INDIAN DEPOSITORY RECEIPTS

India’s economic growth story is now familiar with a comfortable foreign exchange reserve of over US$200 billion. In this context, if a foreign company wants to raise money in the Indian stock market how should it go about doing it? The best possible option would be the Indian Depository Receipts (IDRs). IDRs are basically financial instruments that allow foreign companies to mobilize funds from Indian markets by offering equity and getting listed on Indian stock exchanges. IDRs are certificates that represent the shares of a foreign stock. This instrument is similar to the GDRs and ADRs that allow foreign companies to raise funds from European and American markets. The objective of introducing this provision is to provide Indian investors with one more alternative to acquire a share of the global pie as well as to allow global companies to access funds at cheaper cost.

The Depository Receipts would be listed on stock exchanges in India and would be freely transferable. The actual shares underlying the IDRs would be held by an Overseas Custodian, which shall authorize the Indian Depository to issue the IDRs. The Overseas Custodian is required to be a foreign bank having a place of business in India and needs approval from the Finance Ministry for acting as a custodian while the Indian Depository needs to be registered with SEBI.

Issuers Eligibility Criteria

·         Must have an average; turnover of US$ 500 million during the previous 3 financial years.

·         Must have capital and free reserves which must aggregate to at least US$100 million.

·         Must be making a profit for the previous 5 years and must have declared a dividend of 10% in each such year.

·         The pre issue debt-equity ratio must be not more than 2:1.

·         Must be listed in its home country.

·         Must not be prohibited by any regulatory body to issue securities

·         Must have a good track record with compliance with securities market regulations.

·         Must comply with any additional criteria set by SEBI

·         In one financial year the market cap cannot exceed 15 % of the paid up capital and free reserves of the issuer

·         Redemption into underlying shares is prohibited for 1 year, beginning the issue

Who can Invest?

·         Indian Companies

·         Qualified Institutional Buyers

·         NRI’s and FII’s with permission of the Reserve Bank Of India.

The Issue

·         The minimum issue size is Rs. 50 crores,

·         90% of the issue must be subscribed.

·         Automatic fungibility is not permitted.

Indian depository receipt is a significant step towards internationalization of Indian security markets which can be a potential benefit for the domestic investors in India. However, various safeguards and monitoring mechanisms have to be in place to address investor protection and interests of security markets in India.

Benefits to key stakeholders

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. 

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. Also no resident individual can hold more than $200,000 worth of foreign securities, including shares, as per foreign exchange regulations. However, this will not be applicable for IDR. Besides, these additional key requisites such as demat account outside India to hold foreign securities, KYC with foreign broker, foreign bank account to hold funds are too cumbersome for most investors. These troubles are completely avoided in holding IDRs.

Employees: Foreign companies which do not have a listed subsidiary in India can give employee stock options to the employees of their Indian subsidiaries through the IDR route. This will enable the local employees to participate in the parent companies’ success.

Regulator: IDRs will lead to more liquid capital markets and a continuous improvement in regulatory environment, thereby increasing transactional revenues for the regulator. 

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:

Stringent eligibility norms: The stringent eligibility criteria, disclosure and corporate governance norms, though in the investor’s interests, are unfavorable compared to the listing norms on other global exchanges such as Luxembourg, London’s Alternate Investment Market and Dubai. This results in higher compliance costs for mid-sized companies seeking to tap the Indian capital markets.

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.

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. Currently IDRs are treated at par with shares for taxation purpose till the new tax code comes into effect in 2011.

Indian Financial Markets still quite volatile: Developed countries have less political flux, which lends stability to their financial markets. Indian markets are perceived to be rumor driven which leads to heightened volatility making it an unattractive investment proposition.