Depository ReceiptsRaising equity from the international market

Depository Receipts
y A negotiable financial instrument issued by a bank to

represent a foreign company's publicly traded securities, which trades on a local stock exchange
y Types: -

ADRs- American Depository Receipts 2. GDRs- Global Depository Receipts 3. IDRs- Indian Depository Receipts
1.

ADRs
y A negotiable certificate issued by a U.S. bank representing a specified

y y

number of shares (or one share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. Different type of ADR issuesSponsored ADRs- transfer agents and regulatory bodies are involved. These arte again of three types which are as follows: Level 1 - These are found on Over the counter market and have the loosest requirements from Securities and Exchange Commission. Level 2 - These are listed on an exchange or Nasdaq. They have slightly more requirements from the SEC, but they have greater visibility and trading volume. Level 3 - The issuer floats a public offering of ADRs on a U.S. exchange.

GDRs
y A bank certificate issued in more than one country for shares in a

foreign company. The shares are held by a foreign branch of an international bank. The shares trade as domestic shares, but are offered for sale globally through the various bank branches. y Difference between ADRs and GDRs: Both ADRs and GDRs are represent a claim on the underlying shares.The only difference is the location where they are traded. 1. If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. 2. If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt, or a GDR.

Benefits of Depositary Receipts

y For the Company: 1.

A company may opt to issue a DR to obtain greater exposure and raise capital in the world market. Issuing DRs has the added benefit of increasing the share's liquidity while boosting the company's prestige on its local market. Depositary receipts encourage an international shareholder base, and provide expatriates living abroad with an easier opportunity to invest in their home countries. For the Investor: Buying into a DR immediately turns an investors' portfolio into a global one. Investors gain the benefits of diversification. More importantly, DR investors will be able to reap the benefits of these usually higher risk, higher return equities, without having to endure the added risks of going directly into foreign markets.

2.

Norms for GDRs and ADRs

y Foreign Investment through ADRs/GDRs,)is treated as

Foreign Direct Investment. y Indian companies are allowed to raise equity capital in the international market through the issue of GDR/ADRs. These are not subject to any ceilings on investment. y There is no restriction on the number of GDRs/ADRs to be floated by a company or a group of companies in a financial year. y There are no end-use restrictions on GDRs/ADRs issue proceeds, except for an express ban on investment in real estate and stock markets

Illustration

Fungibility
y A good or asset's interchangeability with other individual goods/assets

of the same type. Assets possessing this property simplify the exchange/trade process, as interchangeability assumes that everyone values all goods of that class as the same.
y Many diverse types of assets are considered to be fungible. y For example, specific grades of commodities, such as No.2 yellow corn,

are fungible because it does not matter where the corn was grown - all corn designated as No.2 yellow corn is worth the same amount. Also, Cross-listed stocks are considered fungible as well because it doesn't matter if you purchased a share of XYZ stock in its home country or in a foreign country; it should be accepted at either location as XYZ stock.

Dual Fungibility
y Dual Fungibility means that the DRs can be converted into

underlying shares and underlying shares can be reconverted into DRs of companies which have issued DRs, up to the originally issued amount and any other secondary share issuances. y Prior to the introduction of Dual Fungibility, only cancellations of DRs were allowed. The Investor could cancel the DRs and either retain the ordinary shares or sell them in the Local Market in India. y With the introduction of Dual Fungibility, it now provides investors an opportunity to purchase local shares and convert them into DRs.

Who is allowed to participate ?

y Indian Regulations : Open for Non Resident Investors. y Overseas Regulations : ADRs - Open for Non Resident Investors y GDRs - Open for Non Resident Investors; some GDRs are

structured whereby only US Qualified Institutional Buyers ( QIB ) and non-US residents are able to purchase them. y The present rules of the RBI make dual fungibility possible, to the extent of ADR / GDR which have been converted into equity shares and sold in the local market. This would take place in certain manner which is explained further.

Continued
y Stock Brokers in India have been authorized to purchase

shares of Indian Companies for reconversion y The Domestic Custodian would coordinate with the Overseas Depository and the Indian Company to verify the quantum of reconversion which is possible and also to ensure that the sectoral cap is not breached. y The Domestic Custodian would then inform the Overseas Depository to issue ADR / GDR to the overseas Investor.

Benefits of fungibility
y Improvement

in

liquidity

and

elimination

of

arbitrage.

A liquid market for a security must have depth and breadth, and aid speedy price discovery. In the one-way fungible regime, ADRs/GDRs suffered from price volatility and liquidity problems, basically for two reasons. 1. Low ADR issue size that accounted for low free-float in the US market and, thereby, low trading volumes in the security.
2.

The GDR market had been largely dormant (with the exception of a few high-profile stocks) for the past couple of years. This affected the depth, breadth and price-discovery process of GDRs in these markets. Two-way fungibility may at least revive some market interest in these stocks.

Continued
y Reduction/elimination

of arbitrage In an efficient market, two assets with identical attributes must sell for the same price, and so should an identical asset trading in two different markets. If the prices of such an asset differ, a profitable opportunity arises to sell the asset where it is overpriced and buy it back where it is under priced. Under the one-way fungibility regime, though identical assets (namely stocks in the domestic market and ADRs/GDRs in the overseas markets) traded at different prices (at a discount/premium), the arbitrage opportunities went a begging because of restrictions on the capital account. By introducing two-way fungibility, market forces may trigger a realignment of prices, minimizing the widely divergent premium/discount levels prevailing between ADR/GDR prices and the domestic stock prices.

