American Depository Receipts and Global Depository Receipts Finance Essay

Trade and commerce has been an important aspect of globalization. Since the 19th century, when the colonial era was at its peak, foreign markets were the reason for colonial wars since the importance of foreign markets were realized. However, towards the end of the colonial era, when newly independent countries began to build their economies from scratch they started clamping down on foreign investment and only decades later, slowly began to open up their markets after centuries of exploitation. Corporate entities, in order to ensure larger capital started looking for foreign investors. For an investor, investing in a foreign corporation would mean unnecessary hassle since it would include going through a lot of technical procedures. In order to solve the problems of both the investors and corporations seeking foreign investment, the concepts of American depository receipts and global depository receipts were introduced. Introduced to the financial markets in 1927, an American Depository Receipt (ADR) is a stock that trades in the United States but represents a specified number of shares in a foreign corporation. ADRs are bought and sold on American markets just like regular stocks, and are issued/sponsored in the U.S. by a bank or brokerage. [1] The ADR price is set to suit the American market, where the face value of share prices is typically higher - perhaps $20-100 or more. At these levels, each ADR usually represents several foreign shares, rather than just one. [2] In order to ensure that investors from different countries and not one country alone may invest in a corporate entity, it was essential to make available such stocks on an international level. A Global depository receipt (GDR) is when [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 branch. The shares trade as domestic shares, but are offered for sale globally through the various bank branches [3] . Indian companies are permitted to raise equity capital in the international market through the issue of Global Depository Receipt. GDRs are designated in dollars and are not subject to any upper limit on investment. [4] Such machinery came to be used in India much later and was introduced first in the 1990s. This system was brought about by the liberalization process of the economy which started during that time. The use of ADRs and GDRs has steadily gained popularity in India with corporations looking towards global markets and attracting foreign investments. Numerous Indian software companies have taken advantage of these schemes [5] and a multitude of other schemes specifically related to information technology companies have been brought about to encourage the issuance of ADRs and GDRs by such companies. In just a few decades, India will be one of the largest economies in the world. To reach that point, companies in India will have to invest colossal sums in developing their businesses. The use of American Depository Receipts and Global Depository Receipts have become commonplace and in India they are regulated by the Securities and Exchange Board of India. The use of ADRs and GDRs has simplified the process of investing in a foreign corporation making stock trading in international companies as simple as investing in a domestic company The paper shall explain the concept of ADRs and GDRS and the highlight their importance to the Indian economy with the help of corporate examples. It is essential to regulate such liberalized mechanisms and therefore, the researcher shall look into the SEBI schemes, rules and guidelines and also the RBI circulars.

CHAPTER I

AMERICAN DEPOSITORY RECEIPTS IN INDIA

American depository receipts are basically stocks of companies located outside of the US that are traded on US stock exchanges. [6] Although the concept appears to be rather unidimensional, there arise several complications in the regulation and trading of such stock. ADRs were introduced as a result of the complexities involved in buying shares in foreign countries. Primarily the difficulties associated with trading at different prices and currency values. For this reason, U.S. banks simply purchase a bulk lot of shares from the company, bundle the shares into groups, and reissues them on either the NYSE, AMEX, or Nasdaq. [7] The concept of American and global depository receipts were introduced and permitted in India through the Central Government scheme, the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 [8] . This scheme has laid down definitions, rules and procedures with regard to ADRs and GDRs. This scheme was deemed to have come into effect from the first day of April, 1992.

1.1: ELIGIBILITY CRITERION FOR ISSUING ADRs

In order to understand the concepts and the working of the ADR system, it is essential to know certain definitions connected with the procedures of this system. ADRs are traded by depositories through a certain regulation. A "depository" means a company formed and registered under the Companies Act, 1956 (1 of 1956) and which has been granted a certificate of registration under sub-section (1A) of section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992). [9] However, in order to be able to issue both ADRs and GDRs, registration with the Securities and Exchange Board of India [10] is not sufficient. Under the FCCB Scheme, 1993, a company eligible to issue ADRs and GDRs are known as an issuing company. An "issuing company" means an Indian company permitted to issue Foreign Currency Convertible Bonds [11] or ordinary shares of that company against Global Depository Receipts [12] in order to be eligible to issue Foreign Currency Convertible Bonds [13] or ordinary shares for the purposes of raising foreign funds, an issuing company require to obtain prior permission of the Department of Economic Affairs, Ministry of Finance, Government of India. [14] These issues need to conform to the rules regarding Foreign Direct Investment and the related policies and other mandatory statutory provisions. [15]

