The Role Of AI And Fintech In The Dematerialization Of Shares - Enhancing Transparency And Liquidity
Author: LawSphereX
Category: Technology, Cyber & Privacy
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THE ROLE OF AI AND FINTECH IN THE
DEMATERIALIZATION OF SHARES: ENHANCING TRANSPARENCY AND LIQUIDITY Gaurav Anoop, CHRIST (Deemed to be University)
ABSTRACT
This research paper presents a meticulous exploration of the compulsory dematerialization of shares in private companies, emphasizing its profound implications for transparency and liquidity within financial markets, also focusing on the integration of AI and Fintech solutions. A review of the regulatory environment, an investigation into the difficulties regarding its implementation, and the effects this has on financial markets, this paper aims to establish targets to provide valuable insights on the complexities of the aftermath effects of the dramatic change in regulation. The AI-based algorithms are now being deployed for detecting and preventing fraud. It makes for a safer trading ecosystem. This analysis also further refers to the role that the FinTech companies play in making these technologies available and applied to the de-materialization processes. Further, this paper elaborates the challenges and Risks associated with such adoption, such as cyberattacks and legal compliance. Taking into account private firms' inputs on comparisons against experience gained in the public sector and integrating the best possible understanding of global practices, this paper represents an interesting view on the complex dynamics of dematerialization, transparency, and liquidity.
INTRODUCTION
Dematerialization, commonly known as 'Demat,' is a process in which securities like shares and debentures undergo conversion into electronic data and are stored in computer systems managed by a Depository. When physical securities held in an investor's name are submitted to a Depository Participant (DP), they are then forwarded to the respective companies. Subsequently, the companies nullify the physical paper through a process known as "Dematerialization" and credits the investor's depository account with the DP. The securities, after dematerialization, are reflected as balances in the investor's depository account and maintain transferability like physical shares. Should an investor decide to revert these 'demat' securities into paper certificates, the Depository facilitates this reconversion. In India, two 2 There are two major depositories, namely the National Securities Depository Limited (NSDL) and Central Depository Services Limited (CDSL), oversee this process. It guarantees that a minimum of Depository Participants (DPs) are assigned by these depositories to assist investors. An investor has a choice of opening an account with any of the DPs of the two depositories. However, it is important to note that transfers subsequent to stock exchange transactions can be carried only between accountholders covered under NSDL's DPs. Transparency and liquidity are basic tenets of any viable financial market. The A transparent market is one which offers relevant information that is available to all participants, hence ensuring fairness and the making of informed decisions. Liquidity is, on the other hand, one of the major factors affecting the efficiency of a perfectly working market because one can buy or sell assets without any significant influence on the prices or even the dematerializing of the shares guarantees the presence of both these variables.1 Both these variables are important to attract investment and build confidence in the financial sector. In the private companies, a combination of mandatory dematerialization with transparency and liquidity becomes highly interesting. Determining how share dematerialization impacts these vital mechanisms of the market is important for evaluating the overall impact on private businesses and the respective investors. An application of AI-based 1 Nti IK, Adekoya AF and Weyori BA, ‘A Systematic Review of Fundamental and Technical Analysis of Stock Market Predictions - Artificial Intelligence Review’ (SpringerLink, August 2019) <https://link.springer.com/article/10.1007/s10462-019-09754-z> algorithms and blockchain technologies, the compulsory integration of AI technologies into dematerialization with transparency and liquidity shows some particularly interesting directions1. The purpose of the current study is to provide a holistic critical analysis of the compulsory dematerialization of shares in private companies and its effects on transparency and liquidity in the financial markets by using AI. To this end, the paper will drill down into Putting these potential benefits associated with the new regulatory mandate into perspective, the paper hopefully will contribute valuable insights for both the policymakers, the market participants, and researchers. PROCESS OF DEMATERIALIZATION Before delving into the effects of the dematerialization of shares it is important to understand the process of how it is implemented by the government authorities. When an investor decides to dematerialize securities, they are required to complete a Demat Request Form (DRF) provided by the Depository Participant (DP) handling the dematerialization of shares. The DRF is then submitted along with the physical share certificates. It's noteworthy that each security possesses a unique International Securities Number (ISIN), and a distinct request form corresponding to the ISIN must be provided. The dematerialization process unfolds through the following steps:
1. The investor submits the physical share certificates along with the DRF to the DP.
2. The DP notifies the depository of the dematerialization request.
3. The physical certificates are then forwarded to the registrar of the issuer company.
4. The registrar confirms the dematerialization request.
5. Subsequently, the registrar updates the accounts post-dematerialization and notifies the
depository upon completion of the process.
