The economic boom from 2004 through 2011 saw many issues of equity and debt in capital markets, such as IPOs, preferential allotments, NCDs, GDRs and FCCBs. When Lehman Brothers hit in 2008, the capital markets in India began to slow down. While Indian companies still raise funds through IPOs and preferential allotments, the fund raise through GDRs and FCCBs dwindled.
During the economic boom, Indian companies did not contemplate that they will have to redeem the FCCBs and were confident that they will be converted into shares. However, given the financial depression in 2008 and the FCCB holders asking for redemption, Indian companies started defaulting in repayments and the FCCB holders began to initiate winding-up proceedings against the Indian companies. This has eroded investors trust in Indian companies and thereafter, investors subscribing to FCCBs were few and far between.
Understanding the previous norms and framework of the DR Scheme 2014 and reasons why it didn’t take off successfully
The GDR standstill has another story to tell. Companies preferred to raise funds (overseas) by issue of GDRs, since these were direct equity and there was no question of redemption of the subscription amount. GDR was an attractive instrument till such time that the threshold limit under the Takeover Regulations was 15%. In 2006, the SEBI enhanced the threshold limit to 25%. Investors could now directly acquire 25% in the Indian company without the fear of triggering an open offer under the Takeover Regulations. Even then, investors were interested to subscribe to GDRs as against a preferential issue of shares.
In 2011 (and again in 2013), Pan Asia and its promoter, Arun Panchariya, were debarred from the capital market by SEBI for market manipulation through GDR issues. SEBI stated that certain companies that raised funds through GDRs were involved in dabba trading and or off-market transactions. Again, this eroded investor trust in Indian companies and thereafter, investors subscribing to GDRs were few and far between.
In 2014, the Ministry of Corporate Affairs ("MCA") issued the Depository Scheme, 2014 ("GDR Scheme") and the Companies (Issue of Global Depository Receipts) Rules, 2014 ("GDR Rules"). The GDR Scheme was more of less on the same lines as the 1993 GDR Scheme. However, the MCA sought RBI and SEBI approval to the GDR Scheme for it to be effective. The SEBI was, at that time, opposed to promoting GDRs and held back in issuing appropriate regulations. As such, no GDR issues could be floated till such time that SEBI issued the regulations. GDR issues came to naught.
It was SEBI’s concern that ADRs and GDRs are difficult to monitor and may be used for money laundering and market manipulation and these are policy and operational issues. SEBI also raised concerns in tracking the ultimate beneficiary, the potential for unsolicited takeovers and money laundering. Even though the MCA notified the GDR Scheme, it did not receive the regulatory and taxation push as SEBI saw it as a tool for money laundering and market manipulation. GDR market fell silent.
In the Union Budget of 2015, the Government referred to the GDR Scheme but stated that the tax benefits would only apply to cases valid under the old scheme, which implied that non-residents trading in certain GDRs could now be subject to the same taxes as those imposed on people trading in shares of unlisted companies, besides creating tax ambiguities when such GDRs are converted to shares.
Tweaking of the GDR/ADR norms to aid the current Indian economic climate
Surprisingly, on October 10, 2019, SEBI issued a Framework for issue of Depository Receipts ("GDR Framework"). The GDR Framework makes a reference to the GDR Scheme and the GDR Rules and the GDR Framework is issued pursuant to that reference. So now, we have 3 regulations to comply with, the GDR Scheme, GDR Rules and GDR Framework.
While the GDR Scheme sets out the "eligibility criteria" and permits even an unlisted company to issue GDRs, the GDR Framework has expanded the "eligibility criteria", added additional provisions and mandated that only listed or to be (simultaneously) listed companies are eligible to issue GDRs. Both the GDR Scheme and the GDR Framework allow unsponsored issue of GDRs, wherein the shareholders offer their shares to a depositary and the depositary in turn issues GDRs to investors, not being the shareholders who sold their shares to the depositary.
The GDR Framework allows unsponsored GDRs based on similar conditions as those set out below. In an unsponsored GDR (also known as two way fungibility), subject to demand from overseas investor to acquire GDRs, the existing shareholders are called upon to sell (deposit) their shares with the Depositary, against which the Depositary issues GDRs to the (foreign) investors. If there is a demand from (foreign) investors for GDRs, then this route is an attractive exit route for the existing shareholders.