1.2: REGULATION OF ADRs IN USA

In the United States of America, ADRs are regulated by the Securities and Exchange Commission, (functioning under the Internal Revenue Services) through rules and other regulations. An ADR certificate is traded as stock and represents the underlying foreign shares, which can be obtained upon demand. The holder of an ADR is entitled to demand delivery of the underlying shares. The American bank converts dividends, interest, and principal from the foreign security into United States dollars. Once issued, an ADR certificate may be freely traded in United States dollars in the United States on the over-the-counter market. If certain SEC filings are made, it may be listed and traded on a national exchange. Taxpayer represents that any shares of domestic or foreign stock and any ADRs contributed are traded on an established securities market either within or without the United States. [16]

1.3: INDIAN ADRs

The system of ADRs allow the companies which have obtained permission to issue ADRs/GDRs to list the company in any of the stock exchanges namely the NASDAQ, NYSE or Dow Jones. The Indian companies have to comply with such regulations that have been specified by the Internal Revenue Service. Apart from these regulations, the investors can directly trade in Indian ADRs. The companies trading in ADRs include Infosys Technologies, Satyam, Dr.Reddy Laboratories Ltd, Silverline, Rediff.com Ltd., State Bank of India Ltd. etc. The trend of Indian ADRs has been rather unpredictable. Although most of the Indian companies have maintained highly satisfactory returns in the American markets, there have been certain upheavals in the market. The information technology boom was short-lived and when the tech boom had subsided, so did the craving to buy IT stocks. However, in spite of such shortcomings, the number of Indian companies with ADR issues contributed to about 80 per cent in the increase on the number of Asian ADR issues. [17] Also, Infosys Technologies have seen their share prices tripling in the American market. Indian ADRs have, in all been rather successful in the US markets in spite of several limitations and are growing exponentially.

CHAPTER II

GLOBAL DEPOSITORY RECEIPTS IN INDIA

Global depository receipts, means any instrument in the form of a depository receipt or certificate (by whatever name it is 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. [18] GDRs were also facilitated in India by the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993. GDRs are one of the most convenient methods of obtaining Foreign Direct Investment and are increasingly being used by a large number of Indian companies.

2.1: ISSUING GLOBAL DEPOSITORY RECEIPTS [19]

GDRs can be issued by companies with the requisite permission from the Department of Economic Affairs, Ministry of Finance, Government of India [20] . The issuance GDRs has to be done by a Domestic Custodian Bank. [21] The system requires the issuing company to deposit ordinary shares or bonds with the Domestic Custodian Bank and in accordance with the terms of agreement, they instruct the Overseas Depository Bank [22] to issue Global Depository Receipt or certificates in lieu of the shares deposited to the Domestic Custodian Bank. GDRs may be issued in any negotiable form and listed on any international stock exchanges for trade outside India. The FCCB Scheme, 1993 provides that GDRs may be listed in any Overseas Stock Exchanged, or Over the Counter Exchanges or though Book Entry Transfer Systems prevalent abroad. [23]

2.2: LISTING GLOBAL DEPOSITARY RECIEPTS

GDRs can be listed in any international stock exchange. Most of the GDRs are however listed in either Luxembourg or the London Stock Exchange and are traded from these exchanges. Indian issuers get access to all European, Asian and US investors with an interest in their shares. US investors are able freely to purchase GDRs listed on the London Stock Exchange through exemptions to US securities laws covering professional investors. [24] Listing in international stock exchanges gives the right to the company to have foreign investor, however, the rules of that stock exchange with regard to GDRs and foreign investment has to be complied with. The London Stock Exchange has specific guidelines which have to be complied with by any foreign corporation seeking to be listed under the LSE.

