On 22 July the Reserve Bank of India (RBI) further liberalized the norms for foreign companies to raise capital from the Indian market through the Indian depository receipts (IDR) route.
The concept of IDRs was first introduced in India in 2004 with the introduction of the Companies (Issue of Indian Depository Receipts) Rules, 2004 (IDR rules), by the Department of Company Affairs. The IDR rules were later amended in 2007. However, foreign exchange regulations in respect of the issue and redemption of IDRs were unclear. The recent notification by RBI seeks to remove this anomaly.
Issue of IDRs
The mechanism for the issuance of IDRs involves the issue of shares of a foreign company to an overseas custodian bank. The IDR rules require the overseas custodian bank to be a foreign bank having a place of business in India.
The overseas custodian thereafter authorises the Indian depository to issue IDRs to investors against such shares. These depository receipts are freely transferable and are listed and traded on Indian stock exchanges.
Further, the IDRs are denominated in Indian rupees irrespective of the denomination of the securities of the issuer company. A foreign company contemplating an issue of IDRs has to first ensure that it satisfies the eligibility criteria set out under the IDR rules.
Impact of forex regulations
The recent foreign exchange notification prohibits the redemption of IDRs into underlying equity shares prior to one year post issuance of the IDRs. This is consistent with the manner in which the IDR rules are framed, however it also remains one of the greatest challenges that investors have in respect of the IDR mechanism.
Market participants are of the view that IDR issuances are unlikely to begin gathering momentum unless the one-year post-issue redemption regulation is not modified.
Fortunately, the notification makes an exception in case of redemption of IDRs by foreign institutional investors (FIIs), including their sub-accounts and non-resident Indians (NRIs). The exemption might prove significant as it makes it attractive for NRIs to route their investments through a stock market in India.
The permission for FIIs and their sub-accounts may not be expected to be a route that is often used, but the fact that foreign exchange regulations permit such issuance is a step in the right direction.
Although the notification does make exceptions for NRIs and FIIs on the redemption front, the success of any IDR issuance is expected to be through local subscription by Indian residents as opposed to non-residents who already have access to the stock in markets overseas.
The notification clarifies that upon conversion of the IDRs into equity shares, the foreign exchange regulations that are ordinarily applicable to Indian residents would continue to apply. As a consequence, Indian residents, other than the listed Indian companies and Indian mutual funds registered with SEBI, are required to sell the equity shares within 30 days of their conversion from IDRs. It appears that this provision has been included to make it a deterrent to convert the IDRs which are otherwise trading on an Indian exchange.
As expected, the notification has confirmed the position that the proceeds from the issuance of IDRs are required to be immediately repatriated by the foreign issuer company. This is consistent with similar restrictions, albeit on remittance into India, for external commercial borrowings (ECBs) and proceeds of Foreign Currency Convertible Bonds (FCCBs).
An attractive regulation?
The government has routinely amended the regulations relating to IDRs with the motive of luring foreign companies to seriously consider the Indian market as an avenue for capital raising but these measures have so far not been met with equal enthusiasm by companies overseas.
Although the amendment to the regulations have clarified issues such as foreign exchange repatriation, issuance by foreign companies, redemption by IDR holders, etc. to attract foreign companies to issue of IDRs, key provisions like the one-year lock-in still remain unchanged.
The clarification of foreign exchange regulations are a welcome change, however their success will be determined by the IDR issuances that will take place in future.
Amit Tambe is a partner at Trilegal in Mumbai where Namrata Sinha is an associate. Trilegal is a full service law firm that advises on corporate and commercial law in India and provides commercially oriented legal advice in relation to all sectors of the economy. The firm has offices in Delhi, Mumbai, Bangalore and Hyderabad and have over 80 lawyers, some with experience at law firms in the US, the UK and Japan.
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