INTRODUCTION
Companies incorporated outside India can raise funds from the Indian capital markets through the issue of Indian Depository Receipts (“IDRs”). IDRs allow the issuing foreign companies to access untapped pools of liquidity in the Indian markets. They offer the issuing company a new class of investors as well as greater market capitalization for pursuing growth opportunities. Foreign companies with a presence in India can use the IDR route to finance their local capital requirements. Not only this, IDRs may also help enhance the visibility and image of the issuing company’s products and services in India.
This bulletin seeks to analyze the regulatory framework governing the issue of IDRs including the eligibility criteria and procedure for an IDR issue. Further, it briefly analyses the rules and disclosure norms to be adhered by the issuing companies, which are quite stringent as compared to other regional exchanges, and therefore put a question mark on the viability of IDRs as a tool to raise funds.
1.0 Meaning and regulatory framework
Depository receipts are instruments traded on a local stock exchange representing a security, usually in the form of equity, issued by a foreign publicly-listed company. IDR is an instrument in the form of a depository receipt created by the domestic depository1 in India against the underlying equity shares of the issuing foreign company2. Issue of IDR is governed by Section 605A3 and 6424 of the Companies Act, 1956 (“the Act”) and the Companies (Issue of Indian Depository Receipts) Rules, 2004 (“Rules”) as modified by the Companies (Issue of Indian Depository Receipts) (Amendment) Rules, 2007 (“Rules 2007”). In addition, the foreign company issuing IDRs has to comply with Chapter VIA of the SEBI (Disclosure and Investor Protection) Guidelines, 2000 (“Guidelines”) relating to listing of securities notified by Securities and Exchange Board of India (“SEBI”).
2.0 Eligibility criteria for an IDR issue
The eligibility norms for an IDR issue provided under the Rules were extremely stringent, and did not take into account the realities of the market. The norms specified that the issuer company should have a pre-issue paid-up capital and free reserves of at least US$ 100 million, an average turnover of US$ 500 million during the three preceding financial years, profits for at least five years preceding the issue, dividends of at least 10% in each year for the said period and a pre-issue debt-equity ratio of not more than 2:1. Additionally, IDR issue size in any financial year could not exceed 15% of paid up capital and free reserves.
While notifying the Rules, the Indian government did not recognize that countries from the developing world – more particularly from the Indian subcontinent – and not large-sized MNC’s are likely to resort to IDRs as a means to raise capital, as it would be cheaper compared to US and European markets.
The government failed to consider that a company capable of satisfying the stringent IDR norms would much rather approach the more prestigious US/European capital markets to raise funds.
Owing to the stringent Rules, no company came forward to issue IDRs. The government took a realistic view of the market scenario and relaxed the eligibility norms by enacting the Rules 2007 on July 11, 2007. Now, the issuing foreign company is required to fulfill the following amended criteria:5
- Pre-issue paid-up capital and free reserves of US$ 50 million.
- Minimum average market capitalization of US$100 million (in home country) during the last three years.
- Size of IDR issue should not be less than US$ 12.5 million (INR 500 million6).
- Continuous trading record of at least three years in the stock exchange of the parent country.
- Track record of distribution of profits in three out of five years preceding the issue.
- Underlying shares not to exceed 25% of the post issue number of equity shares of the company.
- Any other criteria provided by SEBI.
The Rules 2007 prescribe market capitalization as eligibility criteria instead of an average turnover. This is a positive step and may encourage companies to resort to using the IDR route, as the chances of a company with average turnover of US$ 500 million raising capital from the Indian markets was quite bleak. A minimum rate of dividend for the last five years and a minimum 2:1 debt equity ratio have been dropped as requirements. The profit making criteria has been retained in the Rules 2007. Profit and loss made by a company has an impact on its share price, and should be a matter between the company and its investors. However, from a regulatory point of view a check on the credibility of the overseas issuer company is required. Therefore, the profit making criteria may be dispensed in a phased manner.
Further, the Guidelines provide that in addition to the aforesaid eligibility criteria, the issuing foreign company should (1) be listed in its home country, (2) not be prohibited by any regulatory body to issue securities and (3) have a good track record of compliance with the security market regulations.7 Further, the Guidelines also stipulate that the company issuing IDRs should receive a minimum subscription of 90% of the issued amount by the closure of the issue. The issuer is required to refund the entire subscription amount received in case the minimum subscription of 90% is not achieved or the subscription level falls below 90% after the closure of the issue.8
3.0 Procedure of issue of IDRs
Prior approval of SEBI is required for the issue of IDRs. An application for SEBI’s approval has to be made along with the draft prospectus or offer letter 90 days prior to the issue with a non-refundable fee of US$ 10,000. The issuing company is required to file a due diligence report with SEBI, through a merchant banker, along with the aforesaid application and prospectus/offer letter. SEBI is empowered to call for additional clarification as well as specify changes in the prospectus of the issuing company, and is required to dispose the application within 60 days of the receipt of information. Upon grant of SEBI approval, issue fee is to be paid by the company.9
Once the SEBI approval for issue of IDRs is obtained, the issuing company is required to (1) obtain approvals and exemptions from home country, if any, (2) appoint overseas custodian, domestic depository and merchant banker, (3) deposit underlying equity with the overseas custodian bank, (4) appoint underwriters for the issue, and (5) obtain in-principle listing permission from a recognized stock exchange in India, which is detailed in 4 below.