Understanding the new proposed norms
The GDR Framework mandates that an Indian company may issue GDRs only if it complies with the following conditions:
- The company is in compliance with SEBI LODR;
- The company or promoters or directors (in case of unsponsored GDRs, selling shareholder) have not been debarred from accessing the capital markets;
- The promoter or director is a promoter or director of another company, which is not been debarred from accessing the capital markets;
- The company or the promoters or its directors are not wilful defaulters; and
- Any of the promoter or director is not a fugitive economic offender.
There are, however, a few anomalies between the provisions of the GDR Scheme and the GDR Framework, the crucial ones being:
- The GDR Scheme defines "permissible securities" (the underlying instrument to the GDR) to mean securities as defined in the SCRA; the GDR Framework narrows this definition to include only equity shares and debt securities and does not permit issue of other instruments, such as a derivatives, units or rights or interests in securities;
- The GDR Scheme defines "permissible jurisdiction" to mean a (foreign) country which is a member of the Financial Action Task Force on Money Laundering and the regulator of securities market in a jurisdiction is a member of the International Organisation of Securities Commission; the GDR Framework expands this definition to include jurisdictions as may be notified by the Government, keeping in mind determination, identification and verification of the beneficial owner;
- Prior to notification of the GDR Framework, NRIs were permitted to subscribe to GDRs; the GDR Framework has now defined "permissible holder" to mean a person not resident in India and not a NRI. The GDR Framework also states that if any person proposes to hold GDRs on behalf of the Indian resident or the NRI (beneficial owner), then such person will not be eligible to subscribe the GDRs;
- The GDR Scheme did not mandate that the GDRs be listed on a stock exchange in a permissible jurisdiction; the GDR Framework mandates that the GDRs be listed;
- prior to the GDR Framework, it was not necessary to seek SEBI approval to the offer document; the GDR Framework mandates that the Indian company must seek approval from SEBI prior to issue of the GDRs.
Why companies in India should consider GDR / ADR
Raising funds through the GDR issue is one of the easiest way to raise funds from overseas investors. The GDRs or the underlying shares are not subject to lock-in, as is the case in a preferential allotment, and the GDR holders do not demand any special rights in the issuer company. In terms of exit, the GDR holders convert the GDRs into shares and sell them on the floor of the stock exchange, without any obligation on the issuer company to redeem the GDRs. It is a win-win situation for both, the investors and the issuer company.
Even though the MCA notified the GDR Scheme, the SEBI did not bless it for reasons stated above and the GDR route to raise funds came to a stand-still. In one of it’s move to revive the slowing economy, the Government (through SEBI) notified the GDR Framework and allowed GDR issues but subject to the strict conditions set out therein. In fact, in this slowing economy where companies are wary to avail loan for fear of default and being dragged into insolvency and bankruptcy proceedings, GDRs are the safest way to raise funds and use the proceeds for working capital and general corporate purpose.
Challenges for SEBI and other regulators when it comes to the tweaking of norms
While the GDR Scheme permits unlisted companies to issue GDRs, the GDR Framework does not permit unlisted companies to issue GDRs. In fact, under the GDR Framework, if an unlisted company desires to issue GDRs, then it must simultaneously list on the Indian stock exchange. This will not allow unlisted companies access to the GDR market.
In a welcome move, the GDR Framework allows companies to issue Level-III ADRs. Level-III ADRs are similar to level-II issues in terms of reporting requirements and listing on United States exchanges. Level-III ADRs may also be issued to raise capital through a public offering within the United States. Companies issuing level-III ADRs must fulfil all registration and reporting requirements imposed by the SEC. Such companies must also comply with the Sarbanes-Oxley Act, which requires accounting and financial disclosure, as well as other reporting standards.
SEBI has notified the GDR Framework at an appropriate time and this is a welcome move to cater to the liquidity crunch the market is roiled with today. If we look at the GDR Scheme and the GDR Framework from the issuer companies' angle, the compliances are not onerous and issuer companies' should be able to adhere to them.
No doubt SEBI has imposed additional compliances, which are in addition to the GDR Scheme, but this is only to save the issuer companies from default and provide comfort to the investors that the issuer companies are regulatory compliant and genuine companies and they may safely invest in the GDRs of such companies.
The Government now needs to amend the Income Tax Act and not impose tax on conversion of the GDRs (appreciation) into shares and then again capital gains on sale of the shares. Companies may cheer the notification of the GDR Scheme and the GDR Framework but without amendment to the Income Tax Act, the GDR Scheme and the GDR Framework may not take off.
The author, Sangeeta Lakhi is Senior Partner, Rajani Associates