ADR, GDR norms further relaxed

Indian bidders allowed to raise funds through ADRs, GDRs and external commercial
borrowings (ECBs) for acquiring shares of PSEs in the first stage and buying shares from
the market during the open offer in the second stage.

Conversion and reconversion (a.k.a. two-way conversion or fungibility) of shares of

Indian companies into depository receipts listed in foreign bourses, while extending tax
incentives to non-resident investors, allowed. The re-coversion of ADRs/GDRs would,
however, be governed by the Foreign Exchange Management Act notified by the Reserve
Bank of India in March 2001.

Permission to retain ADR/GDR proceeds abroad for future foreign exchange

requirements, removal of the existing limit of $20,000 for remittance under the
employees stock option scheme (ESOP) and permitting remittance up to $ 1 million from
proceeds of sales of assets here.

Companies have been allowed to invest 100 per cent of the proceeds of ADR/GDR issues
(as against the earlier ceiling of 50%) for acquisitions of foreign companies and direct
investments in joint ventures and wholly-owned subsidiaries overseas.

Any Indian company which has issued ADRs/GDRs may acquire shares of foreign
companies engaged in the same area of core activity upto $100 million or an amount
equivalent to ten times of their exports in a year, whichever is higher. Earlier, this facility
was available only to Indian companies in certain sectors.

FIIs can invest in a company under the portfolio investment route upto 24 per cent of the
paid-up capital of the company. It can be increased to 40% with approval of general body
of the shareholders by a special resolution. This limit has now been increased to 49%
from the present 40%.

Two way fungibility in ADR/GDR issues of Indian companies has been introduced
subject to sectoral caps wherever applicable. Stock brokers in India can now purchase
shares and deposit these with the Indian custodian for issue of ADRs/GDRs by the
overseas depository to the extent of the ADRs/GDRs that have been converted into
underlying shares.

On Fungibility
Two-way fungibility of ADRs/GDRs issued by Indian Companies was permitted by the
Government of India and the RBI. The RBI has now, vide APDIR Circular No: 21 dated
February 13th 2002, issued operative guidelines for the 2 way fungibility of ADR / GDR.

Earlier, once a company issued ADR / GDR, and if the holder wanted to obtain the underlying
equity shares of the Indian Company, then, such ADR / GDR would be converted into shares of
the Indian Company. Once such conversion took place, it was not possible to reconvert the
equity shares into ADR / GDR. The present rules of the RBI make such reconversion possible, to
the extent of ADR / GDR which have been converted into equity shares and sold in the local
market. This would take place in the following manner:
Stock Brokers in India have been authorized to purchase shares of Indian Companies for
reconversion
The Domestic Custodian would coordinate with the Overseas Depository and the Indian
Company to verify the quantum of reconversion which is possible and also to ensure that the
sectoral cap is not breached.
The Domestic Custodian would then inform the Overseas Depository to issue ADR / GDR to
the overseas Investor.
Re-issue of ADRs/GDRs would be permitted to the extent of ADRs/GDRs that have been
redeemed and the underlying shares sold in the domestic market. Two-way fungibility implies
that an investor who holds ADRs/GDRs can cancel them with the depository and sell the
underlying shares in the market. The company can then issue fresh ADRs to the extent of shares
cancelled.
No specific permission of the RBI will be required for the re-conversion. Besides, investments
under foreign currency convertible bonds and ordinary shares will be treated as direct foreign
investment. Accordingly, the re-conversion of shares into ADRs/GDRs will be distinct from
portfolio investments by foreign institutional investors (FIIs). The RBI guidelines state that the
transactions will be demand-driven and would not require company involvement or fresh
permissions. The custodian would monitor the re-issuance of ADRs/GDRs within the sectoral
cap fixed by the Government. Each purchase transaction will be only against delivery and
payment received in foreign exchange through banking channels. For this purpose, all SEBI
registered brokers will be able to act as intermediaries in the two-way fungibility of
ADRs/GDRs.

Benefits of fungibility
The key benefits that could accrue to investors (ADR/GDR holders and domestic investors) and
companies from two-way fungibility are: improvement in liquidity and elimination of
arbitrage.
The conventional definition of liquidity is the ease with which an asset (in this case,
ADRs/GDRs) can be bought or sold quickly with relatively small price changes. This essentially
means that a liquid market for a security must have depth and breadth, and aid speedy price
discovery. A liquid market is said to have depth if buy and sell orders exist both above and below
the prices (at which a stock or ADR/GDR) is transacting. Similarly, the market is said to have
breadth if buy and sell orders exist in good volume.

