The Indian government has recently relaxed the eligibility norms for foreign companies to raise capital from the Indian market through the Indian Depository Receipts (IDRs) route. Why the relaxation? In its anxiety to prevent fly-by-night foreigners from robbing Indian investors, the IDR eligibility norms prescribed in 2004 went overboard. These specified that the issuer company should have pre-issue paid-up capital and free reserves of at least $100 million, an average turnover of $500 million during the three preceding financial years, profits for at least five years preceding the issue, dividends of not less than 10% in each year for the said period and a pre-issue debt-equity ratio of not more than 2:1. Phew!
It was not recognised that companies willing to use the IDR route would not be famous MNCs or even companies in developed countries with deep capital markets. They would instead be from the developing world, and very likely from neighbouring countries. In addition, there could be a handful of foreign companies with presence in India seeking to meet their domestic capital expenditure through an IDR issue. The eligibility norms, though, nixed all these possibilities.
In fact, if a company could have met the IDR norms, it would have been a strong candidate to raise money from its own market and at much lower cost, or from the more prestigious EU/US markets. Even private equity investors would have chased such companies.
Neither was it acknowledged that IDR issues would necessarily be FPOs, as the guidelines allow only listed companies to float IDRs. Significantly, only QIBs are allowed to invest in IDRs. These are sophisticated, well-informed investors. To model the eligibility norms on the domestic IPO norms that seek to protect retail investors, therefore, was guaranteed to keep capital seekers uninterested.
It is good news that the government has now taken a realistic view. Prime Database had submitted a detailed research paper on this subject, and we are glad that our suggestions have been taken. Our study covered the universe of all public issues above Rs 100 crore (32 in all) that were made in 2005-06. The findings were startling. If these 32 companies were foreign-based and had wanted to float an IDR, not even one company would have qualified!
No single company met even three of the five criteria, while eight companies did not meet even one. In view of this, even the well-regarded Indian companies which made public issues in 2005-06, like IDFC, Suzlon, HT Media and Shoppers’ Stop, would not have qualified.
As suggested by Prime, market capitalisation has been provided for as an eligibility condition. Also, a new condition requiring the company to have a three-year trading history on a stock exchange in its parent country has been introduced. This would ensure that only seasoned companies get in. Moreover, a minimum rate of dividend for the last five years and a minimum 2:1 debt equity ratio have been dropped as requirements. But the profit-making criterion has been retained. Even in India, we have dropped profit and dividend criteria in the case of book-built issues (which have a mandatory QIB participation). Many loss-making companies have made IPOs in the last three years, including Jet Airways, Deccan and Global Broadcast News). Profit and loss is a market concern that is reflected in the offer price, and should be a matter between a company and the investor.
So, will foreign companies come rushing to India? Well, for one, no survey has been done of the potential market size, even in neighboring countries. We have no clue on how many companies would comply with the relaxed norms, leave aside any sense of their capital raising plans. In any case, this instrument needs aggressive marketing overseas. Indian exchanges have not been known for their marketing skills, as almost all listings have come to them automatically. We will also have to compete with at least two regional exchanges?Singapore and Dubai?which are getting global attention. Quite like them, and even the NYSE, Nasdaq and AIM, Indian exchanges need to go out and market themselves to potential issuers abroad.
Some complain that India is capital-starved to begin with, so why allow Indian capital to finance foreign companies? The counter argument is that India has to demonstrate to the world not only its depth as a capital market but also its quality of regulation. In the long-term, IDR companies would endow the Indian market with a ruboff effect. Meanwhile, Indian economic policymakers want to encourage capital outflows to help balance excessive inflows.
Is there enough depth in the Indian market to absorb IDRs? There appears to be little concern on this front, as the Indian market has shown a ravenous appetite for equity in recent times, as validated by the huge mobilisation done through IPOs, FPOs and QIPs. With only QIBs being eligible investors, though, will IDRs become a means for foreign companies to mop up FII money through the Indian capital market? To a large extent, yes, but that?s no worry. Domestic QIBs like mutual funds and insurers, meanwhile, would welcome the opportunity to diversify their portfolios.
?The writer is managing director, Prime Database. These are his personal views