[Bhaskar is a student at Jindal Global Law School.]
The Ministry of Corporate Affairs (MCA) recently notified (Notification) Section 5 of the Companies (Amendment) Act 2020 (Amendment Act). The provision concerns an amendment to Section 23 of the Companies Act 2013 (Act), which outlines the public offer and private placement process for Indian companies. The Amendment Act, through Section 5, permits certain public companies to access foreign markets through direct listings on foreign stock exchanges. Such companies and their proposed securities will be prescribed by the government through later notifications.
The Notification is a progressive step in unlocking additional channels of capital for Indian companies. Accessing global capital markets through direct listing measures will help companies prioritize fundraising without having to undergo the logistical hurdles involved in the traditional process of using depository receipts.
The author highlights the benefits of introducing a direct listing measure on foreign exchanges for Indian companies in addition to the country’s IFSC scheme. The IFSC regime in India has provided the ideal testing ground for a limited framework for international listing through certain exchanges. It is hoped that the regulatory experience gathered through this mechanism will help further the objectives of a direct foreign listing regime.
How Indian Companies Previously Raised Funds through Foreign Exchanges
While companies can also access markets through debt instruments like foreign convertible currency bonds, this article focuses on equity instruments. Before the Notification, Indian companies would broadly access global markets through depository receipts. Depository receipts (DRs) are financial instruments held by depository banks in a foreign jurisdiction. DRs derive their value from an issuing company’s equity and are generally classified as either Global Depository Receipts (GDRs) or American Depository Receipts (ADRs). The difference between the two instruments concerns the jurisdiction of listing—GDRs can be issued in multiple countries/regions like the United States, United Kingdom, Singapore etc., whereas ADRs are exclusively listed on bourses in the United States.
DRs originate from the purchase of a public company’s shares by a domestic custodian bank. Say, a depository bank in the United States requests a domestic custodian bank to purchase shares in an Indian company. The custodian bank confirms the purchase to the American depository and a fresh DR is generated as proof of shareholding. These DRs of a non-American institution are then held/traded by market participants in the United States. The Infosys ADR, for instance, was managed by Deutsche Bank (depository bank) with ICICI Bank as the domestic custodian to the issue.
While DRs provide a streamlined channel to tap into global markets, their utility has been waning in recent years. Despite the Indian government’s efforts to liberalize the DR scheme, there have not been many takers. In fact, a third kind of DR – the Indian Depository Receipt (IDR) – failed to take off when the only listed IDR entity (Standard Chartered) delisted in early 2020. This decline may be attributed to evidence concerning circuitous manipulation – trading through multiple entities to evade related party restrictions – of GDR issues.
Additionally, the growth of the Qualified Institutional Placement (QIP) as a popular alternative to fundraising has also furthered disinterest in the onerous process required in DR issuances. Introduced by the Securities and Exchange Board of India (SEBI) in 2006, QIPs have become a key driver of domestic fundraising in India. That said, not all is lost. The pivot from DRs has also come about due to progressive measures towards the country’s International Financial Services scheme.
India’s Tryst with International Financial Services Centers
An International Financial Services Centre (IFSC) is a special environment created for trans-national financial engagement. Hosted within a country’s territory, an IFSC creates the ideal circumstances and regulatory climate to operate beyond the host’s domestic restrictions on financial interactions. GIFT City, India’s first IFSC, aims to create a beneficial regulatory canvas for foreign investors to invest in India. This is achieved through inter alia broad tax breaks and regulatory exemptions concerning investments, entry, projects etc.
The GIFT City Special Economic Zone (GIFT SEZ) is the hub for exporting financial services out of India. All operations in the GIFT SEZ are facilitated by the International Financial Services Authority (IFSCA). One of the key developments in the IFSC are the number of exchanges that have been set up for foreign investors and Indian companies. The National Stock Exchange and the Bombay Stock Exchange – two of India’s premier stock exchanges – have offices in GIFT IFSC. The government recently announced that domestic companies could opt for direct listing on these exchanges in the IFSC to access international markets easily. This may be considered an inflection point for capital markets in India, as international exchanges like India International Exchange and international banking units in GIFT IFSC prepare to provide foreign market access to Indian companies without taking the DR route.
