In recent years, the securities markets have become increasingly international and it has become easier to trade internationally around the world. A growing number of countries have opened their stock markets to foreign investors and abolished laws restricting their citizens from investing abroad. Companies that previously had to raise capital in the domestic market can now tap foreign sources of capital.
Indian companies such as VSNL, MTNL, BPL, etc. have since the mid-90s 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.
As the Indian stock markets have become deeper and with the BSE Sensex now above 17,000, global companies have become interested in tapping the Indian markets for funds.
A recent example is that of the global banking giant Standard Chartered PLC (SCP) which is likely to raise up to $1 billion (over Rs 4,500 crore) through Indian Depository Receipts (IDRs).
SCP is currently in discussions with anchor investors for its IDR issue. The issue is likely to come out in June. The bank had filed a draft red herring prospectus (DRHP) for its IDR with capital market regulator Securities and Exchange Board of India (SEBI) in March 2010.
Indian Depository Receipt (IDR): A Background
An IDR is an instrument denominated in Indian Rupees in the form of a depository receipt created by a ‘Domestic Depository’ (custodian of securities registered with SEBI) against the underlying equity of the issuing company in order to enable foreign companies to raise funds from the Indian securities markets. The receipts are based on a ratio of shares equivalent to depository receipts.
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.
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.
In addition, the regulations state that in the case of raising of funds through the issuance of IDRs by financial/banking companies having a presence in India, either through a branch or subsidiary, the approval of the sectoral regulator(s) should be obtained before the issuance of IDRs. Therefore, the approval of the Reserve Bank of India (RBI) will need to be obtained for the Standard Chartered IDR.
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 would be the first IDR ever undertaken, there will be 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.
Benefits of IDRs for Indian Investors and Rights
--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.
--Additional key requisites for investing in foreign securities such as a securities trading account outside India to hold foreign securities, know your customer norms (KYC) with foreign broker and foreign bank account to hold funds are generally too cumbersome for most Indian investors. Such requirements are avoided in holding IDRs.
--Whatever benefits accrue to the shares, by way of dividend, rights, splits or bonuses would be passed on to IDR holders also, to the extent permissible under Indian law.
Benefits for International Issuers
The main benefit would be in terms of branding, besides allowing foreign companies to access Indian capital. IDRs also allow the creation of acquisition currency and a management incentive tool. Issuers have the option to reserve a proportion of the issue for their employees.
Challenges for IDRs
There is the possibility of IDR issues being undersubscribed if they are not well marketed or fail to catch the imagination of investors. In addition, the challenges mentioned below are certain challenges with respect to the issuance of IDRs.
--Stringent eligibility norms: The stringent eligibility criteria, disclosure and corporate governance norms (Although in the investor’s interests, they compare unfavourably with listing norms on other tier II global exchanges such as Luxembourg, London’s Alternate Investment Market (AIM) and Dubai. This could result in higher compliance costs for companies seeking to tap the Indian capital markets).
--Fungibility: Current regulations do not provide for the exchange of equity shares into IDRs after the initial issuance i.e. reverse fungibility is not allowed.
--Tradability of IDRs: How one trades in the instrument/how the instruments are traded.
--Returns on IDRs: What kind of returns would be made on the instrument.
--Risks: What risks are involved given that the same shares would be simultaneously trading in London and Hong Kong.
--Taxation: Lack of clarity on taxation. It is not clear whether IDRs are exempt from capital gains tax.
--Voting Rights: It is not entirely clear whether IDR holders will have voting rights or not – the SEBI guidelines do not specifically mention voting rights, it leaves that to the discretion of the issuer.
--Market: Indian financial markets are still considered volatile and contain emerging market risk.
Tax issues: Related to IDRs
Indian investors need to consider the tax implications of investment in the IDRs. While Section 605A of the Companies Act, 1956 (the “Companies Act”) discusses IDRs, there are no specific provisions regarding capital gains taxation of IDRs in the Companies Act or in the Income Tax Act, 1961. Therefore, the general rules relating to capital gains taxation apply and no benefits for long term holders of IDRs (ie. if the Securities Transaction Tax is paid, there is no capital gains tax on long term holders of listed securities) are available. It is possible that the upcoming Direct Tax Code may clarify the issue but as of now the capital gains tax treatment of IDRs is not favorable.
Conclusion
IDRs are a significant step towards the internationalization of the Indian security markets which would also be a potential benefit for the domestic investors in India. There remain a number of challenges as detailed above. However, if the Standard Chartered IDR is successful, it may herald a new trend of international companies listing IDRs in India. In the future, India may become a source for capital for international issuers.
(Assisted by Nisha Mallik, Associate, Sand Hill Counsel)