2.3: IMPACT OF GDRs ON THE INDIAN ECONOMY

From May 1992 onwards, Indian companies have been issuing Global Depository Receipts and Foreign Currency Convertible Bonds/Euro Currency Bonds (FCCBs/ECBs) on the Euro market on a large scale. Upto December 1995, Indian firms raised US$ 5,180 million through 64 issues of GDRs & FCCBs. During 1995-96, seven Euro issues, all in the form of GDR were made which together raised $652 million. To date, 47 GDR issues have taken place, which raised $3,856 million, and 11 ECB issues which raised $998 million. [25] GDRs have proved to be a rather efficient way for attracting foreign investment. Numerous companies ranging from Infosys to State Bank of India have started issuing GDRs in order to expand their share capital base. It is quite noteworthy that all such companies have received extraordinary response and have fared more than satisfactorily. There are now 20 Indian companies listed in London, ranging from large capitalisation companies such as GAIL and State Bank of India to smaller technology and services companies. Another 15 Indian companies have listed elsewhere in Europe but - in the absence of any trading in the location where they listed - have been admitted to trading on the London Stock Exchange. [26] The recent inclusion in the London Stock Exchange are the UTI Bank, which raised over $250 million in March 2005, and Srei Infrastructure Finance, which came to the market with a $35 million offering in April 2005. [27] Vedanta Resources have till date been the most successful company trading in GDRs which raised US$ 1 billion in 2003 by an initial public offer. Amongst the latest companies intending to issue GDRs, Bharat Forge has come up with a proposal in April 2005. Bharat Forge will raise $100 million through Global Depository Receipts and $120 million through Foreign Currency Convertible Bonds (FCCBs). The GDRs represent one equity share of the paid-up value of Rs. 10 and were priced at $27.50 each, the company informed the Bombay Stock Exchange. [28]

2.4: THE PROPOSED BHARTI - MTN MERGER AND ITS IMPACT ON THE INDIAN ECONOMY

The talks between the Bharti Airtel Group and MTN are very significant from the perspective of GDRs since some significant developments in this instrument were witnessed in the backdrop of the proposed merger. The deal was structured in a manner such that the Bharti Group would acquire 49% of MTN while MTN would hold 36% of Bharti. MTN itself would acquire a 25% stake in Bharti with its shareholders directly acquiring the remaining 11%. The 36% total acquired by MTN would be in the form of GDRs with voting rights. The primary issue in the proposed merger was whether the acquisition of 36% of the shares of the Bharti Group in the form of GDRs with voting rights would trigger various obligations under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. [29] On July 7, 2009 SEBI published its informal guidance in the matter pertaining to the proposed merger and addressed these issues. The Takeover Regulations lay two primary obligations upon the acquirer; (i) to make an open offer to the other shareholders when the acquisition exceeds 15% of the total, and (ii) to make certain disclosures when the acquisition crosses certain threshold limits that have been predefined, e.g. 5%, 14% etc. MTN was scheduled to acquire 36% of Bharti not in the form of shares but in the form of GDRs with voting rights. SEBI opined that GDR holders would be required to make an open offer only when they converted their GDRs with voting rights into shares thereby exceeding their holding beyond 15%. There was consequently no requirement for an automatic open offer upon purchase of GDRs with voting rights in excess of 15% of the total equity of the company. SEBI quoted Reg. 3(2) of the Takeover Regulations to support its case which read: Nothing contained in Chapter III of the regulations shall apply to the acquisition of Global Depository Receipts or American Depository Receipts so long as they are not converted into shares carrying voting rights. As far as disclosures were concerned however, SEBI quoted Chapter II of the Regulations to infer that the exemption that applies to an open offer does not apply. Furthermore, Reg. 2(k) of the Takeover Regulations includes any security which would entitle the holder to receive shares with voting rights. SEBI believed that since GDRs can be converted into shares with voting rights, they would also fall within the ambit of this definition. SEBI thus concluded that all disclosure requirements that apply to shares would be applicable to GDRs as well. However, SEBI amended the Takeover Regulations on September 22, 2009 and brought ADRs/GDRs on par with domestic shares. If an entity holds 15% of a company through GDRs, then he is required to make a mandatory open offer to buy an additional 20% equity in the company.

CHAPTER III

REGULATION OF ADRs AND GDRs IN INDIA

The Central Government, in 1993 first introduced these systems in India. In all countries which allow issue of ADRs/GDRs have some sort of regulation mechanism in place. In India, the Securities and Exchange Board of India and the Reserve Bank of India mainly through schemes, policies, rules and guidelines regulate ADRs and GDRs. FCCBs issued against GDRs are treated as foreign direct investment in the issuing company. [30]

