A couple of days ago the government gave the green signal to companies to directly list on foreign stock exchanges. So in today’s Finshots, we give you a lowdown on it.

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The Story

Companies that go public, do so because they get larger access to capital. It helps them expand their business, launch new products or cut down debt. Most businesses in India tap into the Indian equity markets. However, if they were allowed to step outside and list on foreign stock exchanges, they could raise even more money.

But unfortunately, Indian laws don’t allow companies incorporated here to do that. Granted, there are Indian companies that have listed overseas in the past. There’s Infosys, Tata Motors, HDFC Bank, MakeMyTrip and many others. But they did so using something called Depositary Receipts (DRs).

Simply put, an Indian company that wants to list overseas sells its shares to a local bank. It could be the Stock Holding Corporation of India, HDFC Bank or ICICI Bank. These banks keep the shares safe in their custody. Meanwhile, there’s another intermediary called a depositary bank overseas which works with the Indian bank by putting together an arrangement. For every 10 shares held by the Indian bank, they create and issue a new share (called a depository receipt or DR). The receipt derives its value from underlying shares in India. This example assumes that 10 shares represent 1 DR. But that ratio could change. Anyway, once the overseas bank issues these DRs, foreign investors can buy and sell them on a foreign stock exchange using their local currency. So effectively, they can lay their hands on the Indian company's stock.

So when Infosys floated its shares on the New York Stock Exchange it used American Depositary Receipts (ADRs). Likewise, if a company wants to list its shares in other global markets it can use Global Depositary Receipts (GDRs).

But soon, that may not be necessary at least for select Indian companies. Because a couple of days ago, the government gave effect to an amendment it made to the Companies Act in 2020. It said that certain companies could go the direct route and list on foreign stock exchanges. Okay, but what’s wrong with going the GDR way, you ask?

To begin with, companies could not take this route if they weren’t listed on the Indian stock exchanges in the first place. So they’d have to get the necessary clearance to float their shares to the Indian public. Then, they’d have to spend more time and money to float their shares overseas through an intermediary. It was a time-consuming and costly affair.

Foreign investors also preferred investing directly since DRs are traded in their local currency. It exposed them to a currency fluctuation risk. This means that an Indian company’s GDR could be valued differently in the US and European markets despite being associated with the same company.

Of course, the government and market regulator SEBI (Securities and Exchange Board of India) understood this and floated simpler rules for DRs in 2014. Unlisted companies could use them to tap overseas financial markets. Even if companies didn’t choose to raise capital overseas, a foreign depositary could still issue DRs for its shares if there was a lot of demand from investors. It’s called an unsponsored DR. The depositary would have to be a broker cum dealer who’d hold the Indian company’s shares.

But these rules didn’t really take off even until a couple of years later. And the ambiguity led to a drop in ADR and GDR issues. Between 2008 and 2018 Indian companies issued over 100 ADRs and GDRs in foreign markets. But since then, there have been no issues at all.

So why weren’t the new DR rules implemented faster then?

Well, regulators were worried about companies using DRs to launder money. You could blame it on a huge GDR manipulation scam worth over $150 million since 2010. Arun Panchariya, the man at the epicentre of this fraudulent scheme used interrelated companies to round trip shares floated via GDRs back to India, pocketing crores of Rupees. Basically, he and his associates pushed companies to create an artificial demand for their GDRs.

And they misused one GDR trait we didn’t tell you about earlier. Foreign investors can surrender their GDRs in exchange for shares. Once they have these shares in their kitty, they can sell them to Indian investors. That’s exactly what foreign investors did in the Panchariya scam. They offloaded their shares to a common bunch of investors who traded the stocks among themselves first. That would artificially inflate stock prices before selling them to innocent retail investors.

That explains why the government has been sceptical about the new DR rules. However, with a set of amendments in 2020 and some additional rules to keep a watchful eye on money laundering, the government hoped to fix this issue once and for all. And these rules finally took off a couple of days ago.

Will this make it easy for Indian companies to raise money overseas?

Well, the government still needs to clear the air over a lot of nitty-gritty details that the market is still unsure about. But it's definitely a start.

Until then…

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