IDRs likely to get a makeover

IDRs likely to get a makeover

Mumbai: Rules on Indian depository receipts (IDRs) may see a makeover with financial sector regulators planning to eliminate two critical roadblocks that have been discouraging foreign firms from listing in India and kept the market dull for such instruments. Standard Chartered Plc is the only company that has issued IDRs thus far.

Discussions are on and once the Securities and Exchange Board of India (Sebi), the Reserve Bank of India (RBI) and the Insurance Regulatory and Development Authority (Irda) agree, the IDR norms will be amended to allow two-way fungibility and investment by local insurers in these instruments, said a person familiar with the development.

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The present regulations don’t permit such fungibility. Besides, Irda norms prohibit insurance firms from investing in such securities.

Two-way fungibility is the ability to purchase existing shares of the issuer foreign company on foreign bourses where its shares are listed and deposit them into the IDR holding and vice-versa.

An IDR is a rupee-denominated instrument, like an equity share, in the form of a depository receipt created by a domestic depository against the underlying equity of issuing company. It enables foreign firms to raise funds from the Indian capital market.

Any foreign firm with an existing business in India can float IDRs if it has a pre-issue paid-up capital and free reserves of at least $50 million (Rs 230 crore) and its parent company has at least $100 million average market capitalization during the last three years.

Standard Chartered raised 2,486 crore in its IDR offering in June 2010. No other foreign entity has entered the market in the absence of two-way fungibility. Besides, without the participation of local insurers, the biggest domestic investors in the institutional category, it is not easy to make an IDR issue a success as foreign investors can anyway buy shares of these firms overseas where they are listed.

The monthly turnover of Standard Chartered’s ID has slumped from 335.33 crore a year ago to 3.37 crore now on BSE.

Priced at 104, Standard Chartered’s IDR hit a high of 134.50 in March, but has since fallen at least 42%. On Wednesday, the IDR lost 0.38% to close at 77.70.

The fall in price was sharp after one year of listing when Sebi did not allow the redemption of IDRs for underlying equity shares unless they were illiquid. To be sure, the capital market regulator had not committed to allow this after one year from the date of issue of IDRs, but investors had expected this to happen.

Such redemption would be permitted only if IDRs were infrequently traded on the stock exchanges in India. This is defined as annualized trading turnover in the six calendar months immediately preceding the month of redemption being less than 5% of the listed IDRs.

Sebi’s existing rules are based on the argument that in the absence of two-way fungibility, allowing redemption freely could result in a reduction in the number of IDRs listed, thereby impacting liquidity in the domestic market.

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 RBI now prohibits—the number of IDRs could have fallen and, thus, made the market illiquid.

RBI has reservations about two-way fungibility, but the capital market regulator and the banking regulator have been in discussion to thrash out differences. Irda is also not uncomfortable with the idea of allowing insurance companies to buy IDRs, said the person familiar with the development.

IDRs enable Indian investors to tap overseas markets. Though investors are permitted to invest in shares abroad, this has been limited to around $200,000 and issues such as transacting through specific types of bank accounts and requirement of foreign dematerialized accounts make this process tedious.

IDRs have the potential to overcome these procedural issues, but the limitations of the existing rules have dampened interest in the instrument as evidenced by the retail holding in Standard Chartered IDRs having fallen to zero.

Standard Chartered’s shares are listed on the London Stock Exchange and the Hong Kong Stock Exchange. If two-way fungibility is allowed, investors will be able to buy the underlying shares of the foreign company on overseas bourses any time, which will make these instruments as flexible as equity shares.

Ashwin Ramarathinam contributed to this story.