This article is written by Team LawSikho. This article discusses the Depository Receipts scheme of RBI.

The prevailing law for GDRs is the Depository Receipts Scheme, 2014 of RBI (RBIDRS 2014) (see here), which repealed the earlier Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993 (FCCBDRMS 1993).

Who can issue depository receipts?

As per the FCCBDRMS 1993, only listed companies could make issuance of GDRs in foreign markets, but this situation has been altered. Now unlisted and even private companies in India can make depository receipt issuances abroad as per the RBIDRS 2014.

In which jurisdictions can depository receipts be issued?

As per Clause 2(g) of the RBIDRS 2014, a depository receipts can be issued in permissible jurisdictions, i.e. which is Financial Action Task Force compliant (see an exhaustive list of FATF-compliant members here) and is a member of the International Organization of Securities Commissions. As of the date of the notification, 34 jurisdictions have been notified as permissible jurisdictions in Schedule I of the RBIDRS 2014 itself, as follows:

1. Argentina
2. Australia
3. Austria
4. Belgium
5. Brazil
6. Canada
7. China
8. Denmark
9. European Commission
10. Finland
11. France
12. Germany
13. Greece
14. Hong Kong
15. China
16. Iceland
17. Ireland
18. Italy
19. Japan
20. Republic of Korea
21. Luxembourg
22. Mexico
23. Netherlands
24. New Zealand
25. Norway
26. Portugal
27. Russian Federation
28. Singapore
29. South Africa
30. Spain
31. Sweden
32. Switzerland
33. Turkey
34. United Kingdom
35. United States of America

Which securities can be issued under GDR?

As per RBIDRS 2014, any instrument that is considered as a security under Securities Contracts (Regulation) Act, 1956 can be the basis of a GDR issuance. Thus, shares, bonds, debentures Government securities, rights or interests in securities can all be the underlying basis of a GDR issuance.

What are Sponsored and Unsponsored DRs?

Depository receipt issuance can be led by a company itself, that is, the company’s shares are issued or existing company shares are created into depository receipts at the instance of the company. Alternately, an institution that validly holds shares of a company can create and issue depository receipts (unsponsored) at its own instance, without the involvement of the company and sell them to investors, which can be traded on a stock exchange. Thus, the types of Depository Receipt issuances are as follows:

A. Sponsored: Where the Indian issuer enters into a formal agreement with the foreign depository for creation or issue of DRs. A sponsored DR issue can be further classified as:

Capital Raising: The issuer issues new securities which are deposited with a domestic custodian

Non-Capital Raising: No fresh underlying securities are issued. Rather, the issuer gets holders of its existing securities to deposit these securities with a domestic custodian, so that DRs can be issued abroad by the foreign depository. Sponsored non-capital raising of DRs has been allowed in the DR Scheme, 2014.

B. Unsponsored: Unsponsored DRs are where any person other than the Indian issuer may, without any involvement of the issuer, deposit the securities with a domestic custodian in India. A foreign depository then issues DRs against such deposited securities. This is not a capital raising exercise for the Indian issuer, as the proceeds from the sale of the DRs go to the holders of the underlying securities. This can create incentives for financial intermediaries who hold shares to issue depository receipts offshore for secondary trading. In such situations, the Indian company will not earn any extra money as no investment is received into the company, but it creates an opportunity for offshore investors to gain exposure to the Indian market. This will help them diversify their portfolio and also engage in trading of shares.

We will be referring to sponsored depository receipt issuances in this course.

Parties

The parties that are involved in the issuance of the DRs and their roles are as follows:-

Issuing Company – It is the company which intends to raise its capital from foreign investors.

Eligibility under the DR Scheme, 2014:

1. a) Any Indian listed/ unlisted/ private/public company
2. b) any other issuer of permissible securities;
3. c) any person holding permissible securities;

which has not been specifically prohibited from accessing the capital market or dealing in securities.

Note: Permissible securities mean shares, scrips, bonds, debentures, derivatives, mutual fund units, government securities

Lead Manager – responsible for setting into motion the process of raising capitals by issuing DRs. They are responsible for drafting of various agreements that will be required by the company, drawing up various marketing strategies for the issue post Offer activities for the offer will involve essential follow-up steps, which include the finalization of trading and dealing of instruments and dispatch of certificates and demand of delivery of shares

Depository bank – Bank which holds the securities of the issuing company and transfer the same to the custodian banks. They decide the design of the DRs.

Custodian Bank – Domestic bank who holds the underlying shares/bonds against which the DRs are issued. They are banks defined under SEBI Custodian Regulation, 1996. New format of the return that is to be filed by the Domestic Custodian bank has been notified and is annexed here.

