Indian Depository Receipts

 

Introduction

The past decades have witnessed the increased internationalization of various firms through cross listings on international exchanges. This internationalization has been supported by the process  of market liberalization, which has led to greater integration of global securities markets. Cross-border listing  by the various companies has become one of the important  avenues for the integration of global securities markets. There  are  namely direct listing and indirect listing as  two forms of cross-border .  The meaning of the direct listing implies that the firm concerned offers ordinary shares to the public while on the on the  other hand Indirect listing on exchanges is through Depository Receipts (DRs).  The concept of Indian Depository Receipts (IDRs) were introduced for the listing of foreign companies on Indian stock exchanges in order to attract Indian investors. The IDRs are freely priced[1]

In recent years  due to internationalization  of the security market and it has become easier to trade at international level.  Various countries  have  abolished the law  restricting their citizen to invest  in other countries  and opened their  stock markets  to foreign investors.  Companies can now tap foreign sources of capital Companies  previously had to raise capital only  in the domestic market.  Since the mid-90s  Indian companies like MTNL,  VSNL,  BPL have listed American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) in London, Luxembourg and New York to raise funds from international sources. The trend now is moving the other way round  because global companies have become interested in tapping the Indian markets for funds  as the Indian stock markets have become deeper.  A recent example is that of the global banking giant Standard Chartered PLC (SCP) which  had to raised up to $1 billion (over Rs 4,500 crore) through Indian Depository Receipts (IDRs).[2]

IDR stands for Indian Depository Receipts. An IDR is a means for a foreign company to raise money in India . An IDR is a depository receipt denominated in Indian rupees issued by a domestic depository in India. Much like an equity share, it is an ownership pie of a company. Since foreign companies are not allowed to list on Indian equity markets, IDR is a way to own shares of those companies Here  foreign companies would issue shares  to an Indian Depository which would in turn issue depository receipts (IDR) to investors in India and the actual  possession of shares underlying the IDRs would be held by an Overseas Custodian, which shall authorize the Indian Depository to issue the IDRs.[3].

As per the definition given in the Companies (Issue of Indian Depository Receipts) Rules, 2004, IDR is an instrument in the form of a Depository Receipt created by the Indian depository in India against the underlying equity shares of the issuing company[4].These IDRs are listed on Indian stock exchanges. You need not take the trouble of taking your money abroad yourself, but can invest rupees into the international companies that have now begun to come at your doorstep[5].

Earlier position

The  RBI has allowed investments in international equity instruments up to $200,000 (Rs94.8 lakh). Since you need to have  a bank account with funds in the same country™s currency and  a demat account in the country in which you invest,  it may turn out to be a cumbersome process[6]. Another alternative is to go  to domestic mutual fund (MF) that invests its corpus abroad in a foreign fund, which invests in international companies or directly in scrips.  But  mutual funds  are directly affected by currency-exchange risk because your investments in Indian rupees are converted into global currencies before they are deployed in the international markets. The recent winding up of Franklin India International Fund, a feeder fund that invested in US government securities, besides underperformance by several other international funds over the past three years, shows that these funds are fraught with exchange-rate and global market risks[7].

 

IDR Issue Process

Eligible companies resident outside India are allowed to issue IDRs through a Domestic Depository pursuant to Circular No. SEBI / CFD / DIL / DIP / 20 /2006 / 3 / 4 dated April 3, 2006 and the provisions of Issue of Capital and Disclosure Requirements (ICDR) Regulations 2009 (which replaced the SEBI (Disclosure and Investor Protection) Guidelines, 2000). In addition, the Circular and the ICDR Regulations 2009, permit persons resident in India and outside India to purchase, possess, transfer and redeem IDRs[8]. Qualifying companies resident outside India issue IDRs through a Domestic Depository subject to compliance with the Companies (Issue of Depository Receipts) Rules, 2004 and subsequent amendments made thereto and the ICDR Regulations, 2009 . The SEBI guidelines permit only those companies listed in their home market for at least three years and which have been profitable for three of the preceding five years to make IDR issues.   As the issuance of the IDR by SCP is   the first IDR ever undertaken, there  are   a number of challenges including the structure of the instrument, how one trades in it, what kind of returns can be made on the instrument, and what are the risks involved.[9].

