Anisha Sarkar, Student at SNDT Women’s University Law School
The primary advantages of integration of Indian securities market with the global capital market are two-fold— firstly, it offers companies alternative jurisdictions, beyond their domestic sphere, to raise capital, garner a global presence in the world economy and access sophisticated market participants; secondly, it creates a geographically diversified investment portfolio for investors across the globe that enables the mitigation of systematic investment risks. While the outcome of such internationalization is favorable, it presents a series of legal challenges, hence thrusting the herculean task of framing regulations upon the financial regulatory authorities, that provide liberty to Indian companies to list their stocks across jurisdictions without compromising on the country’s domestic interests.
Last year, the Ministry of Corporate Affairs (MCA) enacted the Companies (Amendment) Act, 2020 (Amendment Act), that propelled a gamut of reforms within the corporate and financial legal framework of the country including the insertion of Section 23(3) and 23(4), permitting a certain class of companies, incorporated in India, to directly list their equity securities in permissible jurisdictions outside India. While, since the liberalization of the Indian economy, several routes of overseas fundraising has become accessible to Indian companies, the route of equity securities foreign listing has been severely restricted and can only be accessed through Global Depository Receipt (GDR) and American Depository Receipt (ADR); on the other hand, debt securities can be directly listed on international stock exchanges.
In this article, I will be foremostly examining the failure of the GDR/ADR mechanism, followed by analysing the merits and probable shortcomings of the overseas listing route and lastly mapping out the subsequent regulatory measures and considerations that may be undertaken by the Indian regulatory authorities to solidify the budding regime.
Regulatory Framework of the ADR and GDR Mechanism
As stated earlier, before the recent amendment, Indian companies were only permitted to access international equity stock markets, including the American stock exchanges such as NASDAQ and NYSE through the indirect listing, by coordinated efforts with the domestic custodians and overseas depository banks. The overseas depository banks are vested with the power to issue Depositary Receipts (DRs). DRs are negotiable certificates that are issued by depository banks representing the ownership of a share in a foreign company. ADRs are depository receipts issued by American depository banks, while GDRs are issued by overseas Non-American depository banks. ADRs/GDRs may be listed as a part of an Initial Public Offering (IPO). Indirect listing entails, both, national and international compliance of a body of regulations that may be a cumbersome procedure for Indian companies. Likewise, foreign companies can list their equity securities on Indian stock exchanges through Indian Depository Receipts issued by an Indian Depository Bank.
While opting for overseas indirect listing, by Indian companies, gained immense traction in the initial years post-liberalization, the trend faltered due to various reasons including GDRs/ADRs underdelivering, stringent eligibility norms set by the SEBI, lack of clarity on tax structure and manipulation in the issuance of GDRs. More so, the indirect listing route is exclusively restricted to a few cash-rich companies of the country.
Only recently, Resurgere Mines and Minerals India Limited was penalized by SEBI for manipulating the issuance of GDR/ADR. Additionally, eleven Indian companies were barred from the securities market in matters relating to alleged manipulation of GDR issuance and flouting market norms.
Direct Listing—A Better Alternative to GDR and ADR?
Recognizing the glaring structural inefficacies and growing unpopularity of the GDR/ADR mechanism among Indian companies, the SEBI constituted an Expert Committee in 2018 that submitted a report (expert report) examining the implications of the introduction of direct overseas listing of Indian companies across foreign jurisdictions. The expert report, additionally, sought to establish a framework governing the direct listing of foreign companies in stock exchanges within Indian jurisdiction but is yet to find a place within the current regulatory framework.
I have analysed the implications of overseas direct listing, including its merits and possible shortcomings, on domestic financial regulators and Indian companies as under:
Dilution in Opacity in Cross-Border Listing
Section 5 of the Amendment Act (amending section 23 of the Companies Act, 2013), permits Indian companies to list their stocks within foreign permissible jurisdictions. Permissible jurisdictions are countries bound by obligations arising from an international treaty to disclose information and cooperate with the Indian authorities for investigative purposes. Countries that are members of the Board of International Organization of Securities Commission (IOSCO) and Financial Action Task Force (FATF) may fall under the ambit of permissible jurisdiction, as prescribed by the Indian Government. The expert report recommended 10 jurisdictions across the globe, including stock exchanges in the USA, UK, Hong Kong etc.
