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By Yash J. Ashar and Nidhi Parekh
Globally, in the last two decades, there has been extensive transformation in the financial system and policies leading to widespread liberalization. Today, companies across jurisdictions are benefiting from capital raising activities in the host country (i.e. place other than the country of incorporation and initial listing) in addition to their home country (i.e. place of initial listing). India liberalized its domestic capital markets predominantly in 1990s and in the year 1993, allowed Indian companies to explore overseas jurisdictions and list in such jurisdictions through the issue of depository receipts which represent the underlying shares of the issuer – American Depository Receipts (ADRs) and Global Depository Receipts (GDRs). This step towards internationalization of capital markets opened the doors for various Indian companies to diversify and mark their presence in markets with higher liquidity and depth such as the United States (U.S.) and the United Kingdom (UK). In addition to capital raising, it helped companies to increase visibility and profile in the host country and reflect their long term commitment to such market.
The concept of depository receipts originated in UK as a response to a law which prohibited registration of shares overseas without a UK based transfer agent. Accordingly, shares of companies in UK were not allowed to leave UK in physical form. During this era, the depository receipts primarily catered to the demands of the investors in U.S. and were popular as ADRs. Sooner than later, the depository receipts were in demand in other jurisdictions in the form of GDRs or christened with the name of the respective jurisdiction such as Hong Kong Depository Receipts.
Following the same principle of international fund raising, in the year 2000, the Indian government allowed companies incorporated outside India to raise funds from the Indian capital markets through the issue of Indian Depository Receipts (IDRs). IDRs are negotiable financial instruments denominated in Indian rupees issued by an Indian depository on the basis of the equity shares of an issuing company incorporated and listed outside India.
This article briefly explains the concept of IDRs and the applicable legal regime to undertake an IDR issue. It also includes a brief description on the integral agreements executed between various participants in an IDR program along with the underlying principle followed to define the roles and responsibilities of such participants.
Development of IDR legal regime
Whilst the Indian legal regime governing the issue of IDRs was in place since the year 2000, it remained untested until the first mover, Standard Chartered PLC, undertook an IDR offering and listed itself on the Indian stock exchanges in the year 2010. The IDR issue by Standard Chartered PLC was not only the first IDR offering but it was also the first public offering to complete listing and trading within the reduced timelines of 12 working days notified by the Securities and Exchange Board of India (SEBI) vide its circular dated April 22, 2010.
Section 605A of the Companies Act, 1956, as amended (the Companies Act) was introduced in the year 2000, whereby the Central Government was authorized to regulate the issue of IDRs by a company incorporated outside India. Pursuant to the same, the Central Government framed the Companies (Issue of Indian Depository Receipts) Rules, 2004, as amended (the IDR Rules) setting out the eligibility, regulatory and procedural aspects for an IDR issue. Chapter X and Schedule XIX of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009, as amended (the ICDR Regulations) prescribes the disclosure requirements in relation to the issuance of IDRs. Further, the SEBI notified a separate IDR Listing Agreement (the IDR Listing Agreement) for companies incorporated in jurisdictions whose sectoral regulator is a signatory to the Multilateral Memorandum of Understanding of International Organisation of Securities Commission which sets out the continuous disclosure norms and obligations of the issuer pursuant to the listing of IDRs. The IDR Listing Agreement allows the issuer to follow home country requirements as part of its ongoing obligations. Separately, the Reserve Bank of India (RBI) vide its circular dated July 22, 2009 (RBI Circular) issued the operational guidelines which govern and facilitate investment by various categories of investors in IDR issuances.
In addition to the above, SEBI had issued the SEBI (Facilitation of Issuance of Indian Depository Receipts) (Amendment) Regulations, 2009 (SEBI Amendment Regulations) to introduce amendments to its regulations governing inter alia foreign institutional investors and mutual funds to facilitate subscription to IDRs.
Under an IDR program, a depositary is appointed in India by the foreign issuer pursuant to a deposit agreement (the Deposit Agreement). Such Indian depositary should be registered with SEBI as a custodian of securities under the Securities and Exchange Board of India (Custodian of Securities) Regulations, 1996. Subsequently, the Indian depositary appoints a banking company based in the home country as an overseas custodian (please refer to the para on origin of the concept of depository receipts) pursuant to a custodian agreement (the Custodian Agreement). Once the initial public offering is complete, the foreign issuer deposits its underlying shares and any subsequent rights, securities, property, dividends, interest, cash and other income attributable to such shares with the overseas custodian. On deposit of the underlying shares with such overseas custodian by the foreign issuer, the overseas custodian sends a confirmation of such deposit to the Indian depositary. Pursuant to this, IDRs are allotted to the investors by the Indian depositary which represents the underlying shares of the foreign issuer. The IDRs so issued are listed on the Indian stock exchanges and are then traded in dematerialized form.