ADRs and GDRs Special Risks

y Currency risk: If the value of the US dollar rises against the

value of the company's home currency, a good deal of the company's intrinsic profits might be wiped out in translation. Conversely, if the US dollar weakens against the company's home currency, any profits it makes will be enhanced for a US owner. y Political risk: ADR status does not insulate a company's stock from the inherent risk of its home country's political stability. Revolution, nationalization, currency collapse or other potential disasters may be greater risk factors in other parts of the world than in the US, and those risks will be clearly translated through any ADR that originates in an affected nation. y Inflation risk: Countries around the globe may be more, or less, prone to inflation than the US economy is at any given time. Those with higher inflation rates may find it more difficult to post profits to an US owner, regardless of the company's underlying health.

IDRs
y An IDR is an instrument denominated in Indian Rupees in the form of a

depository receipt created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India) against the underlying equity of issuing company to enable foreign companies to raise funds from the Indian securities Markets. y The foreign company IDRs will deposit shares to an Indian depository. The depository would issue receipts to investors in India against these shares. The benefit of the underlying shares (like bonus, dividends etc) would accrue to the depository receipt holders in India. y The Ministry of Corporate Affairs of the Government of India, in exercise of powers available with it to see after the issuing of IDRs. y Standard Chartered Plc is the only company that has issued IDRs thus far.

Who can issue IDRs?

y Any company listed in the country of incorporation can issue

IDRs. Besides, the issuer needs pre-issue capital and free reserves of at least $50 million (around Rs 225 crore) and should have a market capitalisation of $100 million (Rs 450 crore) or more during the last three years. The company should have also made profits in three of the preceding five years.

How will it work?

y The process is similar to an initial public offering where a draft

prospectus is filed with the Securities and Exchange Board of India. y The minimum issue size is $500 million (around Rs 2,250 crore). Shares underlying IDRs will be deposited with an overseas custodian who will hold shares on behalf of a domestic depository. IDRs will be issued through a public offer in India in the demat form and will be listed on Indian exchanges. Trading and settlement will be similar to those of Indian shares. y At least half of the investors have to be qualified institutional investors with 30 per cent of the issue size reserved for small investors. Recently, the regulators allowed a single institutional investor to acquire up to 15 per cent of the issue size. In addition, banks have also been allowed to participate. y For a retail investor, the annual $200,000 ceiling (Rs 90 lakh) on overseas remittances, which can be used to buy shares, will not apply to IDRs, as the issues are rupee-denominated.

Benefits for the issuing company..

y The main benefit is in terms of branding, besides allowing foreign

companies to access Indian capital. It is also seen as the platform for creation of acquisition currency and a management talent pool. Issuers have the option to reserve a proportion of the issue for employees. y One can invest in it in the hope of making money over the long term. It is like an equity share, but with subtle differences. The Indian equity market trades shares of companies that are listed in India, the companies can be Indian or foreign, but need to have a significant business presence in India and must be here for Indians to buy shares in them. For example, Hindustan Unilever Ltd is a subsidiary of Unilever Plc, an international consumer goods company, but has a large business footprint in India and is listed on the Bombay Stock Exchange and the National Stock Exchange.

Is there a currency risk?

y In theory, the price of the underlying share of the

international firm at the foreign exchange and the exchange rate would play a role in determining the price of the IDR on the domestic exchange. But, in practice, this may not play out fully because the IDR would need to be bought and sold in Indian rupees and its price discovery would happen based on demand and supply, just like any other equity share.

How can you apply?

y One can apply for an IDR the way you apply for equity

shares. The facility of Application Supported by Blocked Amount is also available for IDR holders. In other words, ones application money wont leave their bank account till they are finally allotted the shares. The money is blocked, but continues to earn interest on it. If one isnt allotted shares, or IDRs in this case, the money is released. y The Indian government has recently relaxed the eligibility norms for foreign companies to raise capital from the Indian market through the Indian Depository Receipts (IDRs) route.

Procedure for receiving Foreign Direct Investment /International equity

y Automatic Route-

FDI up to 100 per cent is allowed under the automatic route in all activities/sectors except where the provisions of the consolidated FDI Policy, paragraph on 'Entry Routes for Investment' issued by the Government of India from time to time, are attracted. 2. FDI in sectors /activities to the extent permitted under the automatic route does not require any prior approval either of the Government or the Reserve Bank of India.
1.

Continued
y Government Route1.

2. 3.

FDI in activities not covered under the automatic route requires prior approval of the Government which are considered by the Foreign Investment Promotion Board (FIPB), Department of Economic Affairs, Ministry of Finance. Plain paper applications carrying all relevant details are also accepted. No fee is payable. Indian companies having foreign investment approval through FIPB route do not require any further clearance from the Reserve Bank of India for receiving inward remittance and for the issue of shares to the non-resident investors.

y The Indian company having received FDI either under

the Automatic route or the Government route is required to report in the Advance Reporting Form, the details of the receipt of the amount of consideration for issue of equity instrument viz. shares ,fully and mandatorily convertible debentures and such.