Investor – Ultimate buyer/ seller of the DRs

Process

The process of issuing GDRs by a company typically involves the following steps:

1. The domestic company enters into an agreement with the overseas depository bank for the purpose of issue of GDR, this is known as a Depository Agreement.
2. The overseas depository bank then enters into a custodian agreement with a domestic custodian bank.
3. The domestic custodian (which is an agent of the depository bank) holds the equity shares of the company.
4. On the instruction of domestic custodian, the overseas depository bank issues depository receipts (against the said equity shares) to foreign investors in foreign currency.

Listing Compliance

The listing norms are market specific and vary from the stock exchange to stock exchange. For example, listing norms and cost implications for Luxembourg Stock Exchange is comparatively relaxed than listing norms of the New York Stock Exchange. In the US, these norms vary upon the level of penetration by the issuer in the foreign markets. The three levels are:-

Level I – It warrants minimal disclosure from the issuer and the DRs are traded only on over the counter platform without listing on stock exchange. In an OTC market, dealers act as market makers by quoting prices at which they will buy and sell a security or currency. In general, OTC markets are therefore less transparent than exchanges and are also subject to fewer regulations.

Level II – Registration allows the issuer to list its ADRs on a major US stock exchange, namely the New York Stock Exchange (NYSE Euronext) or NASDAQ Stock Market, each of which has further reporting and disclosure requirements.

Level III – used not only to establish a trading presence but also to raise capital for the foreign issuer.

Global Registered Shares as the nomenclature indicates, it is that class of securities which trade on multiple stock exchanges in different currencies.

Voting Rights

Voting rights can be structured contractually – hence, the terms of issuance of depository receipt can determine whether voting rights will be exercised by the foreign shareholder or the depository.

They can be issued such that benefits accrue to the holder and any control rights will be exercised by the depository at the direction of the holder.

The position of voting rights is however little different with respect to unsponsored. The international practice is not to have voting rights but depository banks will have to formulate terms specially for Indian Markets to give voting rights to the unsponsored DR holders as well as the DR Scheme, 2014 makes it mandatory for unsponsored issuance.

Pricing of Depository Receipts

The RBI DRS 2014 states that permissible securities shall not be issued to a foreign depository at a price lower than what would have been permissible if the securities were issued to domestic investors under Indian law.

Difference between “1993 Scheme” and “2014 Scheme”

Under the 1993 Scheme, prior approval of the Ministry of Finance (MoF) was required for issuance of depository receipts. Under the 2014 Scheme, this is not required, except if issuance would require approval under the Foreign Exchange Management Act, 1999 (FEMA) for corresponding foreign investment.

Under the 1993 Scheme, depository receipts could only be issued by listed companies (i.e. which were already listed in Indian markets), but now private and unlisted public companies can issue depository receipts too.

Earlier, it was essential that depository receipt issuances needed to be ‘company sponsored’. but now any holder of securities can create depository receipts. The 2014 Scheme creates a provision for issuance of unsponsored depository receipts, that is, issuances which are led by financial institutions which hold the company’s shares and not at the instance of the issuer company.

Depository receipts can be created over any kind of security now within the meaning of Securities Contracts Regulation Act and not just shares. Hence, depository receipts can be created from fully convertible debentures as well.

Removal of government or RBI approval gives companies significant flexibility to issue depository receipts. Second, removal of the requirement to be listed in India enables companies to access foreign capital if they can enjoy a higher valuation from foreign public investors, or higher demand from sophisticated financial investors based offshore.

The effect of some of the other measures, such as depository receipt issuance of unconventional securities and unsponsored depository receipt issuances will need to be measured over time.

US Law Issue for ADRs

Under US law, you can have 3 kinds of ADR issuances:

• Level 1 Issuance – This issuance can be unsponsored and does not require company documents to be filed. Form F-6 (see here) needs to be filed, containing disclosures on the contractual terms of the depositary receipts, a format of the ADR,  copies of the depository agreement with the institution which is creating the depository receipts and certain legal opinions. No information about the company whose underlying securities are the basis of the depository receipts is required to be filed and hence the information is not available with SEC.
• Level 2 Issuance – Under a Level 2 issuance as well, money cannot be raised from American public investors by the company. A Level 2 issuance is only meant for security issuance and trading by American investors for securities that have already been issued by the Indian company. Further, these securities are to be traded in the over-the-counter market (this is a special system and separate from the exchange system for usual trading). In a Level 2 issuance, annual reports of the company in Form 20-F (see here) need to be filed in addition to Form F-6.
• Level 3 Issuance – If the company intends to raise capital from American public investors, then a Level 3 issuance is required. Naturally, these ADRs will be tradeable as well by the investors. In addition to a Form 20-F (annual statements of the company), registration statement with SEC needs to be filed in Form F-1 (see here), Form F-3 (see here), or Form F-4 (see here).  

Filings for Level 2 and Level 3 issuances are available on the SEC’s Edgar system (see here).