Framework of Depository Receipts: A Desirable Change?

By Aastha Agarwalla

To revive the declining access of foreign funding for Indian companies, the Securities and Exchange Board of India [“SEBI”] has introduced a new framework for the issuance of Depository Receipts [“DR’] via its circular dated October 10, 2019 effective immediately, [“DR Framework“]. [1]

The DR Framework is seen as a welcome step as it will open new avenues of foreign investment for Indian companies by streamlining issuance processes and removing uncertainties in regulatory practices.

Background

Simply put, ‘Depository Receipt’ is a foreign currency denominated instrument that is listed on an international exchange, issued by a foreign depository to a domestic custodian and includes global depository receipts. In the past few years, there has been a steep fall in the interest shown by Indian companies in DR due to compliance and regulatory uncertainties in the extant regulations governing the issuance of DR. This resulted in the decrease of access of foreign funds in the commercial markets.

The DR Framework has been introduced in furtherance of the ‘Depository Receipt Scheme’ notified in the year 2014. However, it was not implemented due to concerns raised by the SEBI and other stakeholders on grounds of difficulty in monitoring transactions, tracking the ultimate beneficiary and the potential risk of money laundering.[2] To resolve the aforementioned concerns, SEBI has introduced a clear-cut DR Framework to facilitate and encourage DR issuances by companies and create foreign funding structures for the Indian companies.

Key highlights of the DR Framework

The DR Framework sets out a detailed procedure to be observed by companies while issuing the DR. In addition to that, it specifies the eligibility criteria for DR issuance and obligations of depositories, both Indian and foreign, and domestic custodians in tandem with the Companies Act, 2013 and the foreign exchange regulations. 

The key highlights of the DR Framework are enumerated as follows:

  1. SEBI has permitted only listed companies to issue permissible securities in permissible jurisdiction. Additionally, SEBI has also listed eligibility criteria for issuance of DR. For instance, the listed firms are allowed to issue such securities provided their promoters, directors and selling shareholders are not barred from the capital markets. Besides, they should not be willful defaulters or economic offenders. In addition, existing holders will be eligible to transfer permissible securities for the purpose of issuance of DRs.
  2. Further, listed Companies shall also ensure that DRs are issued only with equity shares and/or debt securities as the underlying assets which are in dematerialized form and listed on a recognized stock exchange.
  3. The DR Framework has barred Indian residents and Non-resident Indians (NRI) as a permissible holder of DR or their beneficial owner by not identifying them. Also, it states that the onus of ensuring compliance with this condition is on the permissible holder or beneficial owner, as the case may be. 
  4. Additionally, the price of issue/transfer of DR by a foreign depository should be based on the corresponding mode of issue of DR to the domestic investors.  The price for the public offer / preferential allotment / qualified institutions placement while issuing DR shall not be less than the price offered to domestic investors under the applicable laws.
  5. It further specifies that the listed company should comply with extant minimum public shareholding norms in India, after excluding the permissible securities held by the depository in form of DR.

Moreover, in tandem with the DR Framework, the recent amendment to the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 [“PMLR Amendment”], also clarified certain long-standing issues for DR. The PMLR Amendment eased reporting and due diligence requirements for the holders of DR, and clarified rules in relation to the identification and verification of the beneficial owner of DR holders bringing clarity in the governance of the DR.

Consequences of the DR Framework: A welcoming step?

With the advent of the DR Framework, India’s capital markets is expected to boom owing to the operationalization of the platform for the issuance of DR. Additionally, it also offers choice to the  investors to spread their portfolio risk in the international jurisdictions creating international presence for the Indian companies.

Whilst the DR Framework has paved the way for the issue of DR, there are still points which need further discussions. For instance, certain matters in relation to the secondary transfers such as mode of transfer by the shareholders of the listed company to the depository, pricing and tax implications for the seller and the acquirer need to be considered by the market regulator and needs further clarification.

From the recent trends, it can be identified that the Indian start-up market in witnessing a boom. It’s well known that these start-up companies depend majorly on the funding by investors (both domestic and international) for their growth, vision and sustenance. However, the DR Framework has excluded start-ups to be an eligible holder of DR. In addition to this, various technology focused companies are also excluded from the DR Framework. Whereas, DR has the potential to create new opportunities for start-ups and technology focused companies by looking beyond the domestic financial markets for raising international capital and developing an investor base which would otherwise not be available to them.  Therefore, the DR Framework should be synced with the contemporary practices and should include start-ups and technology focused companies as an eligible holder to enable them to attract foreign funds.

Additionally, the SEBI has introduced strict obligations for all DR transactions as a safeguard against manipulation. On one hand, India aspires to hold a place in the top 50 ranks in terms of Ease of Doing Business Index; however, on the other hand, the approach adopted in the DR Framework in not in sync with the intent of easing the compliance norms as it increases the paperwork. Hence, the SEBI has failed to adopt the ‘principle of neutrality’ in the DR Framework as recommended in the Sahoo Committee Report.

Last but not the least, the permissible jurisdictions and recognized stock exchanges in the permissible jurisdictions shall be notified by the Central Government at the earliest to set the process of issuance of DR in motion. 

Conclusion

Needless to say, this liberalized DR Framework  will be a welcome step for the sluggish economy as it will help to develop an equity culture across the length and breadth of the country by providing foreign funding; leading to economic development. Thus, it is certainly an excellent move in the right direction and will be hailed by the big corporations awaiting a comprehensive DR regulation.

Thus, the walk from here visualizes revamping the DR regime by putting in place a clear cut DR Framework and offering a viable option to raise foreign capital. As a concluding thought, it will be interesting to see how DR proceeds to create a regulatory framework around it and be a popular mode of foreign financing in India.

The author is pursuing her 2nd Year at the Campus Law Centre, Faculty of Law, University of Delhi.


[1] SEBI, Framework for issue of Depository Receipts (2019), https://www.sebi.gov.in/legal/circulars/oct-2019/framework-for-issue-of-depository-receipts_44609.html

[2] Jayshree P. Upadhyay, Depository receipts regime fails to take off due to SEBI concerns, Livemint (2016),  https://www.livemint.com/Money/BFrGJSAZ9FX151eJ4PAnFO/Depository-receipts-regime-fails-to-take-off-due-to-Sebi-con.html