The mechanism ensures transparency in equity listing and trading, restricts round-tripping of funds and enables regulatory bodies to interject as and when necessary. The transparency counters the opaqueness offered by indirect listing through GDRs/ADRs, hence making direct listing the favoured route towards maintaining a healthy capital markets ecosystem. Additionally, the permissible jurisdictions have a developed regulatory system, hence substantially preventing illegal transactions and money laundering.
Relaxation in Regulatory Compliances
As stated earlier, overseas listing by the issuance of ADRs/GDRs lost popularity among Indian companies because of its complex regulatory compliance rules and high costs. Direct overseas listing on the other hand has a relatively relaxed set of domestic compliances.
The expert report seeks to remove the requirement of Indian companies opting for an overseas direct listing, to comply with provisions relating to the issuance of prospectus and allotment of equity securities and rules laid down under the Companies Act, 2013 and the Companies (Prospectus and Allotment of Securities) Rules, 2014, respectively. Therefore, in this respect, the permissible jurisdiction’s allotment rules and regulations will prevail over Indian companies listed abroad.
The compliance of corporate governance and accounting standards of two different jurisdictions may be a laborious undertaking for Indian companies, more so if companies are opting for dual listing. For instance, in the United Kingdom, foreign issuers must comply with several ongoing obligations including the former’s disclosure norms. In the USA, foreign issuers may follow IFRS or their local GAAP; hence, strict adherence to USA accounting standards is not necessary. That being said, foreign issuers are subject to strict corporate governance requirements such as including internal controls over financial reporting and disclosure.
Elimination of Underwriters and Absence of Price Discovery Mechanism
Unlike an Initial Public Offering, direct listing does not involve underwriters, hence significantly reducing the expenses involved in the listing of securities. On the flip side, the elimination of underwriters may not be advisable due to the absence of a purchase guarantee on unsold shares and may result in greater volatility and low volume owing to the absence of a systematic price determination mechanism.
The concern surrounding volatility has been declining with Spotify’s successful direct listing in 2018 on NYSE, which was met with considerable stability in comparison with most tech companies in the past decade. The success of the direct listing may be attributed to innovative approaches undertaken within regulatory limitations, Spotify’s market position and sound financial advisory. However, it is imperative to note that Spotify was directly listed within its domestic jurisdiction; however, the challenges faced in cross-border direct listing are manifestly different.
Mapping Subsequent Regulatory Reforms
The Amendment Act is the bedrock around which a series of regulatory provisions are to be set upon. There are several considerations that the SEBI has recognized in the expert report, hence serving as a blueprint to rewire certain provisions and remove structural discrepancies. For one, the Foreign Exchange Management Act, 1999 must enable persons resident outside India to buy equity shares from Indian companies listed abroad. Further, there is a need to modify the income tax valuation rules and determine the obligation that is to be borne by a non-resident on the transfer of shares.
Further on, the expert report does not acknowledge the cap on the Liberalized Remittance Scheme (LRS). Under the LRS, resident individuals are permitted to invest up to USD 250,000 per financial year on overseas assets. The RBI must consider setting the cap to an increased remittance amount, to facilitate increased investment by Indian residents on the overseas shares of Indian companies.
Overseas direct listing has kindled great interest among tech and telecommunication companies as it offers enormous potential for growth and better valuation. Direct listing, despite its lustre, may prove to be an expensive process for most companies alike their alternate regime ADR/GDR. albeit relatively less, consequently only incentivizing companies with voluminous capital or demonstrated history in the direct overseas listing to opt for the same. The Unicorns and smaller companies, given their market and financial position, may bear reluctance, since overseas listing involves greater investment risks. Hence, the implied guiding principle of Amendment Act, viz. ease of doing business, will be limited to only a handful of companies.
Having said that, the overseas direct listing regime is still at its nascent stages of development, ergo making room for substantial considerations and due examinations to bolster companies by removing major regulatory roadblocks. Hopefully, the attempts of SEBI and MCA to revive cross-border listing, will not meet the same fate as the ADR and GDR regimes.