INDIAN DEPOSITORY RECEIPTS INDIAN DEPOSITORY RECEIPTS Cross Listing: Developed globally, emerging in India

The principal mechanism that produces competition among market centers has been the issuers decision to cross-list its stock on a foreign exchange. The success of American Depository Receipts (ADR) and Global depository receipts (GDR) has increased the popularity of cross-listings in securities markets. In keeping with Indias ongoing popularity as a preferred investment destination among international entities and Indias 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.

What are Indian Depository Receipts (IDRs)?

IDRs are like ADRs or GDRs, except that the issuer is a foreign company raising funds from the Indian market. IDRs are rupee-denominated and created by a domestic depository against the underlying equity shares of a foreign company.

Who can issue IDRs?

The following are required of any company intending to make a public issue in India: Any company listed in the country of incorporation can issue IDRs. The issuer needs pre-issue capital and free reserves of at least $50 million (around Rs 225 Crores). The issuer should have market capitalization of $100 million (Rs 450 Crores) or more. The company should have also made profits in three of the preceding five years. It should have an average turnover of $ 500 million during the last three years. The pre-issue debt equity ratio of such company should not be more than 2:1.

INDIAN DEPOSITORY RECEIPTS How will it work or what is the issue process?
The process is similar to an IPO where a draft prospectus is filed with the SEBI. The minimum issue size is $500 million (around Rs 2,250 crore). Shares underlying IDRs will be deposited with an overseas custodian who will hold shares on behalf of a domestic depository. IDRs will be issued through a public offer in India in the demat form and will be listed on Indian exchanges. Trading and settlement will be similar to those of Indian shares.

What are the Reservations in IDR issues?

According to current regulations regarding the allocation is as follows At least 50% of the Issue is to be allocated to qualified institutional buyers (QIBs). 30% of the issue to the retail individual investors. Balance 20% of the issue to non-institutional investors and employees. The ratio of noninstitutional investors and employees is at the discretion of the company to decide. Note: Recently, the regulators allowed a single institutional investor to acquire up to 15 per cent of the issue size. In addition, banks have also been allowed to participate. The issue will fail if the company does not get QIB investors to the extent of 50% of the issue size.

What are the benefits to key shareholders?

Foreign companies: 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 brands 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. 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.

INDIAN DEPOSITORY RECEIPTS

Employees: Foreign companies that 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. 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 investors interests, compare unfavorably with listing norms on other tier II global exchanges such as Luxembourg, Londons Alternate Investment Market and Dubai. This could result in higher compliance costs for mid-sized companies seeking to tap the Indian capital markets. No automatic fungibility: The GDR/ADR holders enjoy two-way fungibility option while investors in IDRs can exercise the option only after one year. 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. No Interest & exchange rate arbitrage opportunity: 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. Lack of clarity on taxation issue: IDRs are not subject to securities transaction tax. Besides, dividends received by IDR holders will not be subject to dividend distribution tax. But, at present, exemption from long-term capital gains tax and concessional short-term capital gains are not available for secondary sales on the stock exchanges. However, the issue is expected to be resolved with the implementation of the Direct Tax Code.

INDIAN DEPOSITORY RECEIPTS Who is the first issuer?

Standard Chartered Bank plans to raise at least $1 billion through an IDR. It is currently in discussions with anchor investors for its IDR issue. The issue is likely to come out in May/ June. The bank had filed a draft red herring prospectus (DRHP) for its IDR with SEBI in March 2010. SCB has the largest presence among foreign banks in the country with over 80 branches. In addition, lenders Indian unit is also the second-biggest contributor to group profit at 21%. The phenomena of cross listings hypothesis may entail practical implications for both issuers and investors in IDRs. The important implications for policymakers in India, is that a comprehensive study of the Indian situation is required for developing an understanding regarding the developing ramifications which IDRs will entail upon our securities market. Many factors are simultaneously at play, and the environment intertwines complex financial and legal elements. Nonetheless IDRs remain 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.

For any enquiries, please contact: Jatin Tehri (Director), KGC Consulting Pvt. Ltd., 116 B, Shahpur Jat, Asiad Game Village, New Delhi 110 049 Cell: +91 99 580 93819 Direct: +91-11 -2649 7321 E-mail: jatin.tehri@kgcindia.com