Depositories are necessary for several reasons. They provide security for the bearer of financial instruments and provide liquidity in the market. They offer consumers a place to make both time and demand deposits. Due to the increase in the number and volumes of security transactions depositories were introduced. Dealing with securities in the physical form became cumbersome and inefficient. Thus, to prevent bad deliveries, delays in transfers and irregular settlements depositories came about.
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What is a Depository
A depository is an organisation that holds securities and assists in their trading. It can be seen as a bank for securities. The primary role of a depository is to dematerialise securities and record the transaction in a book entry form. They offer all the services related to the transaction of financial instruments the same way a bank offers services related to cash deposits. These deposits can be stocks or bonds. When they are deposited, the institutions hold these securities in electronic form, or in a paper format such as a physical certificate. A depository functions through its agents who are called depository participants. Investors that wish to make use of the services of depositories open an account with the depository participant. Depositories are governed by a depository act that is relevant in a particular country.
Transfer of Ownership
The first role of depositories is to transfer ownership of shares between investors’ accounts when a trade is executed. This way the depository speeds up the transfer process and helps reduce the paperwork for executing a trade. The transfer of funds and securities is done electronically without handling of either money or securities physically. Also, depositories allot initial public offerings that would’ve been originally allotted in electronic form by issuers.
Elimination of Risk
The second role of depositories is to eliminate the risks of theft, loss or fraud in holding securities. The risk associated with the physical trading and managing of securities is eliminated. The risks of loss, forgery associated with paper based manual processing are minimised if not eliminated completely.
Maintenance of Investors Accounts
Another role of depositories is to facilitate the maintenance of investor’s accounts. They do this by keeping track of all the trading activities and deposits that take place. This is simply recording the transfer of deposited securities. The depository maintains all the transactions entered with investors for a certain period of time. The details of all the securities that have been materialised and rematerialized are kept by depositories on behalf of the beneficial owners. The depository’s role is to maintain all the records to do with approvals, notices and cancellations. Depositories can also freeze and unfreeze accounts. Other roles of depositories, in addition to maintaining accounts are to provide information about the voting rights to the issuers as well as the beneficial owners of the securities.
Safekeeping of Securities
The depositories are accountable for the safekeeping of financial instruments. The depository’s role is to safeguard deposited financial instruments and funds. They operate as custodians to electronic instruments. Depositories maintain a link between the clearing house of a stock exchange for clearance of trades done by investors. Other functions of depositories include updating the data base of the accounts of the beneficiaries. Transaction statements and holding statements are issued at a regular basis.
Increases efficiency in trading
Depositories can convert paper securities into electronic securities and vice versa. This way certificated shares that are converted into electronic securities can be transferred quicker. Thus, the depository’s role is to increase flexibility. Also, the role of the depository is to facilitate fast clearing and settling of obligations to do with financial instruments. Corporate actions can be processed transparently. Depositories facilitate corporate actions by providing information to issuers about the people entitled to corporate benefits which are both monetary and non-monetary. In some cases, the depository can take the responsibility of distributing corporate noncash benefits. Dividends, rights issues and bonuses can be quickly processed to investors in addition to keeping account statements up to date.
Mortgaging of Securities
Another role of depositories is to pledge securities in order to provide a legal framework for the parties involved. That way, their interests are protected. Depositories facilitate stock lending and borrowing and other relevant corporate actions. Investors can earn interest by participating in stock lending schemes.
Facilitation of Cross Border Trading
An important role of depositories is the facilitation of cross border trading of financial instruments through the regional integration of depositories in different countries. Cross border trading of securities occurs when trade in financial instruments amongst people in different locations takes place. Such trade is normally facilitated by international central securities depositories or the use of a bilateral link between central securities depositories in different countries. Shares which are held in a dematerialised form can be easily transferred through an electronic book-entry system locally and internationally. As a result, depositories can hold securities issued in various countries.
Other roles of Depositories
The role of depositories can vary from country to country and the range of services offered in each country may differ. Nowadays depositories continue to expand and offer new services on a continual basis. Some of the other roles of depositories are;
- Removing or minimising problems associated with a change of address of an investor
- Removal of problems associated with the transfer or selling of shares of a minor
- Ease in portfolio monitoring
- The role of depositories in other countries includes underwriting new securities
- Processing dividend and interest payments
- Announcing, reporting and facilitating tender offers and reorganisations in addition to the deposit and withdrawal of securities
Depositories offer their services through depository participants. All of the functions including the various roles of depositories are performed by depository participants. Depository participants are a bridge between depositories and investors. This means that any investor who wishes to make use of the services provided by depositories does so through the depository participants. Depository participants can be banks or other financial institutions, brokers, custodian participants, registrars, share transfer agents or non-banking financial companies. There can be one or various organisations offering depository services in a country. Depositories are regulated by the securities exchange board.