In the one-way fungible regime, ADRs/GDRs suffered from price volatility and liquidity
problems, basically for two reasons. The first reason was the low ADR issue size that accounted
for low free-float in the US market and, thereby, low trading volumes in the security.
Second, the GDR market had been largely dormant (with the exception of a few high-profile
stocks) for the past couple of years. This affected the depth, breadth and price-discovery process
of GDRs in these markets. Two-way fungibility may at least revive some market interest in these
stocks.
Reduction/elimination of arbitrage
In an efficient market, two assets with identical attributes must sell for the same price, and so
should an identical asset trading in two different markets. If the prices of such an asset differ, a
profitable opportunity arises to sell the asset where it is overpriced and buy it back where it is
under priced. Obviously, arbitrageurs (speculators aiming to exploit these riskless opportunities)
can step in and exploit this profit opportunity.
Under the one-way fungibility regime, though identical assets (namely stocks in the domestic
market and ADRs/GDRs in the overseas markets) traded at different prices (at a
discount/premium), the arbitrage opportunities went a begging because of restrictions on the
capital account. By introducing two-way fungibility, market forces may trigger a realignment of
prices, minimising the widely divergent premium/discount levels prevailing between ADR/GDR
prices and the domestic stock prices.

Euro Issues by Indian Companies

Earlier, Indian Companies required approval of the Government of India before issue of Foreign
Currency Convertible Bonds (FCCBs). The RBI, has vide FEMA Notification No : 55 dated
March 7th 2002, liberalised these rules. Accordingly:
Indian Companies seeking to raise FCCBs are permitted to raise them under the Automatic
Route upto US 50 Million Dollars per financial year without any approval.
The FCCBs raised shall be subject to the sectoral limits* prescribed by the Government of
India.
Maturity period for the FCCBs shall be at least 5 years and the "all in cost" at least 100 basis
points less than that prescribed for External Commercial Borrowings.
Some restrictions had been imposed previously on the number of issues that could be floated by
an individual company or a group of companies during a financial year. There will henceforth
be no restrictions on the number of Euro-Issues to be floated by a company or a group of
companies in a financial year.
GDR end-uses will include:
financing capital goods imports;

 capital expenditure including domestic purchase/installation of plant, equipment and

buildings and investments in software development;
prepayment or scheduled repayment of earlier external borrowings;
investments abroad where these have been approved by competent authorities;
equity investment in JVs/WOSs in India. However, investments in stock markets and real
estate will not be permitted. Up to a maximum of 25 per cent of the total proceeds may be used
for general corporate restructuring, including working capital requirements of the company
raising the GDR.
Currently, companies are permitted to access foreign capital market through Foreign Currency
Convertible Bonds for restructuring of external debt that helps to lengthen maturity and soften
terms, and for end-use of funds which conform to the norms prescribed for the Government for
External Commercial Borrowings (ECB) from time to time. In addition to these, not more than
25 per cent of FCCB issue proceeds may be used for general corporate restructuring including
working capital requirements.
FCCBs are available and accessible more freely as compared to external debt, and the
expectation of the Government is that FCCBs should have a substantially finer spread than
ECBs. Accordingly, the all-in costs for FCCBs should be significantly better than the
corresponding debt instruments (ECBs). Companies will not be permitted to issue warrants along
with their Euro-issue. The policy and guidelines for Euro-issues will be subject to review
periodically.
Sectoral Caps
As per the Foreign Investment guidelines issued by the Government of India, Ministry of
Industry, foreign investment (equity/preference shares) upto certain specified limits would be
permitted by Reserve Bank under Automatic Route as under:
In relaxation of earlier guidelines, GDR end - uses will include :
Foreign investment (equity/preference) upto 50% in respect of Mining activities;
Foreign investment (equity/preference) upto 51% in (i) industries/items included in part 'B' of
Annexure III to Ministry of Industry's Press Note No.14 (1997 series) dated 8th October 1997**
and (ii) a trading company primarily engaged in export activity; in software development
Foreign investment (equity/preference) upto 74% in industries/items included in part 'C' of
Annexure III to Ministry of Industry's Press Note No.14 (1997 series) dated 8th October 1997**
Foreign Investment upto 100% in industries/items included in Part 'D' of Annexure III, to
Ministry of Industry's Press Note No.14 (1997 Series)** as amended from time to time provided
the foreign investment in a project does not exceed Rs.1500 crores.