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Anyone who has ever invested in securities has encountered the term ‘dematerialization’. In the following guide, we will explore what dematerialization is, how it started, and why it is important.
When it comes to investing in and holding assets, the term ‘dematerialization’ comes up a lot, especially when we talk about shares. Not everyone knows about dematerialization and what it means, but you should be aware of it if you’re interested in investing. This is because dematerialization is an important step that has helped to modernize investment practices, protect investors, save time and money, and prevent risk across the board.
What is dematerialization in the first place? How did it start and why is it important? In this guide, we will explain all these in detail, as well as look at how to get started with dematerialization.
First of all, it is important to understand what exactly dematerialization is. At its core, dematerialization essentially refers to creating a record of ownership of shares beyond the certificate held by the investor. Simply put, dematerialization is the process of converting physical share certificates to digital ones. When a person takes ownership of shares in a company, they are given a certificate that stipulates their name, the number of shares, and other important details.
Needless to say, share certificates are very important to investors and they would need to have easy access to them whenever needed. Dematerialization is the process of digitizing such documents so they can always be accessed. They are kept in digital form and when signing up, investors will have to assign a nominee and provide details of the certificate.
But after this is done, they can reap the many benefits of dematerialization, including easier access and reduced risk. These days, all sorts of documents are being given digital treatment, from university certificates to boarding passes. So, it comes as no surprise that share certificates are finding their way into the mix. Dematerialization has been known to address many of the long-standing issues associated with holding share certificates. And while dematerialization might seem like a fairly recent concept, its history does go back quite a bit.
Dematerialization has existed in some form for thousands of years in the form of bookkeeping. But if we think of modern dematerialization which involves computer systems, this can be traced back to the 1960s. Thanks to technological developments, many territories such as the United States, India, and the European Union began rolling out dematerialization. One example of this was the Securities and Exchange Board of India (SEBI) which was formed in 1992. Typically, regulatory bodies would grant a central institution such as the Depository Trust Company (DTC) in the United States the power to dematerialize assets.
And as technology grew more advanced, dematerialization became more prevalent and efficient. This was also coupled with the fact that the capital markets were only getting bigger and more people than ever before were investing. This increased demand meant that efficient ways to record ownership and transfer of securities were needed. And this was a need that dematerialization was meeting. By the 2000s, a majority of the securities listed on various capital markets were dematerialized and this trend has continued ever since.
The importance of dematerialization can ultimately be put down to the fact that tracking all the transactions associated with securities by paper can be very cumbersome. Suppose an investor buys some shares and is issued a certificate for them. As we all know, paper can get missing, damaged, or stolen. The certificates will have to be kept in a safe and secure place to avoid any of these and this can get tiring over time. But when these certificates are kept in digital form, there is less chance of them getting torn, stained, or stolen.
But even if keeping the certificates wasn’t such a hassle, you also have to consider how many times a single share or bundle of shares might change hands. In very busy market periods, a single security can be bought and sold multiple times, and issuing paper share certificates for each of these will be nothing if not a hassle. Plus, it isn’t free as there is often a 0.5% stamp duty charge.
If the paper certificates get stolen or missing, it is a sophisticated process to report the loss to the authorities, prove they have been stolen, and so on. Dematerialization solves most of these issues and that is why it is important.
The good news for anyone thinking of dematerialization is that the process is generally straightforward and can be done with virtually any legally recognized depository in your country. Here is how the process typically works:
Dematerialization offers many benefits, some of which are as follows:
Despite all the benefits of dematerialization, there are still some downsides to consider.
Firstly, as has been illustrated above, dematerialization requires a bit of technological know-how to deploy successfully. Investors who are not very tech-savvy or who are very used to paper certificates might take a while to adjust to it.
Secondly, market volatility may cause issues. While being able to easily transfer shares offers more convenience for investors, this ease could also lead to more market volatility as there will be more focus on short-term trading as opposed to long-term gains.
Dematerialization is one of the biggest conveniences for investors and this is why it has remained popular for decades. This singular process makes ownership records more secure, makes transfer of ownership faster, and saves time, money, and effort. Anyone looking to invest will probably come across dematerialization at some point and should try their best to take full advantage of this process.
Dematerialization is the process of converting physical (paper) share certificates into a digital format to record the ownership of the assets.
The owner of the assets will need to set up a Demat account with a licensed depository and provide proof of income, address, etc, and the physical certificate. After all this is verified, the physical certificate will be destroyed and a digital version created.
Dematerialization is important because it offers a more convenient way to record ownership of assets and makes it easier to transfer this ownership if needed.
Recording of ownership of assets digitally has been in use since the 1960s.
Dematerialization is conducted by a licensed depository that creates Demat accounts for customers through which ownership of assets can be recorded.
Dematerialization offers lower chances of certificates being lost or stolen and also offers more convenience with transferring ownership.