GLOBAL DEPOSITORY RECEIPTS IN INDIA Chapter – 1 INTRODUCTION OF FINANCIAL MARKETS INTRODUCTION The Indian economy is the second fastest growing economy in the world after China with a growth rate of 6. 5%. India seems to have become an investor’s haven with high returns on investments for foreign Institutional investors. Indian companies are recording higher profits and are gaining global recognition because of operations in several countries. However, for international presence, Indian companies need funds from time to time to expand their business. Companies either raise funds from the domestic market or through international market.
For international funding, the most popular source amongst the Indian companies in the recent times has been American Depository Receipts (ADR) and Global Depository Receipts (GDR). The Finance Ministry has projected inflows of $4. 5 billion through the ADR/GDR/FCCB (Foreign Currency Convertible Bond) route during the current fiscal year. This chapter deals with the concept of ADR/GDR, the process involved in such issues and the recent changes made by the government in the regulations for ADR/GDR. ADR/GDR – The concept ADR/GDR are negotiable certificates that enable domestic investors of a country to own shares in foreign companies.
ADR/GDR are issued by non resident companies to residents of another country through depositories situated in the country from which a company intends to raise funds through depository receipts. Each unit of ADR/GDR represents a given number of a company’s shares and can be traded freely as any other security in the capital market. The role of depositories in an issue of ADR/GDR is very crucial, as depositories act as custodians of the shares, against which the ADR/GDR are issued. As the names suggest, ADR are issued in American capital markets while GDR are issued in all other countries.
Procedure The procedure for issue of ADR/GDR is different from issuing shares in the domestic capital market. The ADR/GDR are issued on the basis of the ratio worked out by the Indian company in consultation with the lead managers of the company. The Indian company issues its rupee denominated shares in the name of the overseas depositories and such issued shares are kept in the custody of the domestic custodian in India. On the basis of the ratio worked out and the rupee shares kept with the domestic custodian, the depositories issue ADR/GDR to the investors outside India.
Statutory provisions Regulations under the Foreign Exchange Management Act, 1999 (FEMA) allow Indian companies to issue shares through ADR/GDR. Issue of Foreign Currency Convertible Bonds and Ordinary Shares (through Depository Receipt Mechanism) Scheme 1993 (FCCB & ADR/GDR Scheme) and the guidelines issued by the Ministry of Finance (MoF) from time to time set out the rules and regulations for issue of ADR/GDR by Indian companies. The MoF has allowed Indian companies to raise ADR/GDR under the automatic route under which there are simpler reporting requirements to the RBI.
Requirements for raising ADR/GDR in view of the recent changes in the FCCB & ADR/GDR Scheme by MoF. To bring the issues of ADR/GDR in line with the Security Exchange Board of India (SEBI) guidelines on ‘Domestic Capital Issues’ i. e. public offers, the Finance Ministry recently amended the FCCB & ADR/GDR Scheme11 whereby from August 2005 it is mandatory for all Indian companies to be a listed company on any of the Indian stock exchanges before issuing FCCB bonds or ADR/GDR or a simultaneous listing of shares of the applicant company is required. Statutory requirements
The requirements for companies under the applicable statutory provisions for issuing ADR/GDR are as follows: FCCB & ADR/GDR SCHEME Eligibility Criteria Indian companies (i)A company must not be barred from raising funds from the Indian capital market nor restrained from accessing the securities market by SEBI. (ii)The applicant company must be a listed company or be in the process of getting listed on any Indian stock exchange. Subscribers Overseas Corporate Bodies (OCBs) and other entities, which are not eligible to invest in India through portfolio route i. e. irectly on the stock exchanges in India and entities which are prohibited to buy, sell or deal in securities by SEBI are prohibited from subscribing to ADR/GDR issues. Pricing For listed companies The price of ADR/GDR should not be less than higher of the following two averages: (i)The average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the six months preceding the relevant date; (ii)The average of the weekly high and low of the closing prices of the related shares quoted on a stock exchange during the two weeks preceding the relevant date.
For unlisted companies As per the recent changes, the applicant company is required to be a listed company or a simultaneous listing of shares should be done. Therefore, the earlier requirement that pricing should be in accordance with the regulations notified under FEMA is not applicable any more. FEMA guidelines in accordance with MoF notifications Indian companies may issue their shares to a person resident outside India through a foreign depository for the purpose of issuing ADR/GDR.
However, the above is subject to the following conditions: The company issuing such shares has an approval from the MoF to issue such ADR/GDR or is eligible to issue ADR/GDR in terms of the FCCB & ADR/GDR Scheme or notifications, which MoF issues from time to time. The company is not otherwise ineligible to issue shares to persons resident outside India in terms of regulations issued under FEMA, like, where a company’s operations fall under activities, where foreign investment is strictly prohibited; and The ADR/GDR are issued in accordance with the scheme provided under FCCB & ADR/GDR Scheme.
The Indian company issuing shares through ADR/GDR route is required to submit to the RBI (a) full details of such issue in the specified form, within 30 days from the date of closing of the issue, and (b) a quarterly return in the prescribed form within fifteen days of the close of the calendar quarter. Benefits to foreign investors under ADR/GDR route Due to restrictions on direct investment by foreign individuals in the Indian capital market, foreign individuals are not allowed to trade directly on the Indian stock exchanges.
They can invest only through Foreign Institutional Investors (FIIs) registered with SEBI, in the stocks of Indian companies trading on Indian stock exchanges. Further, FIIs are also subject to restrictions like 10% cap on investment on the total paid-up capital of a company and are also required to maintain a ratio of 70:30 while allocating their total investments between equities and debts. Thus, such restrictions do not allow foreign individual investors to invest freely in the stocks of Indian companies.
Another benefit of ADR/GDR route is that since ADR/GDR are traded in the respective countries, therefore, the regulations of the concerned country and not the Indian regulations regarding transferability, trading etc. would be applicable, which are generally more investor friendly than the Indian regulations. Chapter – 2 INTERNATIONAL FINANCIAL MARKET INSTRUMENTS Funds are raised from the international financial market also through the sale of securities, such as international equities or Euro-equities, international bonds, medium-term and short-term euro notes and euro commercial papers.
