The Securities and Exchange Board of India (SEBI) has taken a firm step toward tightening regulatory standards in the capital markets. In its latest consultation paper, SEBI proposed that all key shareholders must dematerialise their securities before a company files for an initial public offering (IPO). This proposed move targets lingering gaps in the current regulatory framework and aims to eliminate inefficiencies linked to physical shareholding.
What Prompted SEBI’s Proposal?
Despite nearly two decades of reforms, a considerable number of key stakeholders still hold shares in physical form. These include promoters, directors, key managerial personnel (KMPs), senior executives, and even qualified institutional buyers (QIBs). Physical share certificates expose the system to risks such as theft, forgery, and transfer delays. SEBI has identified this issue as a major loophole, especially when companies transition from private to public ownership.
The market regulator recognized that physical shares in pre-IPO holding structures create compliance gaps. These gaps continue to persist even after listing, resulting in complications around disclosures, settlements, and shareholder rights. SEBI intends to close this loophole permanently by expanding the scope of existing regulations.
Who Must Comply With the New Mandate?
SEBI’s proposal includes a wide list of entities and individuals who must convert their holdings into dematerialised form:
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Promoters
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Directors
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Key Managerial Personnel (KMPs)
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Senior Management
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Selling Shareholders
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Qualified Institutional Buyers (QIBs)
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Domestic Employees holding equity
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Shareholders with special rights under shareholders’ agreements
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Regulated entities including NBFCs, stockbrokers, and others
SEBI’s intent here is clear: every stakeholder with a material interest or strategic role in the company’s IPO must come under a transparent, electronic holding structure before filing the IPO draft offer document.
How Will This Strengthen Market Integrity?
Dematerialisation removes several pain points associated with physical shares. SEBI emphasized that physical certificates can get lost, damaged, forged, or stolen. Settlement of trades involving physical certificates also takes more time, increasing systemic risks.
With mandatory demat holdings for all key shareholders, SEBI can ensure the following:
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Greater Transparency:
Every holding becomes visible through electronic records, reducing ambiguity around shareholding patterns. -
Faster Settlements:
Demat shares can be transferred swiftly and securely through depositories like NSDL and CDSL, improving liquidity and investor trust. -
Improved Regulatory Oversight:
SEBI and stock exchanges gain better visibility into insider holdings, pledge transactions, and potential violations. -
Lower Operational Risk:
Electronic records eliminate the chance of misplacement, fake certificates, and fraud linked to physical shares.
Regulatory Evolution: The Push Toward Demat
SEBI and the Ministry of Corporate Affairs (MCA) started encouraging dematerialisation over two decades ago. Since 2000, they have introduced nearly ten separate mandates to promote or enforce the shift from physical to demat shares. Still, gaps remain—especially in the pre-IPO phase.
Currently, Regulation 7(1)(c) of the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations) requires promoters to hold shares in demat form before filing an IPO. However, other key shareholders—including those with substantial economic interest—could continue holding physical shares. This mismatch created a regulatory blind spot.
To resolve this issue, SEBI proposed expanding Regulation 7(1)(c) to include all stakeholders mentioned in the new framework. This expansion ensures uniform compliance and removes differential treatment between promoter and non-promoter shareholders.
Implications for Companies Planning an IPO
Companies that plan to go public must now prepare for more stringent compliance. Before filing the Draft Red Herring Prospectus (DRHP), companies will need to:
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Verify that all strategic and financial stakeholders hold their equity in demat form
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Work with depositories to convert physical holdings into electronic form
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Update shareholding disclosures to reflect dematerialised records
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Include a certification on compliance with the expanded Regulation 7(1)(c)
Failing to meet these requirements will delay the IPO process or result in regulatory red flags during SEBI’s review of offer documents.
Impact on Stakeholders
Promoters and Directors
Promoters and directors will face no major disruptions since SEBI already requires them to hold demat shares before IPO filing. However, the regulator now expects them to take proactive steps to ensure other key members also comply. Companies must not wait until the last moment to initiate dematerialisation.
Key Managerial Personnel (KMPs) and Senior Executives
KMPs and senior executives often receive equity as part of their compensation. If these shares exist in physical form, they must convert them into demat format. Companies will need to assist employees by facilitating the KYC and demat account creation process.
Qualified Institutional Buyers (QIBs) and NBFCs
Although QIBs and NBFCs are already well-integrated with the securities ecosystem, any legacy holdings or special investment vehicles with physical shares must now regularize their records. These entities usually manage compliance efficiently, but the new rule will still require verification and documentation.
Employees and ESOP Holders
Employees who received shares under ESOPs or incentive plans must also ensure their equity gets dematerialised. Startups and mid-sized companies must educate their workforce about this transition and extend support through internal compliance teams or legal advisors.
Challenges and Considerations
Although the move strengthens market infrastructure, some stakeholders may face practical challenges:
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Legacy Structures: Older companies may have complex shareholding structures with physical certificates distributed across family offices or small investors.
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Demat Account Penetration: Some stakeholders, especially in tier-II and tier-III cities, may not have demat accounts or face documentation challenges.
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Timeline for Conversion: SEBI must offer reasonable timelines and implementation windows for companies to comply without disrupting their IPO schedules.
SEBI may consider phased implementation or provide limited exemptions in genuine hardship cases, but the overall direction remains firm: full dematerialisation across the board.
Conclusion: A Stronger, Cleaner IPO Pipeline
SEBI’s latest move to mandate dematerialisation for a wider circle of IPO-related shareholders marks a critical milestone in India’s capital market reform. By tightening Regulation 7(1)(c), SEBI eliminates regulatory blind spots and strengthens investor protection. Companies, employees, and institutional players must now align themselves with this forward-looking framework.
Dematerialisation isn’t just a compliance exercise—it represents a foundational shift toward transparency, efficiency, and accountability. With this proposal, SEBI has signaled its commitment to a cleaner, more trustworthy IPO ecosystem. Companies planning to go public in 2025 and beyond must prepare early, streamline their cap tables, and embrace the digital transformation of ownership.
