Every time an investor buys a share on a mobile app, a silent chain of activity ensures that the security lands safely in a digital account. Many people now track the NSDL Share Price after the much-discussed public listing of that institution, because it opened a rare window into the business of market plumbing. Others follow the CDSL Share Price as a long-standing example of how a listed depository can grow alongside the retail investing wave. To appreciate why these companies matter, one must first understand what they actually do.
From Paper Certificates to Digital Holdings
A few decades back, owning shares used to involve storing paper share certificates in a drawer. There was scope for loss, forgery, destruction, and delays during transfer. It could take weeks before a trade gets settled. With the advent of dematerialisation, shares are stored electronically, like money in a bank account, without the need for physical certificates.
The entities that maintain these electronic records in a depository are called depositories. They act as custodians for investors. They don’t trade in shares or provide advisory. They keep the records of ownership safe, and ensure that whenever a trade happens, the title to the shares gets transferred to the buyer
Let me explain the process with a hypothetical example. Let’s say I buy a share from someone. The stock exchange finds a counterparty for me and executes the trade. The clearing corporation works out the settlements. Finally, the depository ensures that the share gets credited into my account (through a participant, in this case my broker or bank). This process of settlement only works because the depository keeps proper books, and there is an enforceable set of rules. The depository model allows millions of daily transactions to happen seamlessly. By doing this, the depository essentially acts as a trusted third party that enables the smooth functioning of the capital markets.
Why is this business special? Let’s dissect some of the characteristics of such a market infrastructure company that make it desirable for an investor. First and foremost, they have certain business moats
As a market infrastructure company, their moats include the high barriers to entry due to licensing and the need for huge investments in technology and trust. Next, there is little competition as there are only a handful of such depositories in the country, giving them significant pricing power. Finally, while their revenues are tied to the performance of the market, they are insulated from the performance of individual companies as they earn fees for processing transactions. It doesn’t matter if the Nifty 50 goes up or down, investors will continue to buy and sell shares, and the depository profits from the volumes.
A depository is a type of market infrastructure company that has certain regulatory guardrails around it, prescribed by the Securities and Exchange Board of India. The regulator sets the parameters for dispute resolution, pricing, investor protection, cybersecurity, and governance for the companies.
Being a depository is good, but it also comes with its own risks. The rules around the depository business are constantly changing. Any change in regulation could impact the way the company makes money. For instance, the regulator could decide to change the fee structure. So, it is important for an investor to stay updated with the latest circulars and consultation papers shared by the regulator. The regulation helps create a good business, but good regulation rarely protects investors from bad valuations at the purchase price.
A lot of investors look at a company with a wide moat and assume that it is a great buy at any price. This couldn’t be further from the truth. Most quality companies see their valuation multiple expand based on positive expectations about the future. It is important to assess if you are buying the company at a reasonable price, based on the earnings power, and the trajectory of future earnings. While discussing the business model, it might help to look at revenues, expenses, and the drivers of each. It is vital to analyse the proportion of revenue from initial public offering listing fees and ongoing maintenance charges. Analysing the shareholding pattern, and the historical performance on revenues, costs, margins, and payout ratios could give you an idea of the future trajectory.
It is a good idea to invest in market infrastructure companies only as a small part of a large portfolio. While an investor should always invest in something that they understand, it is a good idea to have a diversified portfolio that includes several companies from different sectors that have a wide moat and a sustainable earnings model. A single position in a company, no matter how well-researched, could prove to be a drag on the overall portfolio if sold at a loss or if the projected earnings do not materialise.
To wrap up, I’d like to restate the importance of such companies to the average investor. As the number of demat accounts increases in the country, and as people become more aware of the benefits of investing in the capital markets, the overall value of the depository keeps growing. More and more Indians are moving their money from physical certificates to digital accounts, and a large amount of securities are getting dematerialised every year.
As always, a good story doesn’t eliminate risk. While it is important to understand the business model and the potential drivers for growth in such a company, it is equally important to understand the risks that come with such a business. Always read the fine print, and do your due diligence before making an investment decision.
