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Indian
Depository Receipts have Arrived!
The
Securities and Exchange Board of India ("SEBI") has issued guidelines
paving the way to the issue of Indian Depository Receipts ("IDRs")
on April 3, 2006. The guidelines enabling the issuance of IDRs
were introduced by way of an addition of a new Chapter
VI A in the SEBI (Disclosure and Investor Protection) Guidelines,
2000 (the "IDR Guidelines").
A Brief History of IDRs
The
history of the IDRs can be traced back to the amendment brought
about to the Companies Act, 1956 by way of the introduction of
section 605-A in the year 2000, which envisaged that certain rules
would be framed by the Department of Company Affairs ("DCA") in
relation to the IDRs. Four years hence, the DCA did finally issue
the Companies
(Issue of Indian Depository Receipts) Rules, 2004 (the "Rules")
on February 23, 2004 (our Corpsec Hotline Advent
of Indian Depository Receipts dated March 5, 2004 had
analyzed the implications of the Rules). The Rules had contemplated
that SEBI will be issuing guidelines stipulating conditions for
the issuances of IDRs, which were issued on April 3, 2006. The
IDR Guidelines have come into effect from April 3, 2006 and seek
to supplement the Rules.
IDR
Guidelines
As
is the case with any depository receipts mechanism, IDR Guidelines
contemplate that a company incorporated outside India can issue
IDRs through a domestic depository against the underlying equity
shares of the issuing company, which are kept with a custodian
in the home country.
The
main aspects of the IDR Guidelines have been examined below:
- Eligibility
for issue of IDRs
The
IDR Guidelines have stipulated certain eligibility criteria that
are in addition to the eligibility criteria set out in the Rules,
the most important one being the requirement that the issuing
foreign company has to be listed in its home country. The two
additional criteria are more of a consequential in nature to the
first one, these are, good track record with respect to compliance
under their respective securities market and that the issuer should
not have been prohibited by any regulatory authority from issuing
securities.
Implications:
The criteria that required that the issuer has to be listed in
its home country seems to be quite stringent. This is especially
so, in light of the fact that when one sees the kind of companies
which would want to list in India would be small and mid-cap foreign
companies, which are familiar with Indian markets or have promoters
of Indian origin and are likely to be in the emerging sectors
such as, technology, pharma, auto-components, etc., looking for
a better valuation that what it would be getting in its home country
or looking for a lower cost of compliance.
Further,
many companies who are looking for issuing IDRs would be doing
so because they want to 'flip' their current structure and would
like to make the Indian company as the parent company with the
global operations under the Indian company and this Indian company
could then be listed to capture the value of the global operations.
It
has been clarified that Non-Resident Indians and Foreign Institutional
Investors cannot invest in IDRs unless it has obtained the approval
of the Reserve Bank of India ("RBI"). The minimum application
amount for an IDRs issue is Rs.200,000 (approx. USD 4,500 at current
rates).
Further,
a IDRs issue can only be subscribed by Qualified Institutional Buyers
and that Indian companies investing in IDRs cannot exceed the
investment limits, if any, prescribed under their respective applicable
laws.
Implications:
This would mean that individuals would not be able to buy IDRs,
which is a set back to individuals who wish to participate in
this new instrument.
Interestingly,
the IDRs are not automatically fungible, which means that for
the investors to convert the IDRs into the underlying shares would
require the regulatory approvals.
Implications:
The fact that automatic fungibility has been disallowed is a set
back for the investors, who will not be able to access the underlying
security without the permission of the authorities in India.
- Disclosures
requirements for IDR issues
The
IDR Guidelines, have provided an option for filing the draft prospectus
through public filing or through a confidential filing, interestingly
this option is not currently available for domestic companies
accessing the capital markets. The filing of both, the draft and
the final prospectus has to be made through a merchant banker
registered with SEBI and a copy of the final prospectus has also
to be filed with the Registrar of Companies at New Delhi.
Implications:
The fact that SEBI and the main stock exchanges (BSE and NSE)
are located in Mumbai and only one filing has to be made with
the Registrar of Companies at New Delhi, is a minor irritant and
should not be an impediment.
In
addition to a long list of disclosures and information which needs
to be made, the name, address and contact information of the overseas
custodian bank needs to be provided along with the address of
its office in India.
Implications:
Whether intended or not, this seems to suggest that the Overseas
Custodian Bank has to have an office in India.
The
IDR Guidelines stipulate that the capital raised from the issue
of IDRs has to be transferred to a separate domestic bank account.
