Friday, April 5, 2013

Central Depository System (CDS) and Nepalese Capital Market

Today’s business is the paperless business. In the paperless business, the businessman can do any kind of transaction without any lengthy paper work. But till date, no any investor can transact securities in the Nepalese Capital Market without extensive paper work. Nepal is also moving its steps towards the paperless business; one of the emerging steps of Nepal for this is the process of establishment of Central Depository System (CDS) in the Nepalese Capital Market. Central Depository System (CDS) is the buzzword in Nepalese Capital Market since last 4 to 5 years. The Securities Board of Nepal (SEBON) granted the license to the CDS and Clearing Ltd. on 25th August 2011 for the operation of central depository system in Nepal.

What is Central Depository System (CDS)?
The depository is an organization where the securities of a shareholder are held in the form of electronic accounts. The depository holds electronic custody of securities and also arranges for transfer of ownership of securities through the modern system of effecting transfer of ownership of securities by means of book entry on the ledgers of the depositary without the physical movement of scrip's on the settlement dates. This system is known as ‘scripless trading system’. The new system, thus, eliminates paper work. CDS is purely a settlement vehicle and will not affect the trading in any manner whatsoever. Automatic facilities and transparent trading in scrip's shortens the settlement period and ultimately contributes to the liquidity of investment in securities. The principal function of a Central Depository System is to immobilize or de-materialize securities, assuring that the bulk of securities transactions are processed in book-entry form. CDS may also have the capability for trade clearance, safe custody and settlement/post settlement processing of securities and information.

How share market functions at present in Nepal?
For buying or selling of the securities, every investor should go to the broker office. The broker trades securities either from NEPSE’s trading floor or from the broker’s office. NEPSE uses sophisticated technology through which brokers can trade remotely from their office located inside or outside the Kathmandu valley.
At present the only one share market of Nepal i.e. NEPSE operates on the ‘NEPSE Automated Trading System ‘(NATS), a fully screen based automated trading system, which adopts the principle of an order driven market. But Settlement will be carried out on the basis of paper verses payment. The best buy order is matched with the best sell order. For order matching, the best buy order is the one with the highest price and the best sell order is the one with the lowest price. This is because the system views all buy orders available from the point of view of the sellers and all sell orders from the point of view of the buyers in the market. So, of all buy orders available in the market at any point of time, a seller would obviously like to sell at the highest possible buy price that is offered. Hence, the best buy order is the order with the highest price and the best sell order is the order with the lowest price.
After trading the securities, the buying brokers have to submit bank vouchers for settlement with covering letter, after than the selling brokers must submit share certificate with covering letter. After submission of the share certificate, NEPSE prepares billing for payment and this will be forwarded to the bank.
The system of physical delivery of scrip's poses many problems for the purchaser as well as the seller in the form of delayed settlements, long settlement Periods, high level of failed trade, high cost of transaction, bad deliveries etc.  In many case transfer process takes much longer time than two months.  

How CDS works?
CDS is the fully automated system for trading of the securities in the capital market. The overall procedure relating to purchase of the securities in the market is as below:
  1. At first the investor, who wishes to purchase the share, orders the broker to purchase the shares from the market.
  2. Investor purchases securities in any of the stock exchange connected to Depository Member (DM) of CDSCL) through a broker.
  3. Broker receives payment from investor but payment method may be different depend upon the broker and investor (e.g. payment through online, cheque or other method)
  4. Broker arranges payment to CDSCL.
  5. Broker receives credit of securities in clearing account.
  6. Broker gives instruction to Depository Member to debit clearing account and credit client’s account. For crediting the demat account, the investor may give order to DM once or every time.
  7. Investor receives shares in his account.
  8. The investor should ensure that the broker transfer the securities purchased to his account, before the book closure. If the securities remain in the clearing account of the broker, the company may give corporate benefits to the broker. Therefore the investor has to collect benefits from the broker.

1-      Seller and buyer order their broker to buy or sell the securities.
2-      Brokers process the order into the market
3-      Brokers get response from the market
4-      Brokers intimate their buyer/seller about the response from the market.
5-      If the shares are sold by the brokers into the market, the Seller order the DP to debit his demats account and credit the brokers (clearing account pool) account.
6-      The Depository Participants enters the order from the investor to the CDSCL system.
7-      CDSC gives the intimation to the DP about posting into the server.
8-      CDSC debited the seller Dmat account.
9-      CDSC credited the buyer Dmat account.

*CDAS: Central Depository Accounting System
*DP: Depository Participants
*CDSC: CDS and clearing Ltd.

