In a way, the Securities and Exchange Board of India’s (Sebi) decision to disallow unrestricted conversion of Standard Chartered Plc’s Indian depository receipts (IDRs) into common shares is seen as something that will kill the fledgling market for this instrument.
The common refrain is that since investors can no longer convert these instruments into underlying shares, it will make these unpopular. But perhaps the markets regulator didn’t have much of a choice.
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Sebi’s logic goes thus: if IDRs were easily converted into shares, foreign investors would have done so and taken advantage of the arbitrage opportunity to book profits. Even if the arbitrage opportunity didn’t exist, there is the possibility that large investors may have preferred to hold shares in London where there is greater liquidity.
With two-way fungibility—something that another regulator, the Reserve Bank of India, prohibits—the number of IDRs could have reduced, and thus made the market illiquid. In short, it would have killed the market in a different way.
Now, Sebi’s mandate is to promote the development of a local securities market and the interests of local investors. The idea behind IDRs was to let foreign companies raise capital from the domestic market and provide a window for local investors to take exposure in multinational firms. In keeping with those objectives, the regulator has done nothing wrong.
Yet, Sebi’s Saturday circular was interpreted by some investors as a disaster in the making. In a perverse way, it perhaps provides an incentive for illiquidity. The ruling clearly says that redemption of IDRs into shares would be allowed only if they are infrequently traded, according to the regulator’s definition.
The first reaction of the market was to hammer the security down some 20%, though naturally, volumes spiked. Still, that conclusion need not be true for all future IDRs that may hit the market. But now that the arbitrage opportunity no longer exists, will investors value the stock on fundamentals and will price discovery be a function of domestic supply and demand?
Not really. In fact, the price discovery of the Standard Chartered scrip is going to be discovered in the international markets and the local IDRs will merely reflect that price.
What the regulator could have probably done was to ensure more clarity at the time of the IDR issue. Yes, every new security or product evolves into its own over a point of change and there are tweakings that need to be done. In case of IDRs, there were many open questions such as redemption, taxation and even its classification as a security. Some of these still remain.
But the more fundamental concern is that if Sebi is so certain that investors will take advantage of the fungibility of IDRs to hold their shares in the London market, does that mean IDRs are hothouse flowers, an artificial creation that cannot stand the test of the market? Why then have IDRs at all?
Graphic by Ahmed Raza Khan/Mint
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