Whilst an IDR structure is similar to an ADR/GDR structure, the economics of the host country for an IDR and an ADR/GDR are significantly different, particularly in terms of liquidity (i.e. number of shares outstanding, frequency of trading, size of trades, etc.) and the consequent trading price of such instruments. Ultimately, this affects the discount or premium at which such instruments trade in the host country vis-à-vis the underlying shares.
Key transaction agreements
Under a typical GDR program governed by English law, the underlying legal basis of the role of a depositary is that it acts as a bare trustee in respect of the deposited property for the benefit of the holders of GDRs (the GDR Holders). The GDR Holders are accordingly the tenants in common of such deposited property.
Under the IDR program, the Deposit Agreement and the terms and conditions of the IDRs provide that the Indian depositary: (i) shall have only those duties, obligations and responsibilities as expressly specified in the Deposit Agreement/terms and conditions; and (ii) other than holding the deposited property as bare trustee, does not assume any relationship of trust for or with the IDR holders or any other person. This concept of bare trust is of utmost importance for reasons inter alia that it offers protection to the IDR holders in the event of insolvency of the Indian depositary because such deposited property will be outside the reach of the general creditors.
Additionally, as the IDR holders are not identified at the time of appointment of the Indian depositary, the issuer makes a unilateral declaration by way of a deed poll in favor of holders and beneficial owners of depositary receipts allowing them to enforce certain specified obligations of the issuer under the Deposit Agreement directly. Such deed poll recognizes IDR holders in perpetuity and creates privity of contract of the IDR holders with the issuer.
The Custodian Agreement is an arrangement between the Indian depositary and the overseas custodian to hold the shares and other deposited property on behalf of the Indian depositary as a trustee. It primarily sets out the roles and responsibilities of the overseas custodian towards Indian depositary and vice versa for the issue of IDRs as well as any subsequent corporate action.
For all purposes, the filing process for an IDR issue is similar to an initial public offering by an Indian company other than the additional option of confidential filing. Under an IDR program, the issuer has the option of confidentially filing the draft red herring prospectus (DRHP) with SEBI. SEBI provides its observations on the DRHP which are incorporated along with any other updates at the time of public filing of the DRHP. Pursuant to the final set of observations from SEBI, the DRHP is updated with all the relevant information and is filed with SEBI and the Registrar of Companies, New Delhi (the RoC) as the Red Herring Prospectus (the RHP). Subsequently, the bid cum application forms are made available along with the abridged prospectus and the issue opens for subscription. Based on the book building process, the issue price is finalized and the RHP is updated with the issue details including the issue price and is filed with the RoC as the “Prospectus”. The RHP and the Prospectus are also filed with SEBI and the stock exchanges for record purposes.
Recent development – fungibility of IDRs
Fungibility of an instrument refers to inter-changeability of such instrument into another. Such fungibility may be one-way fungibility or two-way fungibility. ADRs/GDRs are two-way fungible i.e. ADR/GDR holders may convert ADRs/GDRs into underlying shares of the issuer as well as the existing shareholders may deposit their shares and subscribe to ADRs/GDRs up to the number of ADRs/GDRs cancelled.
With respect to IDRs, originally, automatic fungibility of IDRs was not permitted under the IDR Rules and the RBI Circular. Further, the RBI Circular had provided that IDRs shall not be redeemable into the underlying shares before the expiry of one year period from the date of issue of the IDRs. In this regard, SEBI notified a circular in June 2009 allowing one-way fungibility of IDRs i.e. conversion of IDRs into underlying shares of the issuer on satisfaction of certain prescribed conditions.
Recently, the Finance Minister in the budget speech for Fiscal Year 2013 has announced that IDRs will be two-way fungible. However, the legal and the procedural framework for the same have not been notified by the regulators.
For the full fledged development of IDRs, there are certain significant outstanding issues on which regulatory clarity is required. Insurance companies, one of the largest investor in most public offerings and shareholder in many Indian companies, are not permitted to invest in IDRs. Further, IDRs are not subject to securities transaction tax and thus long term capital gains on IDRs are not exempted from tax and short term capital gains on IDRs are taxed at higher rate. With clarity on these outstanding issues and India being one of the preferred markets for various foreign corporates, IDRs have a long way ahead.
Yash J. Ashar is a Partner and Nidhi Parekh is a Senior Associate in the Mumbai office of Amarchand & Mangaldas.