Implications:
The above requirement seems to suggest that the issuer has to
open a bank account in India and the issue proceeds have to be
transferred to the same. As per the current laws, any foreign
person seeking to open a bank account in India requires the prior
permission of the RBI. It would normally take around 3-4 weeks
to obtain such an approval. However, since opening of a bank account
for issue of IDRs is uncharted territory, there is no estimation
that can be provided as to the time that would be taken by the
RBI in granting such an approval .
- Foreign
Investment and Exchange Controls of the country of incorporation
As
per the IDR Guidelines, information relating to the foreign investment
laws and the exchange control regulations of the country of incorporation
of the issuer or where the underlying equity shares are listed
should be set out.
As
per the IDR Guidelines, a report of the statutory auditor on the
financial results and status of the foreign company issuing the
IDRs, for five financial years preceding the issue of the prospectus
is to be provided. Such information should be in Indian Rupees
in addition to the home country currency and has to be prepared
in Indian GAAP or IFRS or US GAAP. If the financial information
is prepared in IFRS or US GAAP, then such information has to be
accompanied with a reconciliation statement vis-à-vis Indian GAAP
and the IFRS or US GAAP results have to be audited by a professional
accountant or a certified public accountant or an equivalent in
accordance with the International Standards on Auditing.
Further,
the domestic depositary is required to prepare a report, which
has to be certified by a chartered accountant practicing in India,
and such report has to be for five financial years preceding the
issue. This seems to be quite an onerous responsibility given
to a depositary.
The
IDR Guidelines also mandate that in case of the proceeds of the
issue are used for investing in other entities, then the names
and addresses of such entities and a the financial reports as
stated above would be required to be furnished for such entities
.
Implications:
The requirement for the disclosure of an investee company seems
to be quite a stringent stipulation since in many a times the
issuer company may not have ascertained the particular entity
in which they would be investing funds and in some situations
such information, especially the financial reports, etc. may be
confidential, either due to commercial considerations or statutory
compulsions.
The
basis of pricing of IDRs would need to be disclosed in the prescribed
format and shall have to contain, among others, information such
as, earnings per share for the last three years, P/E pre-issue,
minimum return on increased net worth required to maintain pre-issue
EPS, etc.
The
said basis of issue is conditional upon the premise that the projected
earnings are not used as a justification for the issue price in
the prospectus and that the accounting ratios disclosed in the
prospectus should support the basis of the issue price.
The
issue of IDRs would be subject to the provisions of the SEBI (Disclosure
and Investor Protection) Guidelines, 2000 ("DIP Guidelines"),
except for Chapter VI of the DIP Guidelines .
The
additional disclosure requirements cover the customary disclosure
of information which inter alia include information relating
to Industry, Business, details of the Issuer, Subsidiaries and
associates of the issuer, Management Discussions and Analysis,
Litigations, Information about the IDRs, management of the issuer,
etc.
The
IDR Guidelines also prescribe the requisite information and contents
to be disclosed for an abridged prospectus for an IDR issue.
Listing
Agreement
As
per the Rules, the issuer is required to obtain an in-principle
listing permission from one or more stock exchanges having nation
wide trading terminals in India. Currently there are only the
BSE (Bombay Stock Exchange Limited) and the NSE (National Stock
Exchange Limited) have nation wide terminals, therefore, these
stock exchanges would be the only ones to qualify under this requirement.
In light of the above and in line with the stipulations for the
domestic companies listing their securities, the SEBI has, along
with the IDR Guidelines also issued a Listing Agreement, which
will have to be entered between the issuer and the respective
Stock Exchanges on which the IDRs would be listed. The agreement
contains various stipulations and requirements of on-going disclosures,
filings, conduct, corporate governance, etc. which have
been prescribed.
Conclusion
The
IDRs route is attractive for small and mid-cap foreign companies,
which are familiar with Indian markets or have promoters of Indian
origin. Typically, these companies would be based in USA and South
East Asia. With the cost of compliance increasing for companies
that want to be listed or raise further capital in USA and other
markets, listing in India may be an attractive option for foreign
companies that view India as a potential market. Since the IDR
Guidelines have just been introduced, it would take some time
for the dust to settle and for picture to get sharper on the IDR
scenario in India.
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You
can direct your queries or comments to the authors
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Source:
1)
Sebi circular on the new Chapter VI A of DIP Guidelines dated
April 3, 2006
2)
The IDR Rules
3)
Sebi circular on the IDR Listing Agreement, dated April 3, 2006
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