The securities market began to grow on a big way after the international debt crisis. Earlier 1980. Pesently the use of securities is quite extensive. the different aspect of these securities are as follows. INTERNATIONAL EQUITEIS International equities or Euro equities do not presents debt, nor do they presents foreign direct investment they are comparatively new instruments presenting foreign portfolio equity investment. In this case the investor gets the dividend and not the interest as in the case of debt instrument . on the other hand ,it does not have the same pattern of voting right . hat it does have in the case of foreign direct investment . in fact , international equities are compromise between debt and foreign direct investment . they are instruments that are presently on the preference list of the investors as well as the issuers . this has enabled Euro-equity issues to surge to US$7. 3 billion during 1990 to US $44 billion in 1995, to US $ 59 billion in 2000and to over 70 billion in 2004 from a mere US $ 2. 7 billion during 1985. (euro- equities are the ordinary shares sold to international investors in the form of American /global depository receipts) Benefits to issuer/investor
The issuer issue international equities under certain condition and with certain objective. 1. When the domestic capital market is already flooded with its share the issuing companies does not like to add further stress to domestic stock of shares since such additions will cause a fall in share prices. In order to maintain the share prices the company issues international equities. 2. The presence of the restrictions on the issues of shares in the domestic market. Facilitates the issue of Euro equities. 3The company issues the international equities also for the sake of gaining international recognition among the public. . International equities bring in foreign exchange which vital for a firm in a developing country. 5. International Capital is available at lower cost. 6. Funds raised through such an instrument do not add to the foreign exchange Exposure. Note: From the view point of the investors, international equities bring in diversification benefits and raise return with a given risk or lower the risk with a given return. If investment is made in the international equities along with the international bonds ,diversification benefits are still greater . PROCEDURE OF ISSUE
Planning for the size and the governmental approval When a company plans to issue international equity, it decides about the size of the issue, the market where the equities are to be issued, the price of the issue, and about many other formalities. It approaches the lead manager-normally an investment bank-which has a better knowledge of the international financial market. The lead manager examines the risk factor of the issue as well as its prospect. It suggests about the details of the issue as also in whether the shares are to be routed through the American depository or through the global depository.
When the lead manager gives a green signal, the issuing company prepares the prospectus, etc. and takes permission from the regulatory authorities. Role of custodian bank After getting approval from the regulatory authorities, it deposits the shares to be issued with the custodian bank located in the domestic country. The custodian bank is appointed by the depository in consultation with the share-issuing company. When the shares are deposited with the custodian bank, the latter asks the depository located in a foreign country to issue depository receipts in lieu of the shares held.
The ratio between the number of shares and the number of depository receipts is decided well before the actual issue. In fact. the fixing up of the issue price or the ratio between the depository receipts and the shares depends upon a host of economic variables. Generally, the issues are priced at discount insofar as the earning per share drops in proportion to the increase in capital. The market price of depository receipt in international market is largely dependent upon earnings potential, industry fundamentals, and macro-economic fundamentals. Launching of the ADRs/GDRs
The depository, which is a bank or financial institution situated in an international financial centre, functions as a link between the issuing company and the investor. On getting information from the issuing company about the launch, the depository issues the depository receipts. The American depository issues American depository receipts (ADRs), while the depository in the international financial market outside the USA issues global depository receipts (GDRs). When GDRs are purchased by the investors, the proceeds flow from the depositor to the custodian bank and from the custodian bank to the issuing company.
The company enters the name of the investor in the register of the shareholders. The investor has the right to surrender GDRs and to take back me investment, for the surrender, the investor deposits the GDRs with the depository who in turn informs the custodian who will issue the share certificates in exchange for the GDRs. The proceeds from the sale of shares are converted into foreign exchange for the purpose of making payment to the foreign investors. It may be noted here that once the GDR is surrendered in exchange for the shares, such shares annot be converted back into GDRs. Again, the investors can sell the GDR back in the issuing company’s domestic capital market. In order to discourage this practice, the issuer introduces a clause, known as lock-in period, during which this practice is prohibited. In the process of the issue, the role of underwriting and listing is very important. The lead manager functions normally as an underwriter and charges underwriting fee. The listening agent, who is normally the lead manager, makes an application to the stock exchange for listing.
The agent guides the issuing company and helps it file the required documents with the stock exchange. After the formalities are complete, GDRs are traded on the stock exchange. There are also international clearing houses, such as Euro-clear and CEDEL that facilitate the settlement of transactions. Voting rights The question of voting rights is also important. Since GDR investors keep changing from time to time, they do not seem very much interested in the voting rights even though these cannot be denied to them. There are different procedures followed in this respect.
One is that the issuing company and the overseas depository enter into an agreement which enables a depository to vote either with the majority voters or according to the wishes of the management. In the other procedure, it is understood that the depository votes in the same proportion as the rest of the shareholders do. Again, there is one more alternative where the depository votes in accordance with the instructions of a nominee of the management. The cost of issue The cost of international equity is normally not large, although commission, management fee, etc. re paid to the lead manager according to the different functions performed by it. The depository incurs some expenses. These approximate to 3-4 per cent of the issue amount. Documentation There are many documents used in the process of the issue of international equity. These are: 1. The prospectus containing detailed information about the issue and the issuer, 2. The depository agreement— the agreement between the issuing company and the depositor;—that contains, among other things, the rules followed for converting the shares into GDRs and back. . The underwriting agreement concluded between the issuing company and the underwriter, normally the lead manager, accompanies the issue. 4. A copy of the agreement concluded between the custodian and the depository is also enclosed. 5. A copy of the trust deed is enclosed which provides for the duties and responsibilities of the trustee regarding servicing of the issue. 6. A copy of the agreement with the Listing stock exchange is annexed so that the investors are well aware of the secondary market for the issue.
Besides, a subscription agreement is also enclosed by means of which the lead manager and the syndicate members agree to subscribe to the issue. INTERNATIONAL BONDS International bonds are a debt instrument. They are issued by international agencies, governments and companies for borrowing foreign currency for a specified period of time. The issuer pays interest to the creditor and makes repayment of capital. There are different types of such bonds. The procedure of issue is very specific. All these need some explanation here. Types of International Bonds
Foreign bonds and Euro bonds International bonds are classified as foreign bonds and Euro bonds. There is a difference between the two, primarily on four counts. Firstly, in the case of foreign bond, the issuer selects a foreign financial market where the bonds are issued in the currency of that very country. If an Indian company issues bond in New York and the bond is denominated in US dollar, it will be called a foreign bond. On the contrary, in the case of Euro bonds, they are denominated in a currency other than the currency of the country where the bonds are issued.
