There is no doubt that India has one of the most comprehensive laws addressing capital and financial markets. Moreover, there is enough depth in the Indian markets to attract substantial investor interest for IDRs. But the lack of a favourable regulatory environment (including legal framework and regulations) ease of access, stability of policies and full capital account convertibility are short term hindrances to the growth of IDRs in India. Certain favorable steps by the market regulator in India (SEBI) like amendment of the takeover regulations, offer of facility of anchor investors to IDR issues and a decision to reserve about 30 % of the issue for allocation to retail investors (who may otherwise be crowded out) has increased the attractiveness of such issues. This seems to have started catching attention of global behemoths; Standard Chartered Bank has got approval from the Indian regulator to raise Rs 50 billion through an IDR issue in this financial year. It will be interesting to see if this will herald the entry of other foreign companies in the IDR market.
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The internationalization of securities markets has driven a large number of countries - both developed and developing - to open their stock markets to foreign investors and relax laws restricting their citizens from investing abroad. Indian security markets are taking an active role in this metamorphosis.
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Cross Listing: Developed globally, emerging in India
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The principal mechanism that produces competition among market centres has been the issuer’s decision to cross-list its stock on a foreign exchange. Cross listing on an exchange is usually effected by the issuer first establishing a depository receipts facility (typically, with a major bank). The bank will hold shares of the foreign issuer and issue depository receipts to investors, who will thereby achieve the convenience of denominated trading. These depository receipts then may (or may not) be listed on a Stock exchange. The success of American Depository Receipts (ADR) and Global depository receipts (GDR) has increased the popularity of cross-listings in securities markets.
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In keeping with India’s ongoing popularity as a preferred investment destination among international entities and India’s aspirations to become a financial hub in the South Asian region, the Union government has consistently introduced and modified various instruments through which investments can be made. The year 2004 saw the introduction of Indian depository receipts (IDRs), an Indian counterpart of GDRs and ADRs. The aim was to provide a platform to foreign companies to directly raise capital in India rather than take recourse to GDRs/ADRs and to improve the liquidity in the secondary market in India.
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A foreign company can issue shares to an Indian depository, which then issues depository receipts to investors in India. The shares underlying the IDRs are held by an overseas custodian, which authorises the Indian depository to issue the IDRs against such shares. These rupee-denominated depository receipts are listed on stock exchanges in India and are freely transferable.
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The issue and operation of IDRs are governed, primarily, by the Companies (Issue of Indian Depository Receipts) Rules, 2004 and the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009. RBI has operationalised IDRs under the exchange control regime.
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Benefits to key stakeholders
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Foreign companies: Any foreign company listed in its home country and satisfying the eligibility criteria can issue IDRs. A company which has significant business in India can increase its value through IDRs by breaking down market segmentations, reaching trapped pools of liquidity, achieving global benchmark valuation, accessing international shareholder base and improving its brand’s presence through global visibility. Also, differences in tax structure, regulatory restrictions and informational constraints between the countries may also help in creating economic benefits. Similarly, the foreign entities of Indian companies may find it easier to raise money through IDRs for their business requirements abroad.
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Investors: IDRs can lead to better portfolio management and diversification for investors by giving them a chance to buy into the stocks of reputed companies abroad.
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Employees: Foreign companies which do not have a listed subsidiary in India can give employee stock options (ESOPs) to the employees of their Indian subsidiaries through the IDR route. This will enable the local employees to participate in the parent companies’ success. For Example, Microsoft USA may want to give ESOPs to employees of Microsoft India, which is not listed in India, by floating an IDR for Microsoft USA and earmarking a percentage of the same for its Indian employees.
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Regulator: IDRs will lead to more liquid capital markets and a continuous improvement in regulatory environment, thereby increasing transactional revenues for the regulator.
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Why have IDRs not taken off?
In spite of all the benefits, IDRs have not really taken off. Some of the reasons for this lack of interest in IDRs are:
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Stringent eligibility norms: The stringent eligibility criteria, disclosure and corporate governance norms, though in the investor’s interests, compare unfavorably with listing norms on other tier II global exchanges such as Luxembourg, London’s Alternate Investment Market and Dubai. This could result in higher compliance costs for mid-sized companies seeking to tap the Indian capital markets.
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No automatic fungibility, no arbitrage opportunities for investors and issuers: The GDR/ADR holders enjoy two-way fungibility option (conversion of GDR/ADR into underlying shares and vice versa) while investors in IDRs can exercise the option only after one year (as per regulation). Even after one year, retail investors are required to sell off the shares obtained by redemption in the foreign stock exchange where they are listed. Two-way fungibility enables an investor to benefit from any arbitrage opportunities arising due to exchange rate fluctuations or quotation differences on the two stock exchanges. An IDR investor is denied of this opportunity.
Also, the issuer is required to immediately repatriate the rupee funds through IDR proceeds back to the home country. By not allowing them to park their rupee funds in India, they cannot take advantage of any interest arbitrage opportunity. Also, given the fact that rupee is not a floating currency, it would entail conversion into dollars or other hard currency and then being repatriated. This would exert pressure on the rupee.
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Lack of clarity on taxation issue: It is not very clear whether IDRs are exempt from capital gains tax; this could be a potential roadblock. As per current Income tax laws, securities which are held for more than 1 year are exempt from capital gains tax and for less than 1 year tax is 15%. Treating IDRs at par with shares for taxation purpose till the new tax code comes into effect in 2011 will help promote IDRs.
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Indian Financial Markets still quite volatile: Developed countries have less political flux, which lends stability to their financial markets. Also, Indian markets are perceived to be rumour driven which leads to heightened volatility.
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Nikhil Khandelwal & Ashish Rathi are currently pursuing the post graduate program in management at ISB. The opinions expressed are entirely the personal opinions of the students, formed on the basis of facts and data available in the public domain. The ISB, as an institute, does not subscribe to these views in whole or in part.