Setting up the depository - An attempt to transform a hundred year old heritage

On 8^th November 1996, when Shri. P. Chidambaram, the then Honourable Finance Minister of India, inaugurated National Securities Depositories Ltd. as the first securities depository in India, in front of a packed audience of the luminaries of the Indian financial world, assembled at Nehru Centre, Mumbai, the feelings that bubbled in the minds of the spectators were mixed. For those who used to squirm at the international rating of the Indian settlement infrastructure as the worst in the world, this was a dream come true. For the cynics who had very little faith in India’s capability in establishing institutions, this was too much ado about too little. The expectations from these quarters also were varied. The former expected an instant transformation of the Indian Capital Market like the princess who wakes up with the kiss of Prince Charming; the latter were too eager to predict that the NSDL would take nothing less than seven to ten years to make any meaningful impact in a system that has more than a hundred years of “paper history”. But for those who were closely associated with the formation of NSDL, this was a nothing more than a foundation, on which, a completely new settlement system, that facilitated clean settlement of trades, with very limited scope for the ingenuity of the unscrupulous, could be built. They were happy that the foundation was strong and looked forward to the task ahead.

This article is not an attempt to narrate the brick-by-brick progress of a yet-to-be completed monumental institution; but rather a case study about managing a transitional process of systems & procedures and habits & practices of each and every player in the capital market including issuing companies, their R&T agents, custodians, clearing houses, brokers, institutional investors and even retail investors.

While most of the recent efforts in establishment of scripless trading in many markets have been by means of an executive fiat, the Indian policy makers, attempting to liberate from the inefficiencies of legal monopolies, provided options to the companies to link with NSDL, eligible entities to join as depository participants and investors to use the system. Although this policy framework evoked considerable skepticism, the progress achieved by NSDL by eliciting support of each of the affected segments and by relevant policy interventions from the regulator, clearly demonstrates the potential for a model based on consensus building and incremental growth with each step designed & tested for stress resistance.

The first challenge for NSDL, after it commenced operations in November 1996, was to convince the issuing companies to make their securities available for dematerialisation. This also meant active support to their R&T agents in establishing systems & procedures and computing & telecommunications infrastructure required to ensure the superior service standards envisaged in the depository system. In the first year, about 100 companies forming about 40% of the aggregate market capitalization had connected with NSDL. This has, since then, increased to 300 companies forming about 73% of the market capitalization.

The second challenge was to convince various eligible entities like banks, custodians and brokers that investment in establishing themselves as DPs was a meaningful growth strategy. This was quite critical, as without a nation wide DP network, NSDL could not take a single step forward. By the end of the first year, NSDL had managed to have 37 DPs providing services from about 102 locations. Today, this has increased to 76 DPs giving services at about 600 locations in 160 cities/ towns across the country.

The third challenge was to garner the support of a significant part of the users of the depository like brokers, custodians, both domestic and foreign institutional investors and retail investors spread all across the country. This turned out to be the most challenging of all due to a variety of factors. These include:

· unlike in the case of issuing companies and the DPs who joined NSDL, the users of the depository like brokers, custodians and fund managers needed answers to many questions about the potential impact of this system in their main line of business (in addition to the visionary thinking on the part of their management);

· although there was an in-principle understanding about the benefits of scripless trading, absence of a proper framework to quantify the benefits of this system and the hitherto unfamiliar custody and settlement costs in the depository, stood in the way of evolving a convincing cost benefit balance;

· the completely new way of holding and dealing in securities itself evoked a fear of the unknown and needed a lot of clarifications for the users to feel comfortable, particularly about safety features, potential pitfalls to guard against, and visibility of holding;

· the change in the rules of the game necessitated a retraining;

· the fear about potential loss in competence in this high technology environment;

· the extensive due diligence requirement of foreign institutional investors and their custodians to feel satisfied about the inherent strength of the new system; and

· the resistance of those who saw a potential revenue/ profit loss in a cleaner and more efficient system.