If the Indian company’s bond denominated in US dollar, the bonds will be issued in any country. Other than the U. S. A. then only it will be called euro bond. Secondly, foreign bonds are underwritten normally by the underwriters of the country where they are issued. But the Euro bonds are underwritten by the underwriters of multinationality. Thirdly, the maturity of a foreign bond is determined keeping in mind the investors of a particular country where it is issued. On the other hand, the Euro bonds are tailored to the needs of the multinational investors.
In the beginning, the Euro bond market was dominated by individuals who had generally a choice for shorter maturity, but now the institutional investors dominate the scene who do not seek Euro bond maturuy necessarily to match their liabilities. The result is that the maturity of Euro bonds is diverse. In England, Euro bonds with maturity between 8 and 12 years are known as intermediate Euro bonds Fourthly, foreign bonds are normally subjected to governmental regulations in the country where they are issued. For example, in the case of Yankee bonds (the bonds issued in the USA), the regulatory thrust lies on disclosures.
In some of the European countries, the thrust lies on the resource allocation and on monetary control. Samurai bonds (bonds issued in Japan) involved minimum credit-rating requirements prior to 1996- But the Euro bonds are free from the rules and regulations of the country where they are issued. The reason is that the currency of denomination is not the currency of that country and so it does not have a direct impact on the balance of payments. Global bonds It is the World Bank which issued the global bonds for the first time in 1989 and 1990.
Since 1992, such bonds are being issued also by companies. Presently, there are seven currencies in which such bonds are denominated, namely, the Australian dollar. Canadian dollar, Japanese yen, Swedish krona and Euro. The special features of the global bonds are: ? They carry high ratings. ?They are normally large in size. ?They are offered for simultaneous placement in different countries. ?They are traded on “home market” basis in different regions. Straight bonds The straight bonds are the traditional type of bonds. In this case, interest rate is fixed.
The interest rate is known as coupon rate. It is fixed with reference to rates on treasury bonds for comparable maturity. The credit standing of the borrower is also taken into consideration for fixing the coupan rate. Straight bonds are of many varieties. Firstly, there is bullet redemption bond where the repayment of principal is made at the end of the maturity and not in installments every year. Secondly, there is rising coupan bond where coupon rate rises over time. The benefit is that the borrower has to pay small amount of interest payment during early years of debt.
Thirdly, there is zero-coupon, bond. It carries no interest, payment- But since there is no interest payment, it is issued at discount. It is the discount that compensates for the loss of interest faced by the creditors. Such bond was issued for the first time in 1981. Fourthly, in case of bond with currency options, the investor has the right to receive payments in a currency other than the currency of the issue. Fifthly, bull and bear bonds are indexed to some specific benchmark and are issued in two branches. The bull bonds are those where the amount of redemption rises with a rise in the index.
The bear bonds are those where the amount of redemption falls with a fall in the index. Finally, debt warrant bonds have a call warrant attached with them. (Warrants are zero-coupon bonds. ) The creditors have the right to purchase another bond at a given price. Floating-rate notes Bonds, which do not carry fixed rate of interest, are known as floating- rate notes (FRNs). Such bonds were issued for the first time in Italy during 1970 and they have become common in recent times. The interest rate is quoted as a premium or discount to a reference rate which is invariably LIBOR.
The interest rate is revised periodically, say, at every three-month or every six month period, depending upon the period to which the interest rate is referenced to. For example, if the interest rate is referenced” to one-month LIBOR, it would be revised every month. FRNs are available in different forms. In the case of perpetual FRNs, the principal amount is never repaid. This means they are like equity shares. ‘They were popular during mid-1980s, but when the investors began to ask for higher rate of interest, many issuers could not afford paying higher rates of interest. Such bonds lost their popularity.
Secondly, there are minimax FRNs where minimum and maximum rates are mentioned. The minimum rate is beneficial for the investors, while the maximum rate is beneficial for the issuer. If LIBOR rises beyond the maximum rate, it is only the maximum rate that is payable. Similarly, the minimum rate is payable even if LIBOR falls below the minimum. The third form is the drop lock FRN where the investor has the right to convert the FRN into a straight bond. Sometimes the conversion is automatic if the reference rate drops below a mentioned floor rate. Fourthly, there flip-flap FRN. It was first issued by the World Bank.
In this case, the investor has the option of converting FRN into a three-month note with a flat three-month yield. Again, the note can be converted into a perpetual note after the completion of the three-month period. Fifthly, there are mismatch FRNs. In this case, the interest rate is fixed monthly, but interest is paid six-monthly. In such a situation, the investor may go for arbitrage on account of difference in interest rates. Such FRNs are also known as rolling-rate FRNs. Sixthly, one of the recent innovations has come in form of hybrid fixed rate reverse floating rate notes.
They were used in Deutsch mark segment of the market in 1990. These instruments paid a high fixed interest rate for a couple of years. The investors received the difference between LIBOR and even a higher fixed interest rate. They reaped profits with the lowering of LIBOR. Convertible bonds International bonds are also convertible bonds meaning that these variants convertible are convertible into equity shares. Some of the convertible bonds have detachable warrants involving acquisition rights. In other cases, there is automatic convertibility into a specified number of shares.
Convertible bonds command a comparatively high market value because of the convertibility privilege. The value is the sum of the naked value existing in the absence of conversion and the conversion value. The conversion price per share is computed by dividing the bond’s face value by the conversion factor, where the conversion factor represents the number of shares into which each bond could be exchanged. Suppose, a bond having a face value of $ 1,000 can be exchanged for 15 shares, the conversion price will be equal to: $ 1,000/15 = $ 66. 66 Thus, if the market price of share is less than $ 66. 6, say $ 60, bond-holders will not be interested in converting the bond into equity share. This is so because for a bond of $ 1,000, a creditor will get 15 shares or $ 900 only. But if the market price of share is $ 80, the investors will convert the bond into equity shares and sell the equity shares in the market. This way each bond for $ 1,000 will fetch $ 1,200. In other words, the price of convertible bonds depends upon the price of the equity shares. In the case of bonds with detachable warrants, the warrant can be detached from the bond and can be traded independently. The issuer has a double source of financing.