According to SEBI guidelines, IDRs will be issued to Indian residents in the same way as domestic shares are issued. The issuer company will make a public offer in India, and residents can bid in exactly the same format and method as they bid for Indian shares. The issue process is exactly the same: the company will file a draft red herring prospectus (DRHP), which will be examined by SEBI. The general body of investors will get a chance to read and review the DRHP as it is a public document, available on the websites of SEBI and the book running lead managers. After SEBI gives its clearance, the company sets the issue dates and files the document with the Registrar of Companies. In the next step, after getting the Registrar™s registration ticket, the company can go ahead with marketing the issue. The issue will be kept open for a fixed number of days, and investors can submit their application forms at the bidding centers. The investors will bid within the price band and the final price will be decided post the closure of the Issue. The receipts will be allotted to the investors in their demat account as is done for equity shares in any public issue. On 256th October 2010, SEBI notified the framework for rights issue of Indian Depository Receipts (IDRs). Disclosure requirement for IDR rights would more or less be in line with the reduced requirement applicable for domestic rights issue[10].

 

Legal frame work for  IDR

Statutes Governing IDRs are given as below:

• Section 605A of the Companies Act, 1956
• Companies (Issue of Indian Depository Receipts) Rules 2004
• Chapter VIA of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009

The Government  of India has taken steps to liberalize India™s corporate and securities laws to permit foreign companies to raise capital in India. As  we know that the ADR and GDR became popular globally, the Indian Government amended the Companies Act, 1956 by implementing Section 605-A which permits a foreign company to make a public offer of its shares to Indian investors in the form of IDRs . It  gives the Central Government the power to create the rules, regulations and conditions governing:

• The offer and issue of IDRs by a foreign company;
• The rules and regulations governing the treatment of IDRs by the Depository, Custodian and Underwriters;
• The disclosure requirements in the prospectus issued for IDRs;
• The manner of sale, transfer or transmission of IDRs in the stock exchanges.

In 2004, the IDR Rules were introduced and set the framework for the issuance of IDRs.

Eligibility for  Issue of IDRs.-

According to  Rule 4 , an issuing company may issue IDRs only if it satisfies the following conditions:-

• it has had an average turnover of US$ 500 million during the 3 financial years preceding the issue.

• Its pre-issue paid-up capital and free reserves are at least US$ 100 millions
• Its pre-issue debt equity ratio is not more than 2:1.
• It has been making profits for at least five years preceding the issue and has been declaring dividend of not less than 10% each year for the said period.
• It shall fulfill the eligibility criteria laid down by SEBI from time to time in this behalf.

Other condition of the  issuing  IDR are given under  Rule 6  of the same rules. These are given as below:

  

      Other conditions for the issue of IDRs[11].-

•  IDRs shall not be redeemable into the underlying equity shares before the expiry of one year period from the date of the issue of the IDRs.
• The repatriation of the proceeds of issue of IDRs shall be subject to laws for the time being in force relating to export of foreign exchange.
•  IDRs issued by any issuing company in any financial year shall not exceed 15 per cent of its paid-up capital and free reserves.
• The denomination of securities of an issuing company, the IDRs issued  it shall be denominated in Indian Rupees.

 

Furthermore, the SEBI has  introduced of SEBI (Disclosures and Investor Protection) Guidelines, 2000 (DIP Guidelines)  which have recently been replaced by the by SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (ICDR Regulations). Afterwards various amendments have been made in the regulatory framework of IDRs which renders clarity on the exchange control implication for investment in IDRs  such as the recent Circular dated July 22, 2009 (RBI Circular) issued by the RBI, the exchange control regulator in India,

 According to  Regulation 97  of ICDR , an issuing company making an issue of IDR shall also satisfy the following:

• the issuing company is listed in its home country;
• the issuing company is not prohibited to issue securities by any regulatory body;
• the issuing company has track record of compliance with securities market regulations in its home country.

