Sebi reforms: Demat for housing societies, cooperatives a boost for financial inclusion

In a consultation paper released on 16 October 2024, the market regulator proposed allowing Associations of Persons (AoPs) to open demat accounts in their names for holding non-equity securities. This reform aims to enhance the ease of doing business for entities such as housing societies, joint ventures, and cooperative associations by streamlining asset management.

Easing regulatory barriers

At present, AOPs, unregistered trusts and partnership firms in the country can open demat accounts in the names of natural persons associated with them. This structure creates inefficiencies when managing collective investments, as assets must be assigned to individual members. Sebi’s new proposal would allow AoPs to directly hold non-equity securities such as corporate bonds, government securities (G-Secs), and mutual fund units in their own demat accounts.

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AoPs will be legally responsible for ensuring they only subscribe to the financial instruments permitted by statutes governing their structure. Importantly, the proposal excludes equity shares, indicating Sebi’s cautious approach in limiting AoPs to less volatile investments. This move aligns with Sebi’s broader goal of promoting dematerialization, shifting away from physical securities, and simplifying financial processes for collective entities.

Legal and regulatory considerations

The consultation paper highlights that Indian laws are currently unclear about whether AOPs, unregistered trusts, and partnership firms can hold certain financial assets in demat form. Sebi concluded that no changes would be made for partnership firms and unregistered trusts due to legal complexities. 

However, AoPs, which can take forms such as joint ventures and cooperative societies, are recognized under current laws as eligible to hold non-equity securities.

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The proposal is open for public comments till 5 November 2024. This reform is part of Sebi’s ongoing efforts to simplify the regulatory environment and promote ease of doing business, especially by reducing the administrative burden on AoPs. By allowing AoPs to manage their financial assets collectively, the reform is expected to reduce personal liabilities for individual members and increase their participation in capital markets.

A conservative approach

Sebi’s proposal, while progressive for India, is more conservative compared to global markets where AoP-like entities have broader access to financial instruments. In the US, structures such as limited liability companies (LLCs) and joint ventures can hold both equity and non-equity securities, providing them with greater flexibility for collective investment and risk management.

Similarly, in countries like Germany and France, AoP-equivalent entities such as associations or cooperative groups are fully recognized as legal persons and can hold both equity and non-equity securities, offering greater autonomy in managing diversified portfolios. 

Russia also allows its non-commercial partnerships broader rights to hold various financial assets, including equity shares, reflecting a more open regulatory framework. 

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In contrast, Sebi’s proposal restricts AoPs in India to non-equity securities, which aims to protect them from the volatility and risks of equity markets.

A cautious yet necessary step

Sebi’s proposal reflects a careful balance between promoting financial inclusion and maintaining market stability. By limiting AoPs to non-equity securities, Sebi seeks to enhance the ease of doing business for these entities while protecting them from the risks associated with equity markets. This approach is particularly important as many AoPs are smaller, non-corporate entities that may lack the resources to navigate the complexities of equity investment.

AoPs will be required to submit their Permanent Account Number (PAN) when opening demat accounts and ensure that they only hold legally permissible securities. This emphasis on compliance aims to reduce the potential for mismanagement and fraud, while also simplifying the asset management process for AoPs. Sebi’s cautious approach aims to protect smaller entities while encouraging their participation in capital markets.

The future outlook

Although Sebi’s proposal currently excludes equity shares, there is potential for reforms in the future. In international markets, collective entities routinely hold both equity and non-equity securities, allowing them to diversify their portfolios and manage risk more effectively. As India’s financial markets evolve, Sebi may consider relaxing restrictions on AOPs holding equity shares, aligning India’s regulatory framework with global standards.

For now, Sebi’s focus is on promoting dematerialization and simplifying asset management for AoPs. While this proposal is a significant step forward, future reforms that allow AoPs to participate in equity markets could unlock even greater financial potential for these entities.

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Sebi’s proposal to allow AoPs to open demat accounts is a vital reform aimed at simplifying asset management and improving the ease of doing business for collective entities in India. By enabling AoPs to hold corporate bonds, G-Secs, and mutual fund units, Sebi is addressing long-standing regulatory inefficiencies and reducing personal liability for individual members. However, the exclusion of equity shares reflects a conservative approach aimed at protecting AoPs from the volatility of equity markets.

While India’s regulatory framework remains more cautious than international standards, Sebi’s proposal is an important step towards modernizing India’s financial landscape. As the country’s capital markets develop further, future reforms may expand the scope of AoPs’ participation, including equity markets, bringing India’s regulatory environment closer to global norms.

Simarjeet Singh is an assistant professor, while Soumyojit Paul and Ritwik Si are students at the Great Lakes Institute of Management, Gurugram. Views are personal.