The bonds remain outstanding even if the warrants are exercised. From the viewpoint of the borrowers, convertible bonds cost less because they have lower coupon. They also help decrease the debt-equity ratio after conversion. From the investors’ point of view, convertible bonds represent a better option as the investors get a fixed income in the form of interest prior to conversion. After conversion, they become the owner of the company. Cocktail bonds Bonds arc often denominated in a mixture of currency. Such bonds are known as cocktail bonds. The SDR bonds represent a weighted average of four currencies.
The investors purchasing the cocktail bonds get automatically the currency diversification benefits. The foreign exchange risk on account of depreciation of any one currency is offset by appreciation of another currency. Procedure of Issue Stage 1 There are different stages involved in the issue of international bonds. Since the issuer—normally a government or a company—does not have a detailed idea about the international financial market, nor it is easy for the issuer to perform several formalities, it approaches a lead manager who advises the issuer on different aspects of the issue.
Normally, the lead manager is a commercial bank or an investment bank. The issuer selects a particular lead manager on the reports published by different agencies about the performance of the investment banks in the area of lead managing. The lead manager advises the issuer regarding the main features of the issue, the timing, price, maturity and the size of the issue and about the buyers potential. The lead manager takes help from the co-managers, although the bulk of the work is done by itself. After getting advice from the lead manager, the issuer prepares the prospectus and other legal documents.
In this process, the issuer’s own accountant, auditor, legal counsel are very important for designing the issue in accordance with the financial need of the company as well as with regulatory provisions existing in the country. Sometimes the advice of the lead manager is also sought in order to make the issue suitable for indicators prevailing in the international financial market. The lead manager charges fee for the advice. The fee is known as management fee. When all this is over, the issuer takes approval from the regulatory authorities. After the approval, it launches the issues. Stage 2
The second stage begins when the issue is launched. Investors look at the credit-rating of the issuer as well as who is underwriting the issue. This is why the lead manager along with co-managers helps in the credit-rating of the issuer by a well-recognised credit-rating institution. At the same time, it function as an “underwriter and charges underwriting fee. Stage 3 The third stage begins after the underwriting process is complete. This stage includes the process of selling the bonds. More often, the lead manager functions as a selling group and for that it charges commission at varying rates.
The investors, on the other end, are individuals. They are institutions, such as investment trust, banks and companies. They often purchase the bond through their buying agents. There are also trustees who are usually a bank appointed by the issuer. Their duty is to protect the interest of the investors, especially in case of default by the borrower. Sometimes the lead manager acts as a trustee. Finally, there are listing institutions. They enlist the bonds for secondary marketing. The secondary market for international bonds is mainly an over-the-counter market, although the bonds are listed with the stock exchanges.
It may be noted that the entire procedure of the international bond issue is complete within a specified time span. After the press release of the prospectus, it takes 27 days. The first 12 days are spent on sales campaign which is known as the offering period. On the 12th day, underwriting agreement is signed, which is known as the pricing day. During the following 15 days, bonds are sold and delivered and the necessary payments made. Documentation Documentation requirements for a bond issue are complex. There are seven documents that are required. The first is the prospectus.
It informs about the issuer, its management and about its past, present and future operation. It also covers the political and economic make-up of the country. The second is the subscription agreement. It comprises denomination, coupon rate, issue price, and maturity of the bond, underwriting commitments, details of selling arrangements, closing date and the terms of payment, names of the paying agents and trustees, details of listing, conditions under which agreement can be terminated, the legal jurisdiction and rules regarding compensation in case of misrepresentations or breach of warranties.
The third important document is the trust deed which is an agreement between the issuer and the trustee for an orderly servicing of the bond. The fourth document is the listing agreement that shows listing centres. The fifth document is the paying agency agreement executed between the issuer and the bank that pays the agent for servicing of the bond. The sixth document is the underwriting agreement that brings in confidence among the investors. The last document is a copy of the selling group agreement that tells about the agencies involved in the sale of the bond.
All these documents accompany the bond certificate. Chapter – 3 GLOBAL DEPOSITORY RECEIPT IN INDIA EURO ISSUE Euro issue is an international source of finance for the Indian companies. Under such an issue, securities are issued in some foreign currency and are offered for sale internationally. That means private and corporate investors in different countries can purchase securities put for sale under an Euro issue by an Indian company. An Euro issue is different from a foreign issue under which securities are denominated in Rupee (i. . , the currency of the country of is me) and are aimed at the investors in the country where the issue is made. The term “Euro market/issue” is not confined to the European countries only, rather it has got an international character now. The two major instruments which are floated in the Euro-capital markets are bonds and equity shares. As a par. of the globalisation of the Indian economy after 1991, the Government of India allowed Indian companies to float their securities in the Euro markets to raise funds in foreign currencies.
Over the years, several Indian companies have raised capital from the Euro markers by issuing Global Depository Receipts (GDRs) and Foreign Currency Convertible Bonds (FCCBs). These too instruments are commonly referred to as Euro issues. Euro issues are treated as foreign direct investments (FDIs) in the issuing company and are subject to the Government policy concerning FDIs. In some cases, the issuing company has to obtain prior clearance of the Euro-issue from ‘the ‘Foreign Investment Promotion Board’ (FIPB). Each Euro issue must be approved by the Ministry of Finance, Government of Indian. Global Depository Receipts (GDRs)
A GDR is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stock exchange. For instance, GDRs issued by Reliance Industries were listed in the New York Stock Exchange in 1992. A GDR represents a: number of shares of the issuing company, registered in India. A holder of GDR can at any time convert it into the number of shares that it represents. Once conversion takes place, the: underlying shares are listed and traded on some Indian stock exchange. GDRs do not carry any voting rights unless they are converted into shares (in Indian Rupees).
However, dividend on GDRs is to be said in Rupees only as in case of equity shares. Thus there is no risk of fluctuation in the rates of: foreign exchange. Moreover, on conversion of GDRs into equity shares, no remittance is to be made by the company as in the case of-redemption of bonds. A Global Depository Receipt (GDR) is issued in the form of a depository receipt/certificate created by the Overseas Depository Bank (ODB) outside India and issued to non¬ resident investors against the issue of ordinary shares or foreign currency convertible debentures (FCCDs) of the issues company.
