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Relax restrictions on IDRs

Mallikarjun Bali

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Stringent eligibility norms could be a major stumbling block for foreign companies wishing to join the Indian DepositoryReceipt market.

Indian companies have reached out to the global equity markets in the past by issuing American Depository Receipts(ADRs)/Global Depository Receipts (GDRs). It now appears that the time is ripe for a role reversal. For overseascompanies seeking to raise capital from the Indian stock markets, the Indian Depository Receipt (IDR) mechanismoffers a way to do so.

In the Indian context, a Depository Receipt is referred to as an Indian Depository Receipt. It isn't a new concept. IDRsare transferable securities listed on Indian stock exchanges in the form of depository receipts.

Conceptually, they are to be issued by the issuing company — a foreign corporation desirous of raising capital in theIndian markets through an Indian depository participant. The last mile issuance of the actual instrument is done byan Indian depository participant. The Indian depository participant will issue depository receipts against theunderlying equity shares of the foreign corporation.

Standard Chartered Plc became the first global company to file for issue of IDRs in India. Standard Chartered Bank isthe first and only entity, as of now, to get listed in India through the Indian Depository Receipts (IDR).

IDRs, however, may have lost a little of their sheen after the Securities and Exchange Board of India's (SEBI's)clarification on their conversion into shares.

NORMS ON REDEMPTION

The notification says only companies with a minimum paid-up capital and free reserves of $100 million and anannual turnover of $500 million for three years prior to the issue will be eligible.

The company wishing to issue IDRs should have a five-year profit record, declaring 10 per cent dividend for the saidperiod. The department has fixed the pre-issue debt-equity ratio at a maximum of 2:1.

After the completion of one year from the date of issuance of IDRs, their redemption shall be permitted only if theyare infrequently traded on the stock exchange(s) in India. Pursuant to the terms of the RBI Circular, IDRs aren'tredeemable into underlying equity shares before the expiry of a one-year period from the date of issue of the IDRs.The SEBI Regulations and the RBI Circular state that automatic fungibility of IDRs isn't permitted.

Further, two-way fungibility (the ability to purchase existing shares on the London Stock Exchange and/or theHong Kong Stock Exchange and deposit them into the IDR programme) and automatic aren't permitted.

The IDR norms have also mandated a one-year lock-in period for the redemption of receipts by companies registeredoutside India, capping the issue size at 15 per cent of the company's free reserves.

For starters, dividend tax will be assessed at 30 per cent (plus 10 per cent surcharge) on all the dividends got fromthese IDRs. Investors don't need to pay any dividend taxes on other common stocks in India. The dividend taxes arepaid by the company itself, and then the investor doesn't have to pay any tax on it.

On Indian stocks, the short-term capital gains are charged at 15 per cent plus surcharge; however, in the case ofIDRs, the short-term capital gains will be charged at 30 per cent.

There are no long-term capital gains on stocks in India, but in the case of IDRs, investors will need to pay a 20 percent long-term capital gains plus 3 per cent surcharge on IDRs.

IMPACT OF RESTRICTIONS

The possible consequences of such a move may be that investor interest in IDRs would diminish and would lead themto become illiquid.

7/12/2014 Relax restrictions on IDRs | Business Line

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In the case of Standard Chartered, it could have become eligible for its shareholders to redeem the IDRs, but theannualised trading turnover is estimated to be around half of its listed IDRs, making its investors ineligible forredemptions.

Another question is whether the new norms or rather clarifications related to redemption will become a deterrent forother multinational firms to issue IDRs.

Institutional investors looking for a price arbitrage may not be excited regarding new IDRs, as they can't be possiblysure of meeting the ‘illiquid' criteria for their IDRs to become eligible for redemption. This can certainly be a blow formulti-national corporations which were hoping to float IDRs.

There are several restrictions on IDRs, stemming from India's controls on inflows and outflows of foreign capital.Though Indian citizens are now allowed to own property and invest in overseas securities, these come with limits.SEBI allowing redemption, when fungibility isn't permitted, will lower IDRs under circulation, bringing downliquidity.

The Department of Company Affairs (DCA) has to review and revise the stringent norms for issue and redemption ofIDRs.

CONCERNS

It is clear that India's plan to replicate the ADR and GDR success story has failed to take off due to capital marketregulations, quixotic policies, and their perfunctory implementation.

This also brings to light the want of depth in our equity markets, and the low risk appetite of investors for foreignassets.

As of now, very few companies would like to raise funds from India and gain the first-mover advantage. Unlessremedial measures are taken by Indian regulators on the IDR front, this market is likely to remain inactive for somemore time.

(The author is on the faculty of Bijapur Liberal District Education Association’s Dr. P. G. Halakatti College of Engg &Tech., Department of MBA, Bijapur.)

(This article was published on February 7, 2012)