Similarly, the overall procedures for selling securities are as below:
  1. At first the investor who wishes to sell the share, orders the broker to sell his shares.
  2. After selling the shares in the market by the broker, it sends intimation to the seller.
  3. Investor gives instruction to DM to debit his account and credit the brokers (clearing account pool) account.
  4. After receiving the sales order from investor, the DM should make sure whether the Demat account of the investor contains enough securities for transaction or not.
  5. The Depository Member enters the order from the investor to the CDSCL system.
  6. If the transaction takes place, investor’s broker transfers the securities to CDSCL for clearing purpose.
  7. The broker receives payment from CDSCL.
  8. The investor receives payment from the broker for the sale of the securities, in the same manner payment is received for a sale in the physical mode

Legal Framework
Security Exchange Board of Nepal (SEBON) issued the Securities' Central Depository Services Regulation, 2067 (2010) for the purpose of regulating the matters regarding central depository of Securities in Nepal. The CDS and Clearing Ltd. has issued the Securities' Central Depository Services byelaws in 2068 for the operation of the Central Depository System.

Transactions handled by CDS

· Deposit of Securities
· Transfer of Securities
· Pledging of Securities
· Pledge Release
· Pledge Call
· Withdrawal of Securities
· Corporate Action

Players in the CDS

In general there are five players in the CDS; they are
i) Beneficial Owner-BO: - "Beneficial Owner" means the person who have opened their Beneficial Owner Account with Central Depository Company for depositing their securities or instruments and who have held the securities and instruments which are capable of being deposited in de-mat form.

ii) Depository:- A “Depository” is a service provider which takes custody of the listed securities from the concerned securities owners and performing the jobs of maintaining their securities account, performing clearing and settlement of the securities transaction including transfer of securities and other similar jobs. Example: Central Depository System and Clearing Limited.

iii) Depository Participants/Member- DP/DM: - "Depository Participant" means securities business person or the body corporate having membership of Central Depository Company. A “Depository Participants” (DP) is an agent of the depository (CDS) who is authorized to offer depository services to investors. According to CDS Service Regulation –Rule-20, a Depository Members (DM) shall be a Bank or Financial Institution, Stock Broker, Registrar and Transfer Agent, custodian or such other entity as from time to time.

iv) Register and Transfer Agents-RTA: - "Registrar and Transfer Agent (RTA)" means any person / body corporate, who on behalf of anybody corporate, maintains the records of holders of securities issued by such body corporate and deals with all matters connected with the transfer and redemption of its securities.

v) Stock Brokers: - A share broker is a regulated professional individual, who plays the role of bridge between buyers and sellers of the shares and other securities in the stock exchange.

Advantage of CDS

Þ    Securities are held in safe and convenient manner
 Þ    Paperless environment (no traditional vaults).
Þ    Bad deliveries, fake securities and delay in transfer are eliminated
Þ    Benefit accruing from issue of bonus shares, consolidation, split or merger or credited without  much difficulty.
Þ    Securities held in electronic form can also be pledged for any credit facility without any hassle.
Þ    Reduced workload and manpower requirements due to paperless settlement.
Þ    No impact in case of sudden increase of settlement volumes.
Þ    Instant credit of corporate entitlements (bonus, rights and new issues).
Þ    Substantial reduction in time & capital investments.

Whether there is any risk with CDS?
CDS is also not free from its inherent risk. The major risk of the CDS is system failure. Because of the system failure, the day to day transaction of the market may be interrupted and there is the possibility of data lost. For avoiding this risk, the depository should be aware about the security of the data and system. The depository may establish data centre for data backup in the different location with high level of security and it may update its system on the regular basis.

Whether CDS gives positive impact to the Nepalese Capital Market?
 Yes, we expect that CDS helps to transact the securities more easily than before, as a result of which demand as well as supplies of the securities increase. Because of the high volume of transactions in the market, no any person or group of person can lead the market easily. So that, market will be free from the tycoons of the share market and NEPSE index will display the actual status of the country economy.

Difficulties in implementation of CDS in Nepal
The major difficulties of implementation of CDS in Nepal are we do not have the previous experience about the CDS. Because of that lacking experience, it is very difficult to take every new steps. In Nepal there is no sufficient resource person for this establishment and operation of CDS so, we have to depend on the foreign resource person who increases the difficulties in implementation and operation of CDS in Nepal.

Is it necessary in Nepal?
Yes, it is the need of Nepalese Capital Market at present. It is already too late to introduce CDS in Nepal. For boarder less business as well as foreign investment, it is one of the basic needs for every investor. It is also the foundation step for listing of shares of Nepalese company in the foreign stock exchange and vice versa. At last CDS is not only the necessity of capital market, it is compulsory for the Nepalese Capital market.