The ODE is the bank authorised by the issuing company to issue GDRs against its issue of ordinary shares or FCCDs. The issued shares or debentures are delivered by the issuing company to a Domestic Custodian Bank (DCB) who would request the ODB to issue GDRs (or ADRs) to the foreign’ investors. American Depository Receipts (ADRs) An ADR is just like a GDR except that it can be issued to the USA citizens only and can be listed and traded on a stock-exchange of the USA. Thus, ADRs are issued on behalf of an Indian company for raising funds from the investors of the USA.
Like GDR, ADRs are also treated as foreign direct investment (FDI) in the issuing company. ADRs are issued by an American Depository Bank certifying that shares of some non-USA based company (say Indian company) are held by some custodian bank in the home country. These may be listed on New York Stock Exchange, American Stock Exchange or Nasdaq. An ADR represents specified number of shares of the issuing company. It does not carry voting rights. A holder of ADRs can at any time convert them into the number of shares they represent. After conversion, shares are listed and traded on the domestic (i. . Indian) stock exchanges. The dividend on ADRs is payable in the Indian currency, i. e. , Rupee. That means there is no outflow of any foreign exchange, like GDRs, ADRs can also be issued within the framework of the guidelines issued by the Ministry of Finance (Government of India) from time to time. The procedure for the issue of ADRs is quite similar to the issue of GDRs. Foreign Currency Convertible Bonds (FCCBs) FCCBs are basically equity linked debt securities, to be converted into equity or depository receipts after a specific period.
Thus, a holder of FCCBs has the option of either converting them into equity shares, normally at a predetermined price and even at a predetermined exchange rate or retaining the bond. The FCCBs carry a fixed rate of interest, which is lower than the rate of any other similar non-convertible debt instrument. They can be traded conveniently and at the same time the issuing company can avoid any dilution in earnings per share. Also, they can still be traded on the basis of underlying equity value. FCCBs can be freely traded and the issuing company has no control over the transfer mechanism and is not even aware of the ultimate beneficiary.
The convertible bonds provide an opportunity to the holders to participate in the capital growth of a company, fill the time a bond-holder holds the bonds, he gets: a fixed return and in case he chooses to convert them into equity, he will earn a capital gain. Thus, the convertible bonds offer a mixture of the characteristics of the fixed interest and equity shares. Another advantage accruing lo the investor is that the bonds can be issued in a currency different from the currency in which the shares of the company are denominated.
This feature enables the option of diversifying currency risks. FCCHs are very much like the Convertible Debentures (CDs) issued in India, FCCBs are issued in a foreign currency and carry a fixed interest or coupon rate. They are convertible into equity shares at the prefixed price, FCCBs are listed a rid traded in foreign stock exchanges. The Depository Receipts Mechanism As mentioned above, the volume of new equity issues in the international markets increased dramatically between 1983 and 1987 and again after 1989. The ’90s saw a growing interest in the emerging markets.
From the side of the issuers, the driving force was the desire to tap low-cost sources of financing, broaden the shareholder base, acquire a springboard for international activities such as acquisitions and generally improve access to long-term funding. From the point of view of investors, the primary motive has been diversification. From the issuer’s point of view, the major considerations are the price at which the issue can be placed, costs of issue and factors related to taxation (such as withholding tax which can affect the attractiveness of the issue to investors).
As we have seen above, if the international markets were integrated, a given stock would be priced identically by all investors and there would be no advantage in choosing one market over another, apart from cost of issue considerations. However, with segmented markets, the price that can be obtained would vary from one market to another. Countries with high saving rates such as Japan (and those like Switzerland with access to others investible funds) would normally have low cost of equity. However, some of these markets may not be readily accessible except to very high quality issuers.
When the issue size is large, the issuer may consider a simultaneous offering in two or more markets. ” Such issues are known as Euroequities. Issue costs are an important consideration. In addition to the underwriting fees (which may be in the 3-5% range), there are substantial costs involved in preparing for an equity issue particularly for developing country issuers unknown to developed country investors. Generally speaking, issue costs tend to be lower in large domestic markets such as the US and Japan.
During the late ’80s, a number of European and Japanese companies have got themselves listed on foreign stock exchanges such as New York and London. Shares of many firms are traded indirectly in the form of depository receipts. In this mechanism, the shares issued by a firm are held by a depository, usually a large international bank, which receives dividends, reports etc. and issues claims against these shares. These claims are called depository receipts with each receipt being a claim on a specified number of shares. The depository receipts are denominated in a convertible currency, usually US dollars.
The depository receipts may be listed and traded on major stock exchanges or may trade in the OTC market. The issuer firm pays dividends in its home currency. This is converted into dollars by the depository and distributed to the holders of depository receipts. This way the issuing firm avoids listing fees and onerous disclosure and reporting requirements which would be obligatory if it were to be directly listed on the stock exchange. This mechanism originated in the US, the so-called American Depository Receipts or ADRs.
Recent years have seen the emergence of European Depository Receipts (EDRs) and Global Depository Receipts (GDRs) which can be used to tap multiple markets with a single instrument. Transactions in depository receipts are settled by means of computerised book transfers in international clearing systems such as Euroclear and Cedel. After a hesitant start in 1992 following the experience of the first ever GDR issue by an Indian corporate, a fairly large number of Indian companies took advantage of the improved market outlook to raise equity capital in international markets.
During the period April 1992 to 1994, almost 30 companies are estimated to have raised a total of nearly US$3 billion through GDR issues. The fiscal year 1993-94 in particular saw a spate of offerings. The fever abated thereafter for a couple of years. There appeared to be a mild revival in 1996 which died away again with the collapse in Asia. The structure of a typical GDR issue is shown in Exhibit A. STRUCTURE OF GDR ISSUE [Exhibit – A ] From the point of view of the issuer, GDRs represent non-voting stock with a distinct identity which do not exhibit in its books.
There is no exchange risk since dividends are paid by the issuer in its home currency. The device allows the issuer to broaden its capital base by tapping large foreign equity markets. The risk is that the price of GDRs may drop sharply after issue due to problems in the local markets and damage the issuer’s reputation which may harm future issues. From the investors’ point of view, they achieve portfolio diversification while acquiring an instrument which is denominated in a convertible currency and is traded on developed stock markets.