6. The depository, in turn, updates the accounts and conveys the information to the DP.
7. Finally, the investor's Demat account is updated by the DP.
This sequential process ensures the smooth conversion of physical share certificates into electronic form, allowing investors to manage and trade securities in a dematerialized format. RULE 9B Rule 9B was an amendment made to the Companies Act in 2023 which mandated for the compulsory dematerialization of shares of every private company. This section reads as '(a) issue the securities only in dematerialised form; and (b) facilitate the dematerialisation of all its securities, in accordance with provisions of the Depositories Act, 1996 (22 of 1996) and regulations made thereunder.'2 This amendment encompasses a wide array of entities. Moreover, Rule 9B mandates that, as of the final day of the financial year ending on or after March 31, 2023, private companies must issue securities solely in dematerialized form. The transition to dematerialization must be finalized within 18 months from the conclusion of the specified financial year, specifically by September 30, 2024. The dematerialization process under the current regulatory framework will be governed by Sub-rules 4 to 10 of Rule 9A, with appropriate modifications applied.
STATISTICAL
ANALYSIS
The data below suggests that there has been a considerable rise concerning the number of shares that have been dematerialized in India. There has been a 336.61% rise in the number of companies available at NSDL and 219% increase at CDSL. The market capital has provided equipped itself with technology to enhance flea market 1243.68% at NSDL and 3780.48% at CDSL and most significantly in relation to the DEMAT the other has grown by a whopping 2465.55% at the NSDL and a 9107.81% increase at the CDSL.3 It is clear that there has been a positive effect on the suppression of information inside the market where such market information is now market’s participants easily accessible enabling them to make wise investment decisions. While this was an old investor – market due to the high cost of trading or intermediation, increased transparency, especially of prices, turned out to reduce the extent of intermediaries, and created room for investors’ direct participation into 2 Thakare S, ‘MCA’s Directive for Dematerialization of Securities for Private Companies’ (IRCCL, 9 December 2023) <https://www.irccl.in/post/mca-s-directive-for-dematerialization-of-securities-for-private-companies>
3 ((PDF) dematerialization of shares and retail investors in India, Surendar Gade - A study)
<https://www.researchgate.net/publication/307966920_Dematerialization_of_Shares_and_Retail_Investors_in_I ndia_-_A_Study> the market. The overlapping of Rule 9B with the provisions of other enactments has enhanced the process of dematerialization, as well as good corporate governance and investor protection. In terms of liquidity, the econometric results support a growth of demat accounts, as well as the value of securities encumbered in demat form. Growth rates, though showing a modest decline, are still impressive leading to a speculation that the interest in electronic trading is of a long-term nature. The decrease in settlement durations surrounding the process of transaction owing to dematerialization has naturally enhanced the liquidity levels in the market by making the assets more easily tradable without surrounding price changes. PROGRESS OF DEMATERIALZATION FROM 2000-2014 TABLE 1- DEPOSITORY STATISTICS BETWEEN 2022-20234 Particulars NSDL CDSL MARCH 2022 MARCH 2023 MARCH MARCH No of investor accounts (Lakhs) No. of Companies Signed up (Listed and Unlisted) Of which companies are listed Quantity of Securities in Demat Form (crore) Custody Value of 22938892 22261191 3228356 3405158 Shares of Listed Companies (crore) Ratio of Dematerialised Equity Shares to Total Shares Listed 86.0 85.0 12.2 13.2 (per cent) Since 2020, there has been a noteworthy increase in the number of demat accounts opened at NSDL and CDSL. As of March 31, 2023, the total count of demat accounts across both depositories reached 11.4 crore. During the fiscal year 2022-23, the growth rates for new investor accounts at CDSL and NSDL were 31.8% and 17.9%, respectively, albeit lower than the growth rates observed in 2021-225. The number of listed companies opting for dematerialization with CDSL and NSDL showed year-on-year increases of 11.2% and 9.4%, respectively, by the end of March 2023. The value of securities in demat form at CDSL and NSDL experienced marginal increases of 6.8% and 0.1%, respectively, by the close of March
2023. At the conclusion of the fiscal year 2022-23, NSDL held a dominant market share of
88.4% in terms of the market value of demat securities, while CDSL accounted for a 11.6% share6. IMPACT ON TRANSPERENCY AND LIQUIDITY The dematerialization of shares with the advent of AI had a marked effect positively on these two important elements of any market, and this is avouched by the statistical analysis above that makes this claim airtight as there are numbers from the last 2 decades to support it. The market's products and services became quite accessible with the price structure connected with them. Such a market tends to be more open and efficient with transparency. Dematerialization, along with electronification of shares, has substantially improved the efficiency of the market, according to brokers. With more presence of AI and fintech in this industry, again it is going to
5 Annual report 2022-23 SEBI
6 Annual report 2022-23 SEBI