3.1: RESTRICTIONS AND LIMITATIONS ON ADRs AND GDRs

The issuing companies have to act within certain parameters set by the central government. These limitations restrict the scope within which companies have to act; however, these guidelines are rather liberally constructed. In order to get an appropriate permission for issuing GDRs/FCCBs, companies shall require having a good track record for a period of three years. [31] However, this track record requirement was dispensed with subsequently. [32] The cumulative of foreign investment in an issuing company, both direct and indirect, cannot exceed 51% of the issued and subscribed capital of the company. [33] Investments in stock markets and real estate are however, not acceptable. However since GDRs/ADRs are equity instruments and there is no repayment liability on the issuing company. Unlike a commercial borrowing or a foreign currency convertible bond which carries a repayment liability on the company, GDRs/ADRs are full risk equity. It has therefore been decided that all end-use restrictions on GDR/ADR issue proceeds be removed. [34]

3.2: FURTHER RELAXATION OF ADR/GDR NORMS

The system of ADRs/GDRs in India are being constantly revised and reviewed. Certain technical difficulties have been restructured in order to ensure maximum flexibility in the system of such issuance. Issuing companies have lesser restrictions and are allowed to issue up to 100 percent of their share capital as ADRs/GDRs. However, foreign investors are still prohibited from investing in industries related to atomic energy, railways, mining, coal and arms and ammunitions. Certain other regulations that have been relaxed are as follows: Indian bidders allowed to raise funds through ADRs, GDRs and external commercial borrowings (ECBs) for acquiring shares of PSEs in the first stage and buying shares from the market during the open offer in the second stage. Conversion and reconversion (a.k.a. two-way conversion or fungibility) of shares of Indian companies into depository receipts listed in foreign bourses, while extending tax incentives to non-resident investors, allowed. The re-coversion of ADRs/GDRs would, however, be governed by the Foreign Exchange Management Act notified by the Reserve Bank of India in March 2001. Permission to retain ADR/GDR proceeds abroad for future foreign exchange requirements, removal of the existing limit of $20,000 for remittance under the employees stock option scheme (ESOP) and permitting remittance up to $ 1 million from proceeds of sales of assets here. Companies have been allowed to invest 100 per cent of the proceeds of ADR/GDR issues (as against the earlier ceiling of 50%) for acquisitions of foreign companies and direct investments in joint ventures and wholly-owned subsidiaries overseas. Any Indian company which has issued ADRs/GDRs may acquire shares of foreign companies engaged in the same area of core activity upto $100 million or an amount equivalent to ten times of their exports in a year, whichever is higher. Earlier, this facility was available only to Indian companies in certain sectors. FIIs can invest in a company under the portfolio investment route upto 24 per cent of the paid-up capital of the company. It can be increased to 40% with approval of general body of the shareholders by a special resolution. This limit has now been increased to 49% from the present 40%. Two way fungibility in ADR/GDR issues of Indian companies has been introduced subject to sectoral caps wherever applicable. Stock brokers in India can now purchase shares and deposit these with the Indian custodian for issue of ADRs/GDRs by the overseas depository to the extent of the ADRs/GDRs that have been converted into underlying shares. [35]

CONCLUSION

The Indian economy is one of the largest in the world and its growth rate is one of the highest in the group of developing nations, next only to China. The economic problems of India are multifaceted and emerge from several social, political and regional considerations. The progress made by the Indian economy averages out to be much less that the actual empirical change since the overwhelming population pressure defeats such economic progress.

However, Indian industry and corporate gurus have taken India into the 21st Century with much to celebrate about. The process of liberalization of the Indian economy was acknowledged by the international community and India was instantly accepted as one of the significant players of the global markets. The pace at which the international businesses of many Indian companies are growing - in some cases, far outpacing growth in India - may mean for some companies that international operations can in future be financed more efficiently if they are capitalised separately from the parent company in India. [36] Yet, there still exist some internal mechanisms which need to be modified in order to ensure a more hassle free transaction in the market. While India is opening up to foreign direct investment, individuals and institutions still have to register as foreign investors with the Securities and Exchange Board before they can buy stocks directly on India's exchanges. Most individuals will likely find the red tape too daunting to cut; ex-pat Indians, however, have it easier because the government is encouraging such repatriation of capital. [37] Although India has faced strong criticism from various countries regarding its internal policies and the complications in regulations, the prospect of investing in India is rather lucrative and therefore, Indian ADRs and GDRs globally have achieved a rather elevated status. India, among the European investors, is believed to be a good investment despite political uncertainty, bureaucratic hassles, shortages of power and infrastructural deficiencies. India presents a vast potential for overseas investment and is actively encouraging the entrance of foreign players into the market. No company, of any size, aspiring to be a global player can, for long ignore this country which is expected to become one of the top three emerging economies. [38]

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