Of course, the investors bear exchange risk and all the other risks borne by an equity holder (dividend uncertainty, capital loss). There are also taxes such as withholding taxes on dividends and taxes on capital gains. For instance, the Indian government imposes a 10% withholding tax on dividends and a 65% maximum marginal capital gains tax on short term capital gains (tax on long term capital gains is only 10% thus encouraging the investor to hold on to the stock). A major problem and concern with international equity issues is that of flowback, i. e. the investors will sell the shares back in the home stock market of issuing firm.
Authorities of some countries have imposed a minimum lock-in period during which foreign investors cannot unload the shares in the domestic market. Withholding taxes on dividends paid to non-residents reduces the attractiveness of the asset to foreign shareholders and consequently raises the cost to the issuer. Some giant multinationals have used the device of a finance subsidiary located in a tax haven country like the Bahamas to issue shares in the international markets. The usefulness and feasibility of this vehicle depends upon the tax laws and other regulations in the issuer’s home country.
During 1993-94, GDR issues were a very popular device for many large Indian companies. Yields in developing country markets were rather low and many Indian issues offered attractive returns along with diversification benefits. The economic liberalization policy of the government made Indian issues an attractive investment vehicle for foreign investors. In subsequent years, a variety of problems with the workings of the Indian capital markets – lack of adequate custodial and depository services, long settlement periods, delivery and payment delays, suspicions of price rigging etc. led to the wearing off of investor enthusiasm. Added to these factors was increasing political uncertainty as the elections were approaching. From roughly mid 1994 to nearly the end of 1995, market for Indian GDR issues remained lukewarm. There was some revival of investors interest thereafter but the Asian crisis in 1997 drove investors away from all emerging markets. Starting in 1999, a number of Indian IT companies have been successfully listed on US stock exchanges and their ADRs had been performing quite well till the NASDAQ nose-divided in late 2000-early 2001.
The global stock markets are becoming increasingly integrated at least as far as investor sentiment is concerned and the NASDAQ appears to drive markets around the world. Exhibit B gives a simple list of Indian corporates who have accessed the GDR-ADR market over the period 1992-2000. SOME INDIAN ADR/GDR ISSUES CompanyIndustry SegmentDate of IssueSize of the Issue (USD Million) Arvind MillsTextilesFeb. 1994125 Ashok LeylandAutoMar-1995138 Century TextilesDiversifiedSep-1994100 Crompton GreavesElectricalJul-199650 Dr. Reddy’sPharmaJul-199448 GE ShippingShippingFeb-1994100
Indian HotelsHotelsApr-199586 Indo GuffFertilizers Jan-1994100 ICICIFinance Sep-1999315 InfosysITMar-199970 L & TDiversifiedMar-1996135 Maha & MahAutoNov-199375 RelianceDiversifiedMay-1992150 Satyam InfowayITOct-199975 VSNLTelecomMar-1997527 WiproITOct-2000131 [Exhibit – B] INDIA’s TOPS LIST OF GDR FUND RAISERS India has topped the list of countries which tapped the overseas depository receipt market so far. As many as 61 companies have raised $ 6. 22 billion from the global markets so far, accounting for 21. 90 per cent of the money raised through the depository receipt route.
According to Skindia Finance, $ 28. 41 billion (Rs 10,162. 429 crore) has been raised globally by 350 corporates through depository receipts under rule 144 A till 1996. “India has floated the largest number of GDR issues, followed by Mexico with 29 and the United Kingdom with 27,” it said. The largest number of issues were made by the banking sector with 35, followed by utilities with 32 issues and chemicals with 18. In terms of amount raised, the banking sector tops again raising $ 4,028. 42 million, followed by utilities with $ 2,660. 56 million and telecom $ 2,620. 1 million. Many Indian companies, especially public sector companies like IOC, GAIL and MTNL have planned GDR issues. However, no major issue has been launched after the mega issue by VSNL three months ago. In the meantime, even as the BSE sensex touched a new 52-week high of 4,395. 31 (intra-day trading) on July 2, the GDR market did not show the same enthusiasm during the week as the Skindia GDR Index moved in a narrow range. Share price shot up in the domestic market due to frantic buying by foreign funds and cumulative net FIIs inflows crossed the $ 8 billion mark.
As a result, 64 GDRs gained an average of 1. 07 per cent and their underlying shares 2. 74 per cent. In the last two weeks, the Skindia GDR Index has gained 0. 18 per cent as compared to a 5. 02 per cent increase in the BSE sensex. This has resulted in the Skindia GDR Index Premium falling to 21. 66 per cent from an all-time high of 35. 24 (June 13). The net profit of Tata Electric Companies plunged 48. 20 per cent to Rs 229. 77 crore in 1996-97. The increased expenditure of Rs 99 crore on account of hike in tariff rates by MSEB resulted in this decline in net profit.
