Photo: Abhijit Bhatlekar/Mint
Photo: Abhijit Bhatlekar/Mint

Depository receipts regime fails to take off due to Sebi concerns

Depository receipts are difficult to monitor and can be used for money laundering and market manipulation, Sebi fears

Mumbai: Eighteen months after the government notified liberalized norms for depository receipts, the industry is yet to see any issuances as the Securities and Exchange Board of India (Sebi) remains opposed to the idea of promoting depository receipts and is yet to issue relevant regulations.

The regulator is concerned that American depository receipts (ADRs) and global depository receipts (GDRs) are difficult to monitor and can be used for money laundering and market manipulation. These concerns have been recently communicated to the government, said two people directly familiar with the developments; both spoke on condition of anonymity.

A depositary receipt (DR) is a negotiable financial instrument issued by a bank to represent a foreign company’s publicly traded securities.

The liberalized DR scheme was notified by the government in June 2014 but came into effect from 15 December 2014. The new scheme was based on the report by a committee headed by M.S. Sahoo, who currently is a member of the Competition Commission of India.

The liberalized regime allowed DRs to be issued at the back of all securities including debt, mutual fund, securities issued by the government or any other issuer such as private companies. Prior to the new rules, DRs were permitted only on equities as the underlying instrument.

The regime also paved the way for unsponsored DRs. An unsponsored DR is one where the company or the issuer of the securities isn’t involved in the issue of the securities.

Sebi sees such unsponsored DRs as a risk. “Sebi had sought feedback from certain custodians regarding the implementation of the liberalised DR scheme. There are policy and operational issues including monitoring related issues in unsponsored DR, this has been communicated to the government," said one of the two people cited earlier.

The other issues raised by Sebi with respect to DRs include difficulties in tracking the ultimate beneficiary, the potential for unsolicited takeovers and money laundering.

An email sent to Sebi on Thursday did not elicit any response.

“In DRs, the complete details of the ultimate beneficial owner of DR holders may not be available with the domestic custodians under the DR scheme," said the second of the two people cited earlier. “There is a likelihood that investors holding DRs of Indian companies can gain access to underlying Indian securities, without their identity being known," he added. Generally, a foreign depository involved in a DR programme has details of the first DR holder but not does track subsequent sell-downs in those DRs.

With Sebi raising concerns and holding back on final rules for the product, DR issuances have been stalled even though there is interest from foreign portfolio investors (FPIs) in the product. “DRs offer the right flexibility with lesser compliance requirement for FPIs to invest in India in a meaningful way. But, if the scheme does not get the required regulatory push it will not pickup," said a head of foreign bank which acts as custodian for FPIs, declining to be identified.

DRs can also become an alternative to Participatory Notes, for which the rules have been tightened by Sebi. Also, the amendment in the Mauritius tax treaty will make P-Notes less lucrative by allowing capital gains on investments made through this island republic to be taxed.

On 19 May, Sebi increased the disclosure requirements and put restrictions on transferring P-Notes, both of which will help regulators keep track of the beneficial owners of these instruments. P-Notes, or offshore derivative instruments (ODIs), are instruments issued by registered FPIs to overseas investors who wish to invest in Indian stock markets without registering themselves with Sebi.

“FPIs are willing to invest in India through DRs considering the renegotiated Mauritius tax treaty and Sebi’s increased compliance requirement for P-Notes, which has effectively brought ODIs at par with FPIs," said Rajesh Gandhi, a partner at Deloitte Haskin & Sells.

“However, the scheme despite being notified by the government has not received the required regulatory and taxation push as it is not meaningfully contributing to the economy," added Gandhi.

The first person cited earlier added that given Sebi’s stance on P-Notes, it would be counterproductive for the regulator to promote a different product which may have similar issues.

“P-Note regime was tightened to avoid opaque structures and increase transparency to avoid money laundering. Sebi is unlikely to favour liberalization of another financial instrument that is viewed as opaque and can be used for concealing ultimate beneficiary," this person said.

Along with the inability to track the ultimate beneficiary, voting DRs could also expose companies to unpredictability in ownership structure, said the second person. “Sebi is not in a position to ensure compliance with Prevention of Money Laundering rules in the DR scheme. The regulator has requested the government to issue suitable instructions to financial intelligence unit and Enforcement Directorate to ensure compliance with PMLA provisions," added the second person.

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