 

 

 Case Study  : Standard Chartered Plc

The first Indian Depository Receipt (IDR) was that of Standard Chartered Plc.  which come into existence on  May 13, 2010. This was done to boost the company™s market visibility and brand perception in India. There was an issue of 240 million IDRs where every 10 IDRs represented one share of StanChart. The company is already listed on the London and Hong Kong stock Exchanges. Standard Chartered CEO Peter Sands is quoted in the Indian media as saying the “IDR listing is to enhance StanChart’s commitment to India.[12] The StanChart IDR issue was opened for subscription on May 25, 2010 until May 28, 2010. Though the price band of the IDR was between INR 100 and INR 115, most of the bids were between INR 100 and INR 104. The bank issued 240 million IDRs including the anchor investor™s share of 36,000,000 IDRs . The total number of bids received at the NSE and the BSE were 312,025,000 and 137,680,000 IDRs, respectively, while the total number of bids received at cut-off price was 15,033,200. At the BSE, the IDR issue of StanChart was subscribed 2.2 times, while at the NSE, the issue was subscribed 1.53 times[13].

Problem   faced by the   Standard Chartered PLC™s

Problems faced by Standard Chartered during the issue as  are given below[14]:

1 )  The pricing and price movement in IDRs was directly linked to the share price of StanChart in the London Stock Exchange; this led to apprehension because any slowdown in the European economy would in turn affect the valuation of the bank, which would hamper its price movement in IDRs.

2 )  The two risks faced by StanChart were:

¢ Interest rate risk due to short term borrowing to fund long term assets; and

¢ Currency risk due to the strengthening of the US Dollar vis-à-vis local currencies in the countries of its presence.

3 ) Tax issues

The IDRs opened at the Bombay Stock Exchange and National Stock Exchange on June 11. There is also problem related tax issue as to how it will be taxed.[15]

 

Advantages  of the IDR

Benefits to the Issuing Company

• It provides access to a large pool of capital to the issuing capita
•  It gives brand recognition in India to the  issuing company
•  It  facilitates acquisitions in India
• Provides an exit route for existing shareholders

Benefits to Investors

•  It provides portfolio diversification to the investor
•  It gives the  facility of ease of investment
•   There  is  no need to know your customer norms.
• No resident Indian individual can hold more than $200,000 worth of foreign securities purchased per year as per Indian foreign exchange regulations. However, this will not be applicable for IDRs which gives Indian residents the chance to invest in an Indian listed foreign entity.

 

Issues related to  IDRs

There are various challenges  before the IDR  which are given as below[16] :

 

• Returns on IDRs

What kind of returns would be made on the instrument of IDR  it is not certain.

 

• Taxation

There is  lack of clarity  on  the  point  of taxation.  It is not  clear whether IDRs are exempt from capital gains tax.  According to the Section 10(38) of the Income-tax Act  which  exempts income arising from transfer of long-term capital asset being equity share or a unit of an equity-oriented fund on which securities transaction tax (˜STT™) has been paid. Further short-term capital gains arising on transfer of equity shares in a company or a unit of an equity-oriented fund are taxed at the concessional rate of 15%, plus applicable surcharge and education cess  under section 111A of the Income-tax Act  Based on the current provisions of Chapter VII of the Finance (No.2) Act, 2004, pertaining to STT, IDRs should not be subject to STT. Accordingly, the corresponding exemption from long-term capital gains tax under section 10(38) of the Income-tax Act and the concessional tax rate for short-term capital gains under section 111A of the Income-tax Act will not be available to IDR Holders on transfer of IDRs[17] There are no specific provisions regarding capital gains taxation of IDRs in the Companies Act o r in the Income Tax Act, 1961.  Therefore, the general rules relating to capital gains taxation apply and no benefits for long term holders of IDR.

 

• Risks: What risks are involved given that the same shares would be simultaneously trading in London and Hong Kong

 

 

 

•  Undersubscribed

If they are not well marketed or fail to catch the imagination of investors so there  is  the possibility of IDR issues being undersubscribed .

 

• Stringent Eligibility Norms

The strict  listing norms and  eligibility criteria  for foreign issuers, has been criticized greatly. Such strict norms regarding disclosure and corporate governance are in the interest of the investors; however, if we compare the norms in India with those in other emerging markets, it becomes apparent that such stringent norms are unfavorable, and would make IDRs unpopular among foreign issuers[18]. Stringent norms can be higher compliance cost, which discourages mid-sized companies from entering the Indian market and includes the stringent eligibility criteria, disclosure and corporate governance norms.