On announcement of results, its GDR remained unchanged at $ 4. 50 but its underlying shares fell 3. 38 per cent to Rs 133. The turnover in the domestic market increased by 22. 54 per cent to Rs 3. 97 crore BSES has experienced a 22. 94 per cent increase in its net profit of Rs 213. 30 crore. The news did not have any impact on its GDR which remained unchanged at $ 27. 00 while its underlying share fell 0. 10 per cent to Rs 238. TAX ON INCOME FROM BONDS OR GLOBAL DEPOSITORY RECEIPTS PURCHASED IN FOREIGN CURRENCY OR CAPITAL GAINS ARISING FROM THEIR TRANSFER 115AC. 1) Where the total income of an assessee, being a non-resident, includes (a)income by way of interest on bonds of an Indian company issued in accordance with such scheme as the Central Government may, by notification in the Official Gazette, specify in this behalf, or on bonds of a public sector company sold by the Government, and purchased by him in foreign currency; or (b)income by way of dividends, other than dividends referred to in [section 115-O,] on Global Depository Receipts i)issued in accordance with such scheme as the Central Government may, by notification in the Official Gazette8, specify in this behalf, against the initial issue of shares of an Indian company and purchased by him in foreign currency through an approved intermediary; or (ii)issued against the shares of a public sector company sold by the Government and purchased by him in foreign currency through an approved intermediary; or iii)[issued or] re-issued in accordance with such scheme as the Central Government may, by notification in the Official Gazette, specify in this behalf, against the existing shares of an Indian company purchased by him in foreign currency through an approved intermediary; or (c)income by way of long-term capital gains arising from the transfer of bonds referred to in clause (a) or, as the case may be, Global Depository Receipts referred to in clause (b), the income-tax payable shall be the aggregate of i)the amount of income-tax calculated on the income by way of interest or dividends [, other than dividends referred to in section 115-O], as the case may be, in respect of bonds referred to in clause (a) or Global Depository Receipts referred to in clause (b), if any, included in the total income, at the rate of ten per cent; (ii)the amount of income-tax calculated on the income by way of long-term capital gains referred to in clause (c), if any, at the rate of ten per cent; and iii)the amount of income-tax with which the non-resident would have been chargeable had his total income been reduced by the amount of income referred to in clauses (a), (b) and (c). (2) Where the gross total income of the non-resident (a)consists only of income by way of interest or dividends [, other than dividends referred to in section 115-O] in respect of bonds referred to in clause (a) of sub-section (1) or, as the case may be, Global Depository Receipts referred to in clause (b) of that sub-section, no deduction shall be allowed to him under sections 28 to 44C or clause (i) or clause (iii) of section 57 or under Chapter VI-A; b) includes any income referred to in clause (a) or clause (b) or clause (c) of sub-section (1), the gross total income shall be reduced by the amount of such income and the deduction under Chapter VI-A shall be allowed as if the gross total income as so reduced, were the gross total income of the assessee. (3) Nothing contained in the first and second provisos to section 48 shall apply for the computation of long-term capital gains arising out of the transfer of long-term capital asset, being bonds or Global Depository Receipts referred to in clause (c) of sub-section (1). 4) It shall not be necessary for a non-resident to furnish under sub-section (1) of section 139 a return of his income if (a)his total income in respect of which he is assessable under this Act during the previous year consisted only of income referred to in clauses (a) and (b) of sub-section (1); and (b) the tax deductible at source under the provisions of Chapter XVII-B has been deducted from such income. 5) Where the assessee acquired Global Depository Receipts or bonds in an amalgamated or resulting company by virtue of his holding Global Depository Receipts or bonds in the amalgamating or demerged company, as the case may be, in accordance with the provisions of sub-section (1), the provisions of that sub-section shall apply to such Global Depository Receipts or bonds. Explanation. For the purposes of this section, a)approved intermediary means an intermediary who is approved in accordance with such scheme as may be notified by the Central Government in the Official Gazette; (b)Global Depository Receipts shall have the same meaning as in clause (a) of the Explanation to section 115ACA. ] 115ACA. [(1) Where the total income of an assessee, being an individual, who is a resident and an employee of an Indian company engaged in specified knowledge based industry or service, or an employee of its subsidiary engaged in specified knowledge based industry or service (hereafter in this section referred to as the resident employee), includes a)income by way of dividends [, other than dividends referred to in section 115-O,] on Global Depository Receipts of an Indian company engaged in specified knowledge based industry or service, issued in accordance with such Employees Stock Option Scheme as the Central Government may, by notification in the Official Gazette, specify in this behalf and purchased by him in foreign currency; or (b)income by way of long-term capital gains arising from the transfer of Global Depository Receipts referred to in clause (a), the income-tax payable shall be the aggregate of i)the amount of income-tax calculated on the income by way of dividends 16[, other than dividends referred to in section 115-O,] in respect of Global Depository Receipts referred to in clause (a), if any, included in the total income, at the rate of ten per cent; (ii)the amount of income-tax calculated on the income by way of long-term capital gains referred to in clause (b), if any, at the rate of ten per cent; and (iii)the amount of income-tax with which the resident employee would have been chargeable had his total income been reduced by the amount of income referred to in clauses (a) and (b).
Explanation. For the purposes of this sub-section, (a)specified knowledge based industry or service means (i)information technology software; (ii)information technology service; (iii)entertainment service; (iv)pharmaceutical industry; (v)bio-technology industry; and (vi)any other industry or service, as may be specified by the Central Government, by notification in the Official Gazette; (b)subsidiary shall have the meaning assigned to it in section 4 of the Companies Act, 1956 (1 of 1956) and includes subsidiary incorporated outside India. ] (2) Where the gross total income of the resident employee a)consists only of income by way of dividends [, other than dividends referred to in section 115-O,] in respect of Global Depository Receipts referred to in clause (a) of sub-section (1), no deduction shall be allowed to him under any other provision of this Act; (b)includes any income referred to in clause (a) or clause (b) of sub-section (1), the gross total income shall be reduced by the amount of such income and the deduction under any provision of this Act shall be allowed as if the gross total income as so reduced were the gross total income of the assessee. 3) Nothing contained in the first and second provisos to section 48 shall apply for the computation of long-term capital gains arising out of the transfer of long-term capital asset, being Global Depository Receipts referred to in clause (b) of sub-section (1). Explanation. For the purposes of this section, (a)Global Depository Receipts means any instrument in the form of a depository receipt or certificate (by whatever name called) created by the Overseas Depository Bank outside India and issued to non-resident investors against the issue of ordinary shares or foreign currency convertible bonds of issuing company; b)information technology service means any service which results from the use of any information technology software over a system of information technology products for realising value addition; (c)information technology software means any representation of instructions, data, sound or image, including source code and object code, recorded in a machine readable form and capable of being manipulated or providing inter-activity to a user, by means of an automatic data processing machine falling under heading information technology products but does not include non-information technology products; d)Overseas Depository Bank means a bank authorised by the issuing company to issue Global Depository Receipts against issue of Foreign Currency Convertible Bonds or ordinary shares of the issuing company. ] 115AD. (1) Where the total income of a Foreign Institutional Investor includes [(a)income [other than income by way of dividends referred to in section 115-O] received in respect of securities (other than unit referred to in section 115AB); or] (b)income by way of short-term or long-term capital gains arising from the transfer of such securities, the income-tax payable shall be the aggregate of i)the amount of income-tax calculated on the income in respect of securities referred to in clause (a), if any, included in the total income, at the rate of twenty per cent; (ii)the amount of income-tax calculated on the income by way of short-term capital gains referred to in clause (b), if any, included in the total income, at the rate of thirty per cent : [Provided that the amount of income-tax calculated on the income by way of short-term capital gains referred to in section 111A shall be at the rate of ten per cent;] iii)the amount of income-tax calculated on the income by way of long-term capital gains referred to in clause (b), if any, included in the total income, at the rate of ten per cent; and (iv)the amount of income-tax with which the Foreign Institutional Investor would have been chargeable had its total income been reduced by the amount of income referred to in clause (a) and clause (b). (2) Where the gross total income of the Foreign Institutional Investor a)consists only of income in respect of securities referred to in clause (a) of sub-section (1), no deduction shall be allowed to it under sections 28 to 44C or clause (i) or clause (iii) of section 57 or under Chapter VI-A; (b)includes any income referred to in clause (a) or clause (b) of sub-section (1), the gross total income shall be reduced by the amount of such income and the deduction under Chapter VI-A shall be allowed as if the gross total income as so reduced, were the gross total income of the Foreign Institutional Investor. 3) Nothing contained in the first and second provisos to section 48 shall apply for the computation of capital gains arising out of the transfer of securities referred to in clause (b) of sub-section (1). Explanation. For the purposes of this section, (a)the expression Foreign Institutional Investor means such investor as the Central Government may, by notification in the Official Gazette, specify in this behalf; b)the expression securities shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956). ] Chapter – 4 FOREIGN PORTFOLIO INVESTMENT INTRODUCTION: Foreign investment has long been a subject of interest. This interest has renewed in recent years due to a number of reasons. One of them is the rapid growth in global foreign investment flows in the 1990s. Another reason is the possibility offered by foreign investment for channeling resources to developing countries.