The Benefits and Nuances in Direct Listing
First, direct listings provide lucrative market access. Biddle and Saudagaran posit that firms have to prioritize the cost of capital when raising funds from equity markets. Smaller capital-markets jurisdictions may suffer from low demand and an unfavourable or sluggish regulatory climate. Factors of low demand and unproductive regulation may be deemed as externalities that have an effect on the price/earnings ratio (P/E ratio). A lower P/E ratio translates into a high cost of capital. This is why Novo, a Danish pharmaceutical giant, pursued a public offer in the United States. The foreign offer helped push Novo’s share price in the United States, translating into a positive effect in Novo’s home jurisdiction. Thus, providing an alternative jurisdiction with more demand may help firms that need additional capital that is just not available domestically. Additionally, there is precedent for foreign investment being a saviour, as foreign institutional investors are known to support Indian equities in trying market cycles.
At the same time, home jurisdictions are often cautious of the locations they permit their companies to list in. The United States, for instance, maintains an OFAC list on prohibited jurisdictions. Prohibited regions usually demonstrate degrees of non-compliance with anti-money laundering laws and inefficient regulatory scrutiny. The nuance in the Notification concerns India’s plan to allow direct listing in only permissible jurisdictions. The author theorizes (because eligibility norms are yet to be released) that the reason to do so may have a relation with the stringent regulatory guarantees provided by some markets, thereby assuring a higher likelihood of investor protection. For example: listing on the New York Stock Exchange requires companies to comply with regulations under the Sarbanes-Oxley Act (SOX) – the American Magna Carta of corporate governance. SOX is known to uphold high standards of financial reporting that is unparalleled by many jurisdictions. India would prefer ‘like markets’ due to its domestic internal financial controls in the form of Clause 49 that was introduced in the wake of the Satyam scandal in 2009.
Secondly, direct listing measures may provide access to sophisticated valuation methods for Indian companies. Indian companies have recently come under scrutiny for questionable valuations. Ironically, this has coincided with the greatest valuation run in recent times—Byju’s, an Indian unicorn, was recently downgraded to a measly USD 3 billion valuation, a significant spiral from its previous USD 21 billion valuation. While Byju's troubles stem from alleged corporate governance issues, a SEBI expert committee report from 2018 observes that direct listing in foreign jurisdictions has the potential to unlock better valuation methods for Indian companies. Higher valuations in foreign jurisdictions are a result of the mass wealth of information available once a company has to abide by the listing requirements in that jurisdiction, thereby reducing information asymmetry. Furthermore, jurisdictions may attract companies through regulatory experiments like the United States’ Inflation Reduction Act, that aims to distribute finances for green and sustainable infrastructure. Several European companies have moved to the United States because of such regulatory stimuli. To that end, it is hoped that the phrase ‘better valuations’ not only focuses on swelling numbers but on a well-informed and wholly considerate (of all material factors) assessment of Indian companies.
Conclusion and Further Clarifications
While the Notification is a significant step forward for Indian companies, it needs to be supplemented with further information and clarifications in addition to eligibility norms for companies and the securities that are eligible for direct listing.
To begin with, Section 5 of the Amendment Act only speaks of a “class of public companies”. This means that Indian companies need to go public in India before listing in other jurisdictions. Such a definition implies that the current Notification permits only secondary listings (also known as cross listings), a step below direct listings that are outside the jurisdiction of incorporation. Listing directly in GIFT IFSC would be an exception since the IFSC is legally separated from Indian jurisdiction. The IFSC scheme for direct listing will help shape the broader listing measure that removes an India-based intermediary. Other jurisdictions like China permit direct listings without going public in the home jurisdiction, albeit with rigorous regulatory scrutiny. China Eastern Airlines is an example of a China-incorporated company that listed directly on the bourse in Hong Kong. It would be prudent to also allow unlisted Indian companies to offer securities on specified exchanges in a regulated manner to provide them with jurisdictional options according to their capital requirements and public demand for their goods/services. It has been estimated that the IPO process typically costs anywhere between INR 2-3 crores in India and therefore, an alternative would ease the financial constraints on companies.
Furthermore, the MCA must clarify whether Chapter III (concerning public issues) of the Act is exempted from the process. This is based on the connection or proximity of the listed equity to the Indian jurisdiction and the obligations arising from the same. As foreign listings, they should be able to avail a degree of severability from the domestic compliance regime. Compliance requirements under the chapter, such as filing appropriate paperwork like draft red herring prospectuses in the form as prescribed by the SEBI for a public offer or the imposition of criminal liability for misstatements in said prospectus(es) are a few examples of the obligations. As a comparative, when masala bonds were formulated, their foreign connection exempted the issuers from such onerous SEBI-compliance standards. For the same reason, the equity of unlisted companies, if allowed abroad, must be maintained under the listing jurisdiction’s laws.
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