NSDL’s response in the face of such a challenge, was a strategic initiative that went beyond conventional marketing tools of mass media advertising, addressing these varied issues in a systematic fashion. As per this strategic plan, the initial focus was towards the major players in the market like institutions, active brokers and custodians. In this direction, NSDL embarked upon a series of measures:

0 to organize detailed exposure program to educate the major broking members, their staff, fund managers, their back office staff and staff members of the custodians about the new rules of the game;

0 to directly work with all levels of the institutional decision making processes to address their concerns and to help them develop a proper framework for cost benefit analysis satisfying the rigors of their approval processes;

0 to proactively assist the foreign institutional investors and their custodians in their due diligence process, so that they feel comfortable about the capabilities of NSDL to meet their exacting standards;

0 to organize a nationwide investor awareness program to educate investors about the operations of the system; and

0 to fine-tune the system itself towards better efficiency and safety.

All these initiatives started showing early results. Within less than a year of operations, many of the major domestic and foreign institutions opened their accounts with NSDL and dematerialised a part of their holding valued about Rs 10,000 crore. In the meantime, Morgan Stanley, a US-based custodian, recommended its clients to use the NSDL system, after it satisfied its due diligence as per the requirement of US SEC. This was followed by such recommendations from many other US-based custodians.

However, trading and settlement in the dematerialised form was yet to be taken care of. This was due to the problem of illiquidity of dematerialised securities. This was due to the creation of a pre-verified pool of securities in the depository system, which itself is a basic design requirement needed for avoiding the ills associated with paper based settlement system.

The success of NSDL in attracting participation of a variety of users and establishment of a nationwide depository participant network, gave confidence to the regulator to initiate a series of policy changes that would address the issue of liquidity of dematerialised securities. These included:

+ mandatory settlement of trades in the dematerialised form for institutional investors with respect to a select list of eight securities from 15^th January 1998, which has been gradually increased to 300 by February 1999;

+ one way integration of physical and dematerialised segments allowing delivery of dematerialised securities in the physical market;

+ mandatory settlement in dematerialised form with respect to a select list of 12 securities for all segments of investors from 4^th January 1999. The list has been increased to 60 securities by April 1999.

Addressing the liquidity problem by these policy measures dramatically increased the participation by all segments of investors. But NSDL did not see this policy intervention as a magic wand ensuring success. It recognized that without a sustained effort in educating the investors at large and ensuring quality in client servicing, these policy initiatives would come to a naught. Accordingly, the marketing efforts were taken to a higher tempo in addition to the strategies already in operation.

ù The broker exposure programs were extended to cover brokers of regional stock exchanges like DSE, BgSE, CSE, LSE, MSE in addition to about 1500 brokers and their staff from NSE and BSE, who where trained in the fist leg.

ù Two media campaigns supplemented by special incentives from DPs were undertaken. One in April 1998, when demat delivery was allowed in physical segment and one in November 1998, when mandatory settlement in dematerialised form for all segments of investors was announced.

ù A variety of educational material were developed including video films in eight languages, NSDL web site and materials addressing issues of various segments like brokers, sub brokers and retail investors.

ù The reach of the investor awareness programs was further extended.

All these efforts yielded encouraging results. The investor accounts with NSDL grew by December 1998 to 141,000 from about 1550 cities and they hold about Rs. 65,000 crore worth of securities in their accounts. The settlement in the dematerialised form in the premier stock exchanges has also reached a level of about 40%. Further, seven major stock exchanges have established connectivity with NSDL.

Now that the most active segments of the investors have been exposed to this new system, NSDL is refocusing its strategies in two major directions:

å The first one is essentially to broaden the scope of the marketing efforts so as to cover the less active segments of the investors so that they are also brought in to the system smoothly. The efforts in this direction envisage Investor Depository Meets (to offer opportunity to retail investors in all major cities/ towns to directly interact with depository officials), media campaigns, surveys to understand the problems of investors, etc.

å The second one focuses on enhancing the quality of client servicing. Towards this direction, NSDL has initiated a Branch Empowerment Program to upgrade the quality of the personnel in the branches of the DPs involved in client servicing. This is further scheduled to graduate to a Certification Program that would insist on having at least one certified professional at each of the branches of DPs.

The ultimate goal that these strategies are directed at, is a transformation of the Indian Capital Market towards “Complete Scripless Trading by the 21^st Century.”

Tailpiece: As all of us are aware, the success of the depository in India is a foregone conclusion. Today the trading and settlement in Indian capital markets happen only in the demat form. However I have reproduced the article of 1998 because I feel that the flavor of hope, aspiration and conviction when the success was still a hope is a is good case study to anybody who is involved in transformational projects.