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Govt may ask public unlisted companies to convert shares into demat form

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The move by the corporate affairs ministry is part of a crackdown on opaque paper transactions, and could impact around 68,000 unlisted companies

Mumbai: In a bid to crackdown on opaque paper transactions, the ministry of corporate affairs (MCA) is considering asking public unlisted companies to convert their shares into dematerialized or demat form, said three people with direct knowledge of the matter. 

The move could potentially impact around 68,000 companies. According to MCA, as of July, there are 1.14 million active companies limited by shares; of these, 75,193 are public companies. Within that category, 67,884 are unlisted companies.

“About 80% of shares issued by these public unlisted companies are in physical form,” said an official from a depository firm, one of the three cited earlier, declining to be named. 

This move is “akin to ‘lifting the veil’ as physical shares by their very nature tend to be opaque,” said Samir Paranjape, a partner at consultancy firm, Grant Thornton India LLP. 

An unlisted public company is one which has more than 50 shareholders, a higher minimum capital requirement of Rs5 lakh and needs to comply with statutory requirements such as holding meeting with shareholders and capping director remuneration.

MCA is only enforcing a provision which is already present in the Companies Act 2013 which mandates that public companies will need to issue the securities only in a dematerialized form by complying with the provisions of the depositories. 

“The ministry is exercising the provisions of Companies Act 2013 for the first time. The conversion of physical shares into demat would be notified by way of a circular by end of this month,” said the second of the three people cited earlier.

MCA has called for a meeting of the depositories National Securities Depository Ltd and Central Depository Services Ltd on 12 of September to gauge their preparedness and the transition requirements to meet the proposal, said the third person. 

Considering the number of companies and shares, it could be a massive exercise.

“The government will need to see the cost benefit analysis of such a large exercise covering tens of thousands of public unlisted companies. If the purpose is that of catching tax evasion, then perhaps they can narrow the number of companies rather than ask all public limited companies to demat their shares. The government could consider a classification of these companies that would catch the maximum number of potential players who could commit mischief,” said Sandeep Parekh, founder, Finsec Law Advisors. 

However, even if the MCA mandates conversion, it might not be so easy to enforce this rule. That’s because the Depositories Act, 1996 allows public shareholders to hold shares in the physical format.

Indeed, Sebi has been unable to enforce 100% demat shares for even public listed firms because of the Depositories Act. In 2015, it had sought the view of the attorney general to push all shares into demat; however, the AG advised the capital markets regulator that this would require an amendment in Depositories Act. 

About Rs2.3 trillion worth of listed company shares are still held in paper format, according to depository data. That compares to Rs134 trillion value of the entire listed universe.

“The notification by MCA has to be drafted in a way that does not bring any conflict with Depositories Act and the regulations made thereunder,” said Sumit Agarwal, partner, Suvan Law Advisors.

“Moreover, section 29 of Companies Act only deals with public offer of securities to be in dematerialized form. Therefore MCA may find it difficult to make any other securities transaction (such as share transfers) by a public company in demat,” said Agarwal.