSL offer a solution to these challenges through the freezing and unfreezing of the ISIN (International Securities Identification Number). By freezing the ISIN, a company can prevent the transfer of shares between Demat accounts without board approval. However, this process comes with a cost—ranging from Rs 10,000 to Rs 15,000 per instance—which can add financial strain on companies that need to frequently freeze and unfreeze shares.

Small companies, defined as those with a paid-up capital not exceeding Rs 4 crore and a turnover of up to Rs 40 crore, are exempt from the mandatory Dematerialisation of shares. This exemption does not apply to holding or subsidiary companies, Section 8 companies, or entities governed by special acts. However, small companies may still need to adopt the Demat process in the future to stay competitive. Companies that delay implementation could face challenges in fundraising until the Demat system is in place. For shareholders, the shift to Demat requires opening a Demat account, which may pose hurdles for those unfamiliar with the process. However, with professional guidance, this transition can be managed smoothly.

Transitioning from paper-based securities to Dematerialisation involves adopting new technologies and incurring additional costs, such as opening and maintaining a Demat account. For shareholders accustomed to physical share certificates, this can feel like a loss of security, as they no longer have the physical proof of their share ownership.
However, the long-term benefits outweigh the initial challenges. Demat accounts make corporate actions, fundraising, and securities transfer far more efficient, reducing the potential for errors and disputes.

While the Demat mandate brings numerous benefits—such as enhanced transparency, easier fundraising, and a more robust corporate environment—it also requires companies to adapt to new processes and technologies. Private companies must navigate the complexities of share transfer regulations and consider the costs of ensuring compliance with the Companies Act. As public expenditure increases and rural economies strengthen, the overall growth trajectory of India’s corporate sector remains promising. However, the Demat mandate will require careful implementation to balance the need for transparency with the operational realities faced by private companies.

In the coming months, as more companies adopt the Demat system, it will be crucial to monitor how this shift impacts India’s corporate ecosystem and whether additional adjustments to the regulations will be necessary.

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