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June 08, 2011 SEBI takes a U-turn: Limited Opportunity for Redemption of IDRs
India Depository Receipts (IDRs) as a concept was introduced in the year 2000 pursuant to amendments made to the Companies Act, 1956, followed by a series of regulatory changes aimed towards increasing the viability of IDRs in the Indian markets. Subsequently, the Reserve Bank of India (RBI) vide its circular dated July 22, 2009 (RBI Circular) operationalized the IDR regime. Till date, only one foreign company Standard Chartered Bank, Plc (Standard Chartered) has availed the benefits of the IDR regime by listing its IDRs last year in June. The RBI Circular and the Clarification Received from RBI Currently, the RBI Circular does not allow two way fungibility of IDRs, however, allows redemption of IDRs to underlying equity shares after the expiry of one year from the date of issue of IDRs (the Lock-in Period). As the RBI Circular merely provided for a Lock-in Period, it was always understood that following the expiry of the Lock-in Period, IDRs would be freely redeemed against the transfer of underlying equity shares, without the requirement of any prior approval from the RBI. This was also a position confirmed by RBI through a specific written clarification sought by our firm on behalf of our clients in December 2010. The SEBI Circular In view of the fact that the Lock-in Period of the IDRs of Standard Charted is due to expire soon, the SEBI Circular aims to put in place framework for redemption of IDRs. The SEBI Circular acknowledges that the extant regulatory framework does not permit fungibility but only redemption. Therefore, allowing redemption freely in the absence of a two way fungibility could result in the reduction of the number of IDRs listed, thereby impacting its liquidity in the domestic market. Accordingly, the SEBI Circular permits redemption of IDRs after the expiry of the Lock-in Period, only if the IDRs are infrequently traded in stock exchanges. As per the SEBI Circular, IDRs are deemed to be infrequently traded if the annualized trading turnover in the IDRs during the six calendar months immediately preceding the month of redemption is less than five (5) percent of the listed IDRs. As per the SEBI Circular, the issuer company is required to test the frequency of trading of IDRs on a half yearly basis ending on June and December of every year. The issuer company is required make a public announcement in an English and a Hindi newspaper with wide circulation, in the prescribed format (including brief details about the trigger of the redemption event, time period for submission of application and the approach for processing the applications) and notify the stock exchanges. The announcement is required to be made within seven (7) days of closure of the half year ending on which the liquidity criteria is tested. The IDR holders have the option to submit their application to the domestic depository for redemption of their IDRs within a period of thirty days from the date of such public announcement. The issuer company is required to complete the redemption process within a period of thirty days from the date of receipt of the application for redemption. After redemption, the domestic depository is under an obligation to notify the revised shareholding pattern of the issuer company to the concerned stock exchanges within seven days of completion of the process of redemption. Powers of SEBI vis-a-vis the Legitimate Expectation of Investors The logic appears to be that so long as the IDRs are liquid, the investors should be encouraged to exit though sale of IDRs on the market so that the liquidity of the IDRs in the market does not get impacted and only where there is not sufficient liquidity in the IDRs which could also impact the effective price discovery should they be allowed to be redeemed into the underlying shares. The logic appears reasonable from the perspective of development of the IDR market considering that dual fungibility is not permitted in case of IDRs. While the intention of the SEBI and the RBI may appear reasonable on one hand from the perspective of future development of the IDR regime, the SEBI Circular which applies to the exiting issue of IDRs has not been received well by IDR holders, more specifically the Foreign Institutional Investors (FIIs). They see this as a change of the rules midway, as when they were offered the IDRs such a condition was never prescribed and the timing of such restriction coming at the stage when the Lock-in Period is nearing an end, puts them in a disadvantageous position as they will not be able to acquire the underlying shares and therefore exit being forced through IDRs would mean they might end up taking a hit on their books on account because of such change in policy. It is important to note that FIIs were specifically allowed to participate in the IDRs through a series of amendments in the IDR Rules, various SEBI Regulations and the RBI Circular brought in the beginning of the year 2009, which played a significant role in the success of the maiden IDR issue. And now this sudden change in the rules few days ahead of the expiry of Lock-in Period of Standard Chartered IDRs is certainly being seen as against the legitimate expectations of holders of IDRs. The sudden change introduced by SEBI has taken the investors by surprise and some have also questioned the legitimacy and legal validity of such a circular issued by SEBI. Conclusion While one can argue that development of the securities market falls clearly within the SEBI powers and issuance of such a circular squarely falls within those powers. However, such change in the policy being made effective retrospectively, against the legitimate expectations of the investors which might force them to suffer losses, could be challenged in the court of law. Introducing circulars which have retrospective effect or which considerably changes the premise of investment by an investor could tarnish the image and the reputation of the Indian market as a matured securities market and hurt the sentiments of the investing community. And prospectively, one needs to examine the impact that the SEBI Circular will have on the success of future IDR issuances if FII participation and interest wanes on account of such exit restrictions.
- Shikhar Kacker, Anil Choudhary, Vyapak Desai & Siddharth Shah You can direct your queries or comments to the authors |
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