In the din over Governor Y. Venugopal Reddy’s worries about the quality and quantity of foreign institutional investment, an important announcement by the Securities and Exchange Board of India (Sebi) almost went unnoticed.
At the Icfai-Sebi conference last week, Sebi Chairman G.N. Bajpai conceded a long-pending demand of Indian investors when he finally cut through the never-ending debate and announced an abolition of account opening and custody charges for all demat accounts.
This move follows at least four years of persistent lobbying and protests by investor groups and retail investors who believe that unreasonably high demat costs are one of the biggest disincentives to entering the capital market today.
G.N.Bajpai correctly said, ‘‘The move is intended to reduce the burden for small investors’’ who currently pay five different kinds of charges to the Depository Participant (DP). These are: account opening charges, custody charges, transaction charges, account maintenance charges and account closing charges. Some of these charges are levied by depositories and others by DPs. Unfair stipulations by bank DPs who force investors to open accounts and maintain a minimum balance are not even included in this list of woes.
The Sebi Chairman has indicated that only two of these charges will be immediately abolished and the change may come into effect from February 1, 2005. However, the regulator may first have to find a way to pass these charges on to listed companies; otherwise there would be a storm of protest from DPs.
While investors are happy at the Sebi chief’s announcement, there is clearly room for further rationalisation and improvement. The long delay in reduction of demat charges, is already inexplicable because it was been recommended by at least two committees — the Bhave committee in July 2002 and an internal Sebi report in February 2004. Moreover, most leading companies do acknowledge that they have benefited at the cost of their retail investors (by winding up their share transfer departments and the burden of checking, transferring and posting physical share certificates every day) and are not averse to sharing the burden.
The Sebi report of February 2004 had in fact suggested that companies by charged a one-time fee of 0.1 per cent of the market capitalisation to make up for the reduction in demat costs. This suggestion was not followed up because Sebi then referred the matter to its Secondary Market Advisory Committee, which has still to take a final view on the subject.
Meanwhile, there is mounting evidence that high demat costs are keeping investors away from the capital market, mainly through a study by former Sebi Director L.C. Gupta. The study titled India’s Stock Market and the household investors 2001-2004 (by the Society for Capital Market Research and Development along with Vivek Financial Focus) found that ‘‘Most of the household investors, who constitute the majority of shareholding population in India have remained outside the share depository system’’.
In many companies, with a shareholder population running into lakhs of investors, nearly 60 to 80 per cent of shareholders held physical shares in 2003. In case of 20 individual companies with the largest number of shareholders in the study sample, nearly half the investors held physical shares. The study concludes that ‘‘the total number of demat accounts is still much below 50 per cent of India’s share owning population’’.
Many experts have correctly pointed out that retail investors in India have a long-term investment horizon and it makes sense for them to avoid high demat costs by holding physical shares. However, since it takes at least six to eight weeks for individuals to open demat accounts and dematerialise their shares, they also stand to lose the opportunity to sell out at the best price. In the first quarter of 2004, many investors did indeed open demat accounts in order to be able to participate the in Initial Public Offerings (IPOs) of public sector undertakings. This trend will only be accelerated this year by Sebi’s decision to abolish some of the demat charges.
But this is only a beginning. When the Depository Act was passed in 1996 the regulator believed that the demand for dematerialisation facilities would make it an attractive business for banks to offer demat facilities to their own depositors. That has not happened; instead there are many stock exchange centres that still do not have any DP, or have a single DP that dictates its fees.
Gupta’s study quotes a Sebi view expressed in 1996 that when the proportion of securities dematerialised in the depository increases, ‘‘the benefits of reduced risk and lower transactions costs will extend to the vast majority of market participants’’. This too did not happen. High demat costs have ensured that the depository is used only by frequent traders who also complain about high demat costs but have no option but to pay them.
Although belated, Sebi’s decision to tackle the issue of high demat costs is important for investors. A reduction in these costs is key to any serious effort at adding depth to the market by encouraging retail investors to participate more actively.
The process of reducing demat charges has to be carried forward by examining other levies such as account closing charges that are currently collected by DPs. An account closing charge aims at killing competition by creating a disincentive for investors to switch DPs. Another equally important issue is the growing incidence of fraud, where shares are transferred out of investors’ accounts by forging or manipulating their consent.
So far, Sebi has treated such incidents as sporadic occurrences, but as the number of accounts increase the regulator needs to put in place a system of dealing with such complaints, ensuring proper insurance cover and educating investors on the need for vigilance about depository accounts.
Now that Sebi has made a beginning in addressing demat concerns, it will hopefully move rapidly along this path to build investor confidence in the system and increase their participation.