Several Indian firms have successfully raised capital by issuing global depository receipts (GDRs) in the overseas markets, be it Luxembourg or London or Singapore or the Americas. In 2004, the Central government paved the way for foreign firms to tap the Indian capital markets through Indian depository receipts (IDRs)—the Indian avatar of GDRs.
Given the stringent eligibility criterion then prescribed, the instrument did not evoke much interest and not a single IDR issue materialized. Recognizing the lack of interest, the regulations have been progressively liberalized; also, a lot has changed fundamentally. First and foremost, the gradual shift of financial power from the West to the East following the credit crisis, a broad-based and mature Indian equity market (primary and secondary) and last, but not the least, an aspiring investor class in India, buoyed by growing per capita income and higher savings rate.
In July, the Reserve Bank of India (RBI) issued a circular to operationalize IDRs from an exchange-control perspective. More recently, the Securities and Exchange Board of India (Sebi) has taken steps on the policy front to facilitate IDR issues by foreign multinational firms (MNCs) in India, be it extension of the anchor investor facility or the 30% reservation for retail investors to ensure liquidity. Also, as new reports suggest, Standard Chartered is evaluating IDR plans. This article looks at key regulations governing IDRs and some related tax aspects.
What is an IDR?
An IDR is an instrument denominated in Indian rupees in the form of a depository receipt created against the underlying equity of the issuing firm. Essentially, the foreign firm would issue its equity shares to an overseas custodian bank, which in turn would authorize a domestic (Indian) depository to issue IDRs to investors. The IDR would be listed on a recognized stock exchange in India and traded like any other listed security. The IDR would derive value from the underlying equity shares of the foreign firm, and the holder would be entitled to participate in the dividends or other corporate actions (bonus, rights etc.), just as GDRs of Indian firms.
The issue and operation of IDRs are governed, primarily, by the Companies (Issue of Indian Depository Receipts) Rules, 2004 and the Sebi (Issue of Capital and Disclosure Requirements) Regulations, 2009. RBI, on its part, has operationalized IDRs under the exchange control regime.
The IDR rules and Sebi regulations lay down the eligibility criteria for the issuing foreign company as under:
• Pre-issue paid-up capital and free reserves of at least $50 million (Rs234.5 crore)
• Average market capitalization (over the last three years) in the home country should be at least $100 million
• Continuous trading track record for at least the three preceding years
• Dividend track records for three out of five preceding years
• Continuous listing and compliance track record in the home country.
The stringent eligibility criteria, particularly dividend track record, though intended to protect Indian investors from fly-by-night companies, are perceived as a barrier for issuer interest in IDRs. Perhaps what the regulations could look at is a carve-out within certain broad guidelines.
The IDR issue would require Sebi approval. Additionally, issue of IDRs by foreign banks/financial firms having presence in India, either through a branch or a subsidiary, would require the approval of the sector regulator concerned. For instance, a foreign bank operating in India would need the approval of RBI.
RBI has, in a June circular, allowed the following category of investors to invest and trade in IDRs:
• Indian residents including Indian firms, mutual funds, individuals, as also other legal persons such as partnership firms, Hindu undivided families, etc.
• Foreign institutional investors (FIIs) and non-resident Indians (NRIs)
The IDR issue, in terms of number of underlying shares offered, should not exceed 25% of the post-issue equity. Further, the Sebi regulations mandate a minimum issue size of Rs500 million. The public issue would be reserved for subscription as under:
• At least 50% for qualified institutional placement (institutional buyers)
• At least 30% for retail investors
• Balance for others
The 30% reservation for retail investors should facilitate broad-based holding as also enough liquidity. The issuing firm would have to make an application to Sebi along with the prospectus/offer letter as also a due diligence certificate issued by a merchant banker. The facility of anchor investor and book building process for price discovery is also extended to IDRs as for equity issue by Indian firms.
In order to protect investor interest, the listing agreement mandates stringent disclosure and corporate governance norms. Thus, the issuing firm would have to disclose to the stock exchange any price-sensitive development. Additionally, the issuing firms are required to ensure compliance with corporate governance requirements relating to the composition of the board, independent directors, remuneration of non-executive directors and appointment of committees. The listing agreement also mandates publishing of annual and quarterly financial statements.
Again, stringent disclosure and corporate governance norms, though in the investor’s interest, compare unfavourably against norms for listing on other tier II global exchanges such as Luxembourg, London’s Alternative Investment Market and Dubai. This could result in higher compliance costs for mid-size companies seeking to tap the Indian capital markets.
Redemption & fungibility
While fungibility (the ability to convert IDRs into underlying shares and vice versa) is not permitted as in the case of GDRs, IDRs can be redeemed for (converted to) underlying shares of the issuing company after a one-year mandatory lock-in period. In such cases, a listed company or mutual fund may continue to hold the underlying shares; however, any other Indian investor would have to dispose of the underlying shares within 30 days of conversion.
The tax law does not contain specific provisions for taxation of IDRs. One of the issues is whether IDRs would be regarded as a “security” under the Securities Contract Regulation Act. Considering that an IDR is essentially in the nature of a derivative instrument, deriving its value from the underlying shares, it should be regarded as a security. Nonetheless, a specific amendment should be helpful. This should facilitate a lower (one year) holding threshold for availing the beneficial tax regime for long-term capital assets. Also, clarity on securities transaction tax applicability, taxability on conversion of IDRs to underlying shares and treaty taxation (for FIIs/NRIs) should provide certainty.
The regulators have been walking a fine line in balancing investor interest and making IDRs an attractive instrument for foreign MNCs to tap the Indian markets. This is quite understandable and will ensure that only sound firms access the IDR route. One also looks for clarity on the tax front. Given that five years have passed since introduction, now seems the time for the regulators to woo global firms, which in turn would not only provide the opportunity for Indian investors to hold international equity, but also broad-base the Indian capital markets.
Ketan Dalal is executive director and Vishal Shah is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org