In keeping with the ongoing popularity of India as a destination for investments from international entities, 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), a type of financial instrument based on a concept similar to that of global depository receipts (GDRs) and American depository receipts (ADRs), the objective of which was to provide a platform to foreign companies to directly raise capital in India rather than take recourse to listing GDRs and ADRs and equity/debt instruments in foreign markets.
Illustration: Jayachandran / Mint
In an ADR/GDR model, depository receipts are represented by negotiable certificates held in the bank of one country representing a specific number of shares of a stock traded on an exchange of another country, consequently making it easier for individuals to invest in foreign companies.
On 20 February 2004, the department of company affairs, pursuant to section 605A of the Companies Act, 1956, issued the Companies (Issue of Indian Depository Receipts) Rules, 2004, which paved the way for foreign companies to raise funds in Indian capital markets. As per the rules, foreign companies can raise funds through issue of depository receipts against their underlying shares at the same time. The rules allowed Indian investors an alternative route to invest in foreign companies. Under the rules, IDRs are defined as “instruments in the form of a depository receipt created by a domestic depository in India against the underlying equity shares of issuing company”. Another aim of introducing this provision is to provide Indian investors with an alternative to acquiring a share of the global pie as well as allowing global companies to access funds at, presumably, cheaper cost.
The mechanism of investing through IDRs is fairly simple. A foreign company will issue shares to an Indian depository, which will, in turn, issue depository receipts to investors in India. The depository receipts will be listed on stock exchanges in India and will be freely transferable. Such IDRs are denominated in Indian rupees. The actual shares underlying the IDRs would be held by an overseas custodian, which will authorize the Indian depository to issue the IDRs against such shares. The rules require that the overseas custodian be a foreign bank having a place of business in India. This needs approval from the finance ministry for acting as a custodian while the Indian depository needs to be registered with Securities and Exchange Board of India.
A company contemplating an issue of IDRs has to first ensure that its pre-issue paid-up capital and free reserves are at least $50 million (Rs212 crore) and that it has a minimum average market capitalization during the last three years in the parent country of at least $100 million. The issuing company has to further ensure that its equity shares should have been traded continuously on the stock exchange in its parent country for at least three immediately preceding years, and that it should have a track record of distributable profits in terms of section 205 of the Companies Act for at least three out of the immediately preceding five years. Also, the issuing company is required to have a good track record in respect of compliance with securities market regulations.
Despite all these provisions and regulations, no foreign company has raised money in the Indian markets through the IDR route till date. This lack of activity with respect to IDRs places a question mark over India’s aspirations towards becoming a financial hub in the South Asia region. A question also arises as to why foreign companies which, since the commencement of liberalization in the 1990s have been eager to invest in Indian companies, are averse to raising money from India themselves by means of IDRs.
The answer to this question is somewhat complex. Various other markets, such as the US, UK and other developed nations, are a great deal more attractive for such capital-raising instruments compared with India because of a number of factors. These countries have more stable economies and financial markets. Further, there is comparatively less political flux, which in turn provides stability to the financial markets, which do not fluctuate with such volatility as in India. The developed countries have mature financial and capital markets which allow easy repatriation of funds, a favourable tax structure and also a realistic market that is driven more by market forces and not so much by rumours. Further, the Indian Income-tax Act, 1961, contains no specific provision for taxing any gains on sale of IDRs; as a result, the general rules on taxing of capital gains apply, making the listing in India expensive.
IDRs are a good initiative from the Union government, but seem to be premature for the purposes of attracting foreign fund-raising from India. It is possible that as the Indian market matures and the acknowledged pitfalls of our slow and cumbersome legal system are addressed, there may be takers for this option. India’s journey in this direction, however, still has some distance to go.
Since independence, India has evolved from being an industrial nation in the 1980s and 1990s to becoming an exporter of information technology and related services in the 1990s and 2000s. It is likely that the mature and stable market and political climate required for attracting international capital funding to India will be achieved at some point in the future.
The lack of a favourable regulatory environment which, among other problems, includes lack of transparency, ease of access, stability of policies, full capital account convertibility in place, have ensured that IDRs have failed to take off as a potential source of foreign capital.
The legal framework which forms the base needs to be brought at par with international standards before foreign companies can even consider listing in India. It is difficult to expect a foreign stakeholder to test fresh waters where he can feel the absence of legal protection. Such protection cannot be merely through the issue of depository receipts rules but has to be all encompassing, that is, to address issues of foreign exchange, capital markets, company laws, taxation, repatriation, expected benefits or even more assured benefits, etc.
There is no doubt that India has one of the most comprehensive laws addressing capital and financial markets, but this is not quite enough to attract foreign companies to list in India — an overall investment climate that is positive and favourable to attract such companies may yet take some time to emerge in India.
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This column is contributed by Deepika Khanna of AZB & Partners, Advocates & Solicitors.