4.0 Listing requirements
IDRs are listed on the recognized stock exchange(s) in India. This requires an application to be made for the approval of stock exchange for listing of IDRs. The issuing companies have to execute a listing agreement with the stock exchange at the time of filing the aforesaid application. Further, the issuing companies are required to comply with all the terms and condition of the listing agreement till the time their IDRs are listed on the stock exchange. SEBI has drafted model listing agreement for IDR issues, which is to be read in conjunction with the Rules (as amended by Rules 2007) and the Guidelines.
It should be noted that the model listing agreement imposes stringent disclosure norms and corporate governance requirements upon the issuing companies. The prominent disclosures by the issuing companies to the stock exchange are:
- Any declaration or payment of dividend, issue of convertible debentures, increase in capital and change in managing directors, auditors, nature of business.
- Any information that may have an impact on operation/performance of a company including (but not limited to) merger/amalgamation, de-merger, re-structuring, voluntary delisting from any stock exchange, cancellation of dividend, alteration in the terms of issue of IDR, as well as any price sensitive information.
- Change in nature of business, developments with respect to pricing of or realization on goods/services, litigation.
- Statement indicating variations, if any, between projected utilization of funds (as mentioned in the prospectus) and actual utilization of funds.
- Disclosures regarding related party transactions, risk management, remuneration of directors, proceeds from public issue etc.
Additionally, the issuing companies are required to ensure compliance with corporate governance requirements relating to composition of Board, remuneration of non-executive directors and appointment of committees. The frequency of the aforesaid disclosures – quarterly, annually, monthly – will vary according to the type of disclosure. For instance, dividend can be declared bi-annually at the most, while litigation and related party transactions can be frequent. The aforesaid disclosure norms and reporting requirements are only some of the norms in terms of the listing agreement, and are not exhaustive. In a nutshell, the company issuing IDRs is subject to strict disclosure norms and requirements.
As compared to this, the disclosure and reporting requirements are less stringent in other stock exchanges like Luxemborg, Singapore Exchange, Dubai International Financial Exchange as well as London’s Alternative Investment Market (“AIM”). Apart from less stringent disclosure and compliance norms, the aforesaid exchanges involve lesser cost (listing fees is not high and there are lesser compliance costs) as well as faster processing of applications for listing and have, therefore, attracted many small and medium enterprises in the recent past. Even the eligibility criteria for raising funds are relaxed. For example, AIM does not specify suitability criteria for listing by companies, such as company size, track record, market capitalization or a minimum float to the public.
CONCLUSION
In its attempt to save the Indian investors from fly-by-night foreign companies, the Indian government prescribed extremely stringent and impractical norms for issue of IDRs. The three plus years since the Rules were introduced did not witness an interest by the foreign companies in IDRs. Further, even pursuant to the amendments in 2007 there was still no significant interest. It is clear that foreign companies may continue to hesitate and resort to IDRs for raising funds, especially in the wake of advantages offered by other exchanges as compared to the Indian eligibility norms, stringent disclosure, corporate governance and other regulatory requirements in force as of today. The eligibility norms need to be further diluted, especially, the criteria relating to distributable profits. Finally, aggressive marketing of IDRs as a tool to raise funds in India may attract overseas companies to the Indian capital markets.
1 Rule 3(i)(c) of the Companies (Issue of Indian Depository Receipts) Rules, 2004 defines domestic depository as the custodian of the securities registered with SEBI and authorized by the issuing company to issue IDRs.
2 Under rule 3(i)(d) of the Rules, an issuing foreign company means a company incorporated outside India making an issue of IDRs through a domestic depository.
3 Section 605A of the Act provides that the central government will make rules regarding the issue, disclosure requirements in the prospectus, manner of sale or transfer etc. of IDRs.
4 Power of the Central Government to make rules.
5 Rule 4 of the Rules (as amended by Rules 2007).
6 1US$ = INR 40.
7 Section 6A.2 of the Guidelines.
8 Section 6A.5 of the Guidelines.
9 The issuing company is required to pay an issue fee equal to half a percent of the issue value subject to a minimum of INR 1 million where the issue is up to INR 1 billion. An additional fee of 0.25% is to be paid if the issue size is more than 1 billion.