Recent incidents of wrongdoing by some companies which raised capital through global depository receipts (GDRs) have prompted the government and regulators to consider tightening the norms for use of these instruments.
On the cards are new rules mandating GDR issuers to seek prior permission from markets regulator Sebi as well as enhanced disclosure requirements. The finance ministry, in coordination with Sebi and the central bank, is also reviewing two-way fungibility ? conversion of shares into GDRs and vice versa ? for GDRs, recognising that this flexibility helped the companies shortchange gullible retail investors.
Confirming the move, government sources, however, told FE that genuine GDR issuers would not be constrained by the proposed changes.
A depository receipt (DR) is a negotiable certificate that represents a company?s specific number of shares traded on the stock exchange of another country.
In an order issued on September 21, Sebi said a large number of Indian investors were duped by several GDR issuers.
With the help of some foreign institutions and their sub-accounts, these companies exploited the loopholes in existing GDR rules to benefit at he expense of domestic investors.
The modus operandi was thus: create a complex chain wherein FIIs would facilitate a GDR issue ? usually in large proportion to the existing share capital of companies and arrange for a connected set of investors overseas. Soon after buying GDRs, the investors would convert them into local shares (through cancellation of GDRs) thanks to the two-way fungibility allowed. In the end, these shares were sold to domestic investors in the open market, who would be lured by increased trading volumes in the stock and rising interest of foreign investors in the company, but unaware of securities fraud being engineered through a series of complex transactions.
After unearthing this racket, Sebi barred seven such companies from issuing any shares or convertible instruments or changing their capital structure in any manner till further directions. It also barred 10 FIIs and sub-accounts from dealing in securities.
Indian companies accounted for nearly 68% of all listed GDRs on the Luxembourg Stock Exchange as on December 2010, according to a Crisil Research report. The report also said investors had lost money in 85% of the 40 Indian GDR issues in 2010.
?This (two-way fungibility) appears to be at the root of the recent manipulations in the GDR market. We will examining the existing arrangement to make the market robust and fool-proof,? an official said. A similar leeway is not given for Indian Depository Receipts, which allow listing a foreign company?s shares on Indian bourses. Standard Chartered Bank is the only company to have issued IDRs.
Lack of disclosure requirements and the inability of the regulators to ascertain the identity of GDR holders are the other loopholes that led to the creation of this organised manipulation.
Officials acknowledge the challenges involved in plugging these gaps. A bigger challenge will be ascertaining the identity of GDR holders. ?Subscription in GDRs escapes the regulatory radar, since disclosure of GDR holders can be protected by taking defence of secrecy laws in foreign jurisdictions,? the Sebi order had said.
Most of the Indian companies which have raised capital through the GDR route during 2010 are from the small and mid-cap space, the Crisil report said.