The Securities and Exchange Board of India (SEBI) has introduced a framework for issuance of depository receipts (DRs) by companies listed or to be listed in India ( DR Framework), by its circular dated October 10, 2019.
In the early years of liberalisation and up to the time SEBI permitted qualified institutions placement (QIPs) in 2006, DR issuances formed a significant and important part of foreign investment into the Indian equity markets. However, in the past five years, there have been very few DR issuances, for a variety of reasons including due to regulatory uncertainty around operational guidelines for DRs and concerns in relation to compliance with rules under the anti-money laundering legislation.
DR issuances allow companies to access alternative and larger pools of capital including industry-specific investor classes that have institutional sectoral expertise, as well as investors that have higher ability to take risk. This, in turn, could provide better valuations for companies as well as benefit shareholders looking for exits. DR issuances also increase visibility of Indian companies in the international markets.
The DR Framework has the potential to reopen this avenue of investment into India and for Indian companies and their shareholders to access the international capital markets.
The DR Framework
The DR Framework sets out requirements for DR issuances in addition to requirements under the Companies Act, 2013 and the rules thereunder, the Depository Receipts Scheme, 2014 (2014 Scheme) and the foreign exchange regulations. The Central Government will separately notify permissible jurisdictions for DR issuances and SEBI will also specify the international exchanges in such jurisdictions and DRs can be issued under the DR Framework after these notifications.
Only listed companies are permitted to issue DRs on the back of equity shares or debt securities listed in India. Companies undertaking a domestic initial public offering (IPO) are also permitted to simultaneously set up a DR programme (subject to successful completion of the IPO). The DR Framework also permits existing shareholders to exit by way of a DR issuance. Where the initial listing of DRs includes such secondary sales, the issuer is required to provide an opportunity to all its shareholders to tender their shares to participate in such DR issuance. Customary eligibility requirements apply including the listed company being in compliance with the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 and the listed company and associated persons (such as the promoter), not triggering regulatory prohibitions such as being debarred from accessing capital markets.
The Framework has introduced certain new requirements. For example, the DR offer document must now be filed by an intermediary with the SEBI and the stock exchanges for their review at the time of initial listing of DRs. Whilst SEBI and the stock exchanges are to provide comments within prescribed timelines. Issuers may need to factor in the time for such review into their issue timelines. Further, Indian residents and non-resident Indians (NRIs), are not permitted to be permissible holders or their beneficial owners, with the onus of ensuring compliance with this condition being on the permissible holder (including its beneficial owner)
The Framework has also modified certain existing requirements. For example, whilst DR issuances have always been subject to foreign investment limits, the Framework now requires shareholders to adopt limits up to which DRs can be issued (both primary and secondary) and further specifies that the listed company should comply with minimum public shareholding norms in India, after excluding the permissible securities held by the depository. Further, the minimum price for issue or transfer of securities is the price applicable to the corresponding mode of issue to domestic investors (earlier listed companies could price based on QIP pricing i.e., average of weekly high and low prices of the underlying shares for two weeks). Additionally, management proxies are not permitted under the DR Framework and depositories must exercise voting rights, if any, only pursuant to instruction from the DR holder.
The DR Framework also provides for SEBI’s power to issue clarifications and exemptions, which would be useful for issuers, particularly for the first few issuances under the DR Framework.
The recent amendment to Prevention of Money-laundering (Maintenance of Records) Rules, 2005 (PMLR Amendment), has clarified certain long-standing issues for DRs. Earlier, compliance with provisions regarding beneficial ownership in respect of DR holders under the rules, had been a cause for concern. The PMLR Amendment has eased reporting and due diligence requirements and has clarified, among other things, that rules in relation to the identification and verification of the beneficial owner of DR holders, who are residents of certain jurisdictions to be notified by the Central Government, would be as per the norms of such jurisdiction
Considerations under the DR Framework
Whilst the DR Framework has paved the way for the issue of DRs, issuers will need to evaluate certain matters with their advisors including the following:
Pricing: Standalone DR issuances are to be priced based on the corresponding mode of issue to domestic investors. Given that the SEBI has prescribed different pricing formula for primary issuances based on the types of offerings (preferential issue, QIP and public offerings), discussions with the regulator may be required to identify the price that would apply for a particular DR issuance. Further, pricing for secondary transfers (by residents or non-residents), may also need analysis, both for an initial listing and on an ongoing basis. Accordingly, simultaneous issuances could be a structuring alternative for both pricing clarity and to increase headroom for DRs.
Fungibility: Whilst fungibility is permitted under the DR Framework subject to the limits set out above, listed companies may need to devise a procedure to make it operational. Further, pricing implications under the DR Framework are required to be evaluated.
Secondary transfers: Certain matters to be considered in relation to secondary transfers include mode of transfer by the shareholder of the listed company to the depository (on market or off market), pricing and tax implications for the seller and the acquirer.
Existing DR programs: Whilst the DR Framework is applicable only to DR issuances by listed companies after October 10, 2019 and the relevant jurisdictions and stock exchanges have not been notified yet, existing programs should consider complying with the terms of the DR Framework such as obtaining shareholders’ approval for DR headroom to permit fungibility. Additionally, DR issuances pursuant to stock options to NRIs and status of existing resident and NRI holders in the programs will also require analysis. Existing programs must also evaluate their DR voting structure for compliance with the DR Framework, before undertaking further issuances.
Although there are some points that require further discussion, SEBI has taken a step in the right direction by issuing the much-awaited DR Framework. Listed companies in India will now be able to consider DRs as a viable option for raising capital or to provide an exit to existing shareholders. Whilst a framework for DR issuances by unlisted companies is awaited (the Ministry of Corporate Affairs would perhaps have to take a lead here), the simultaneous IPO and DR issuance route provided under the DR Framework would allow unlisted companies including technology focussed companies, to access specific investor groups outside India and provide a potential structuring option.