Tougher GDR norms on the cards

Tougher GDR norms on the cards

Mumbai: Indian financial regulators plan to impose more stringent conditions on Indian companies issuing global depository receipts (GDRs).

Two government officials involved in the process told Mint that companies will be required to take prior regulatory approval before they issue GDRs to foreign investors, a change from the current loose arrangement that allows companies to inform regulators and stock exchanges only after a GDR issue is completed.

The fresh regulations will seek to ensure that only companies meeting minimum norms are allowed to issue GDRs and that such issues by weak companies do not create reputational risks for all Indian firms seeking capital from global investors, as has happened with Chinese companies in recent weeks after accusations of accounting jugglery by firms such as Sino-Forest Corp., a Chinese forestry firm listed in Toronto.

“There should be some filtering mechanism to decide the eligibility criteria of companies increasing their authorized share capital by way of GDR issuances. The discussions are on and we may soon see new regulations for GDRs," said one of the government officials.

The Securities and Exchange Board of India (Sebi) along with other financial regulators, including the Reserve Bank of India and the finance ministry, would frame the new GDR regulations, the official said.

The rules are expected to be ready before the year-end, following the ongoing discussions between the financial regulators.

A depository receipt is a negotiable instrument issued abroad, often in lightly regulated markets such as Luxembourg, to represent underlying domestic shares, making it easier for foreign investors to take an exposure to the issuing company without moving money across borders. According to Bloomberg data, there have been 457 overseas GDR listings by Indian companies since 1993. According to their closing prices on various overseas exchanges on Monday, $1.87 trillion (83.4 trillion) worth of investor wealth is parked in such stocks by foreign entities.

“We have found there are several Indian firms which have been increasing their net worth undesirably through issuance of GDRs," said the government official cited earlier.

“When a company increases it net worth by a hundred times merely by issuance of GDRs, it may not be a genuine case. Why is it so difficult for that company to raise such money in the Indian markets? Again, when the GDRs are converted to shares and listed in India at an opportune time, it may create unwanted volatility, going against the interest of domestic shareholders," said the second official.

“Companies would need to take regulatory approval before issuing GDRs under the new regulations. Sebi will have greater jurisdiction on GDRs under the new rules," the official added.

An email sent to Sebi did not elicit a response.

Indian regulators are also worried that the absence of regulations on GDR issues may attract the wrong sort of issuers, whose practices could eventually cloud the reputation of all Indian companies seeking global capital.

Recently, China took a hit on its reputation after a handful of US-listed Chinese firms were found to be flouting accounting and corporate governance norms. Investors lost in billions after the companies were found to be trading at highly inflated prices in the absence of proper auditing. Following this, all globally trading stocks domiciled in emerging markets across the Asia-Pacific region have been in the spotlight.

The new GDR regulations should not be introduced as a protectionist measure, warned one expert.

“We must not try to shield the domestic market from foreign competition, but we must guard against frauds that damage the reputation of Indian stocks in global markets. In the short run, protectionist measures may appear beneficial to the Indian markets, but in the long run they lead to complacency, and make domestic markets inefficient and uncompetitive," said Jayanth R. Varma, a professor at the Indian Institute of Management, Ahmedabad, and chairman of Sebi’s secondary market advisory committee.

The GDR regulations will be tightened on other fronts too.

“The new regulations may also mandate the issuing companies to disclose the name of the end-beneficiaries of the GDR holdings," said a person familiar with the capital market policies of the government. At present, the companies are not required to disclose identities of the investors in GDRs, unlike the disclosure requirements for participatory notes issued by foreign institutional investors.

There are restrictions on how the money raised through GDRs is used, except for a ban on deployment of such funds in real estate or the stock market.

Gautam Chand, chief executive officer of Instanex, a firm that tracks GDR issuances and listings by Indian firms, said: “There might be concerns over market manipulation by companies issuing GDRs. Some companies issue GDRs at a high price and convert them to shares at an opportune time. When a large chunk of GDRs are converted to shares and listed on Indian exchanges, the share prices go down due to an increase in free float. The companies do this in a way they could also get to save capital gains tax. But the regulations should not discourage genuine GDR issuances."

Typically, small and mid-size companies that find it difficult to raise money in India raise funds through GDRs.

Varma added that many firms issue GDRs because the domestic capital markets are not responsive to the needs to smaller firms.

“Initiatives like the SME exchange should help in doing this. It is true that the Luxembourg-listed GDR market is rather lightly regulated compared to the US, UK or India. But in the long run, this is reflected in higher valuations in well-regulated markets. So we should seek to build a well-regulated market, which is cost efficient and liquid," Varma said.