 

• Fungibility

The Indian depository Receipts shall not be automatically fungible into underlying equity shares of issuing company. IDR Holders can convert IDRs into underlying equity shares only with the prior approval of the Reserve Bank of India (RBI). Upon such exchange, individual persons resident in India are allowed to hold the underlying shares only for the purpose of sale within a period of 30 days from the date of conversion of the IDRs into underlying shares. Current regulations do not provide for exchange of equity shares into IDRs after the initial issuance i.e. reverse fungibility is not allowed[19].

As per this aspect is concern the  Rule 10 of the Companies (Issue of Indian Depository Receipts) Rules, 2004 deals with the procedure for the transfer and redemption of IDRs. As per this rule, a holder of IDRs may transfer the IDRs or may ask the Domestic Depository to redeem these IDRs, subject to the provisions of the Foreign Exchange Management Act, 1999 and other laws for the time being in force. [20]The RBI™s circular dated July 22, 2009 prohibited automatic fungibility of IDRs: IDRs shall not be redeemable into underlying equity shares before the expiry of one year period from the date of issue of IDRs. Further, as per Regulation 100 of Chapter X of the SEBI (ICDR) Regulations, IDRs shall not be automatically fungible into underlying equity shares of issuing company. The extant regulatory framework does not permit fungibility, and allows only redemption[21].

Voting Rights : It is not certain that whether IDR holders will have voting rights or not .The SEBI guidelines do not expressly mention voting rights  in favour of  IDR holder  it leaves that to the discretion of the issuer.

Other constraints

• Insurance companies are not allowed to invest in IDRs.
• Another factor could be the lack of advertising of IDRs. . Any new product needs aggressive advertising to make it popular, which was overlooked by the Indian exchanges. The IDRs were not marketed aggressively by Indian exchanges. Depositary receipts like  ADR  , GDR  have offices in various countries, and these offices market their instruments. Implementing these two changes will make the IDR a more popular instrument[22].

 

Dividend Distribution tax be payable on dividend on IDRs

Under the Income-tax Act, dividends declared by an Indian company (or any other company which has made the prescribed arrangement for the declaration and payment of dividends in India ), shall be subject to a dividend distribution tax payable by the company. Such dividends shall then be exempt from tax in the hands of the shareholder under section 10(34) of the Income-tax Act.[23]

This exemption from dividend income under section 10(34) is not applicable to dividends paid to IDR Holders and accordingly, the dividends received by the IDR Holders in India shall be taxable in the hands of the IDR Holders.[24]

 

Need of  an  IDR

The  concept of the  IDR is meant to diversify your holdings across regions to free  from a region bias or the risk of a portfolio getting too concentrated in the home market.   One   has to study the firm™s financial condition  before you buy its IDR so that  one can not be defrauded  or misreprentated. Since these IDRs are listed, bought and sold on the Indian markets, the impact of global markets and exchange-rate risks are reduced, though not totally eliminated.

 

Conclusion

 

IDRs are a important step towards the internationalization of the Indian security markets which would also be a  possible benefit for the domestic investors in India. There  are number of challenges as  discussed above .  To ensure the success of IDRs, India needs to first focus on a smaller region, and then move to the global market depending on its initial success.  There  are various obstacles prevent the issue of IDRs by foreign companies in India, such as tax issues , strict  eligibility criteria . Indian laws relating to capital markets are highly comprehensive so this also one of the problem faced by the IDR. In order to a attain the status of a favourable issuer destination, capital markets, especially emerging markets such as India, need to adopt issuer-friendly regulations, without compromising on investor protection. Strict regulations are required to a certain extent, in order to regulate the market. Though, this may lead to a decrease in the confidence of the issuers.  So, capital markets should adopt a middle path wherein regulations are strong enough to ensure investor protection and  do not deter issuer participation .

Companies in  India  have reached out to the global equity markets in the past by issuing  ADR and GDR .It now appears that the  it  is high  time   for a role reversal.  the Indian Depository Receipt (IDR) mechanism offers to  overseas companies seeking to raise capital from the Indian stock markets .With the introduction of the IDR regime, not only it has advanced  an additional avenue for foreign companies to raise capital in India, but also, an additional flexible route for Indian investors to invest in global corporations. So we can say that  IDRs are a important step towards the  globalization  of the Indian security markets which would also be  benefit for the  investors in India.

 

Kirti  Singh

LL.M  Second Year

NLSIU, Bangolore