make it easier and smooth only.7 This change has made market information available that presents improved opportunities for both buyers and sellers to execute transactions with lower transaction costs. Increased transparency on pricing allows an understanding of the supply and demand dynamics in the market, according to the brokers. This availability of data on bids, asks, and trades helps the participants in making informed decisions. There also is greater transparency that often is credited to lessen, if not eradicate, the requirement for intermediaries therefore lowering cost. Investor can now invest directly in the share market without having to be routed through traditional intermediaries, banks.8 Automated trading, introduced recently, has been the key catalyst to bring about transparency in trading, feels Surajit Banerjee of SMC Securities Global Ltd. The equal playing field this has provided to shareholders and market players across India cannot be overlooked. The reduction in cases of stock market scams is significant; dematerialization in itself has attracted global investors due to lower transaction costs and quicker settlement cycles and overall market transparency. Mr. Banerjee further focuses on dematerialization's positive impact in solving long-persisting issues in the Indian share market, like forged shares, torn or torn paper certificates, either stolen or lost share certificates, and problems related to wrong deliveries. Dematerialization has streamlined the trading process with no defects related to the business of paper-trading business leading to cost cutbacks for brokers as well as investors. Soumik Nag, an owner of a Motilal Oswal franchise, stated that the transparency aspect lies on the regulatory side. According to him, Companies Act 2013, together with other applicable acts and their amendments, in so many ways has significantly impacted the dematerialization of shares of unlisted public companies. It leads to an enhancement of transparency along with the strengthening of investor protection and better governance. While improving transparency, in fact, the dematerialization of securities of unlisted public companies becomes mandatory for 7 J; KSWU, ‘Artificial Intelligence and Blockchain Integration in Business: Trends from a Bibliometric-Content Analysis’ (Information systems frontiers : a journal of research and innovation) <https://pubmed.ncbi.nlm.nih.gov/35431617/> 8Maheshwari, Dr Srivatsava and Shrashsti, ‘A Study on Comparative Analysis of Investment Avenues Such as Stock, Equity Growth Mutual Funds, and Gold Etfs’ (International Journal in Management and Social Science) <https://indianjournals.com/ijor.aspx?article=005&issue=4&target=ijor%3Aijmss&volume=5> the Indian government; instead, it has strengthened the know your customer framework as a measure to cater to the overall protection of investors. Mr. Soumik Nag9 of Motilal Oswal talks of a multitude of advantages of opening a demat account for stock market trading in India. He clarifies that if the demat account is linked to all the other bank accounts of an investor, then money is transferred effortlessly for buying and selling shares. This made so much more efficient than when, in old times, one had to carry cash or physical share certificates to transfer ownership. Settlements in the stock trade will allow the exchange of money and securities between the parties engaged in the transaction. Current electronic times, transactions will settle in three business days, whereas government bonds and actions settle the next business day, that is T+3 and T+1. Tracing this evolution in modern settlement and clearing would depict a need for addressing the paper crisis arising in security trading during the 1960s and '70s, when there was increased physical trading of shares and bond certificates. This again was possible due to electronification of share trading, a direct fallout of Dematerialization. It is undeniable that with all this said, the dematerialization has generally amplified the convenience and simplification of the trading process of stocks by the removal of share certificates, paper currencies, as well as checks. Mr. Nag further emphasizes that things were very different those times. The brokers and dealers would have had to resort to using messengers and the Indian Post to deliver certificates and cheques for payment, which increased the risk multifold and the cost of transaction. Five business days used to be taken to complete and settle trades because the stock exchanges used to close on Wednesdays, as he further elaborates. The benefits of holding shares in electronic form are thus an end because it has reduced the risk of losing physical shares because of thieving or destruction by fire, floods, or other natural calamities that could damage the physical share certificates. Also, electronification of stocks allows transfers from one account to another almost instantly, thereby accelerating the entire process of buying and selling shares. This increases the stock market's effectiveness and efficiency, yet also demonstrates the positive impact of many alterations and innovations 9 Bhadra, Shreya and Dr.Ashok, ‘(PDF) Study of Impact of Dematerialization of Shares On ...’ (Research Gate ) <https://www.researchgate.net/publication/361995743_Study_of_Impact_of_Dematerialization_of_Shares_on_t he_Indian_Stock_Market> accessed 19 November 2024 experienced by the chosen sample of brokers as resulting from improvements in efficiency and effectiveness. BENEFITS OF DEMATERIALIZATION Convenience and Accessibility: A Demat account provides the advantage of electronic transactions. Transactions would not be required to physically come to a broker's office. Investors can access their Demat account with the help of a computer or smartphone, making it a convenient and flexible mode of managing securities. Furthermore, the conversion of physical holdings into electronic format makes it convenient for people to gain legal ownership of their shares. Effortless fund transfer: The demat account may be linked with a bank account so that electronic transfers of funds may be made, saving the investor from the hassle of getting manually written cheques. In this way, management would become much more efficient and freer from high administrative costs associated with traditional methods of fund transfer. Improved Security: The Demat account is one of the safest and most secure means to do electronic transactions. Risks related to physical share certificates, like theft, damage or getting lost, are totally eradicated. This gives more confidence to investors about the safety of their holdings. Nomination Facility: Under the facility of nomination, the investor can give the operational rights to a nominee in case he is absent. Thus, the management of the Demat account, along with transactions, will remain uninterrupted even when the holder of the account is absent. Paperless Transactions: Another primary advantage provided by the Demat account is that it is a completely paperless solution. The natural outcome of this will thus show a reduction in dependence on physical documents. This, in turn, reduces the administrative costs of a company and also has the added environmental sustainability of reducing paper usage. Loan Availment: Investors can raise funds against the dematerialized securities due to the existence of the Demat account. The dematerialized securities in the Demat account can be offered as security, and thus investors can raise funds from the market at the times when necessary. Effortless Monitoring: A demat account makes it easy for investors to monitor their portfolios from any part of the world. This flexibility increases the participation and interest by investors in such an account, which eventually leads to better decision-making and profitability. Corporate Benefits and Multiple Objectives: The demat account streamlines the accrual of corporate benefits like dividends, interest, and refund, as the above amount is credited directly to the account. The account also maintains various financial instruments, namely, equities, debt instruments, mutual fund units, government bonds, and exchange-traded funds; hence, it offers an accessible platform for investors. Advantages of Trading in Demat Form: The depository system brings in many advantages over the traditional method of transacting with physical share certificates. These benefits include elimination of bad deliveries, cost and time saving during rectification processes, reduced stamp duty for electronic transfers of shares, notarization and courier charges are avoided; procedures in case of lost or mutilated certificates are simplified. It has also been beneficial for investors who opt for demat shares since the interest levied on loans taken against demat shares is lower as compared to physical shares. Therefore, they are likely to save money. Small Investors' View: A George Mathew study in 1999 found that small investors have the tendency to sell their small holdings at odd lot counters in order to avoid the mandatory scripless trading that is a part of demat shares. Again, this appears to be prompted by contemplating the efficiency and rapid electronic transfers such counters provide. That people will have to 'dematerialize' shares will have to alert the government and SEBI must pay heed.
CONCLUSION
The most sweeping force of for instrumental changes in the Indian financial markets is the compulsory dematerialization of shares as might be prescribed by Rule 9B of the Companies Act of 2023. This study considers in detail the influence of dematerialization on transparency and liquidity of the market and presents fat evidence of the benefits there are to appreciate in such effects. The DPs like NSDL and CDSL have the dematerialization mechanism so that the aim of equity without paper share certificates is possible. The involvement in share trading does not only create physical movement of paper certificates but also eases the routine by digitizing the certificates and storing them in a safe server.
This too has been a very strong driver for transparency and liquidity enhancement in the sense of the negative effects of forced dematerialization. The institutions have also received a thrust from both institutions and technology and markets which has in turn pushed India’s financial economy to a different level in terms of the efficiency, accessibility and investor trust. The secondary data analysis as presented in the study provides a good basis for the development of additional policies and practices that embrace changes in the issue of dematerialized securities in the Indian market by the policymakers, market players and the academics. This paper examines the degree of technology in sharing economy which aims at the dematerialization of shares by looking specifically at the infusion of AI and Fintech. The paper also addresses the challenges and risks associated with these technologies and provides insights into future trends that may shape the landscape of share the integration of AI technologies in the dematerialization.