Although the components of foreign portfolio investment (FPI) in the total capital inflows into developing countries has not been a significant, its relative importance (FPI) may increase now since many countries have very limited access to other sources of financing. This chapter begins with a discussion on the foreign portfolio investment as an alternative source and highlights the trends and compositional shifts to capital flows in respect of the developing countries and traces their major determinants as well as their implications for growth.
Foreign Portfolio Investment: As An Alternative Source The foreign portfolio investment (FPI) is emerging alternative source of international financing with a higher future potential. Foreign investors provide permanent finance through equity capital that bolsters domestic companies without reducing local control of the venture, since portfolio investors do not seek participation in management. If required, governments can restrict portfolio investments to a certain percentage of shares to prevent foreigners from gaining control of management.
At the same time, the company concerned is less vulnerable to interest rate changes. High-debt equity ratios are reduced and leverage improves. There are also advantages at the macro-economic level since local capital markets can expand and modern business techniques are introduced which help to increase their efficiency. The professional investor is today faced with a multiplicity of options and markets to choose from.
Any effective context against which any investment decision can be made is the macro- economic one. The economic contribution of securities markets must be seen in a wider context than simply the raising of funds for investment in long-term assets. A well functioning equity market-provides an additional channel for encouraging and mobilizing domestic savings and an alternative to bank deposits, real estate investment and the financing of consumption loans; fosters the growth of the omestic financial services sector and the various forms of institutional savings such as life insurance and pensions; provides savers with better protection than most debt instruments against inflation and currency depreciation and thus alleviates two or the major reasons encouraging the flight of domestic capital abroad as well as providing attractive vehicles for repatriating flight capital; increases the overall efficiency of investment since public exposure of company performance focuses attention of corporate management on the return on capital and encourages higher standards of accounting, financial planning and corporate disclosure.
This also facilitates the entry of domestic enterprise into international capital markets; improves the gearing of the domestic corporate and helps reduce corporate dependence on borrowing: thus making the financial system more solvent; equity provides a cushion for companies against the variability of cash flows and even possible losses; and it is a permanent source of funds which does not require fixed payments; improves access to finance for new and smaller companies and encourages institutional development in facilitating the setting up of domestic mutual funds and venture capital, funds and encourages public flotation of private companies, thus increasing the supply of assets available for long-term investment.
There are obvious problems in emerging (as well as mature) markets: potentially high levels of instability caused by market over-reaction and confidence factors; high costs, especially where intermediation (underwriting, dealing, broking) is underdeveloped; and the manipulation of markets and individual shareholders where supervision and regulation is inadequate. In addition to economic and political fundamentals, among the key qualities investors look for in “suitable” stock is tradeability (liquidity). There is a widely perceived shortage of stocks in emerging markets that meet this criterion. This partly reflects the neglect of equity markets in general. It also reflects the fact that, among the stocks listed in the markets, many are in fact not traded or tradeable.
Another potential problem frequently encountered in developing stock markets in the lack of float, the percentage of a company’s capital available for stock market trading to outside investors rather than being held by the major existing owners. Although welcome, the portfolio investment has raised new issues of macroeconomic and financial management for economic policy makers. First, how best to manage the macro-economic effects of large capital inflows manifested in terms of real exchange rate appreciation or the monetary implications of substantial reserves accumulation? And second, how to factor in the dislocation that might be caused by changes in external financial conditions and a sadden withdrawal of these flows? These are valid concerns which, more than ever, will require sound and responsive economic policies.
These concerns also reflect the fact that tolerance of poor policies is sharply reduced and that markets will provide earlier warning signals in a world where financial markets are increasingly integrated. Foreign Portfolio Investment Flows to Developing Countries One of the major forces changing the face and structure of international capital markets since 1990s has been the flow of cross border portfolio investments – especially by FIIs, from developed countries to the developing countries. The process has been reinforced by the ongoing abolition of impediments and capital controls and the widespread liberalisation of financial markets in developing countries during the 1990s.
Not surprisingly, there is ample evidence of high and increasing degree of international capital mobility. A striking feature of the enlarged capital flows to developing countries in recent period is the private (debt and equity) flows as opposed to official flows, have become a dominant source of financing large current account imbalances. Another noteworthy feature has been shift away from debt flows to equity flows. Private capital flows appear, however, to be concentrated in a few emerging market economies. At present, portfolio investors have been providing institutional character to the capital markets, flavoured by highly intensive research and diversified investments.
F1I investments are injecting global liquidity, into the markets, raise the price-earning ratio and thereby reduce the cost of capital. Available evidence suggests a positive relationship between portfolio flows and the growth rate of an economy. Although the issue is far from settled, some studies have also pointed out that foreign portfolio investment in equities promotes (inhibits) growth in countries with comparatively large (small) equity markets and limited (pervasive) corruption. From the perspective of FIIs, investments in various countries