IDR, GDR, Participatory Notes

Depositary receipt (DR)

A depository receipt is a negotiable (transferable) financial instrument or certificate issued by a bank to represent security usually in the form of equity, shares etc., of a foreign company’s publicly traded securities that is traded on a local stock exchange. The depository receipt facilitates the investors of any country to invest, hold shares, and trade in the securities of a company in any other country that entitles the shareholders to partake in the capital gains and dividends of that company. It provides the investors with an alternative to trade on an international market.
The most common types of depository receipts include American depositary receipt, European depository receipt, Global depository receipt, Indian depository receipt, Luxembourg depository receipt, Chinese depository receipt etc.

Working of Depository receipt

A depository receipt  is created when any foreign company  wants to list its publicly traded shares or securities in any international stock exchange. A company needs to meet the specific rules of stock exchange before listing its stocks for sale. A company has to transfer its shares to a brokerage house in the home country. The brokerage house after receiving the shares, uses a custodian connected to the international exchange for selling the shares by issuing depository receipts. The depository receipts can be publicly traded over the counter. The connection between the brokerage house and the custodian ensures that the shares of the stocks actually exist without any manipulation between the foreign company and the international brokerage house.

Benefits of depository receipt

  • The depository receipts increase Global trade which can increase not only the volume of stocks traded on local and foreign markets but can also help in the exchange of Information, Technology etc., and can increase market transparency.
  • Depository receipts provide company greater exposure in the international market and can help the company to raise capital. It can increase the share’s liquidity and can boost the companies prestige in the domestic market.
  • Depository receipts promote International shareholder base and allow foreign investors to enter the local market easily.
  • By investing in depository receipts, an investor's portfolio turns into a global portfolio. Investors are able to get the benefits of higher risk, higher return equities in foreign markets.

American depositary receipt (ADR)

  • American depositary receipt refers to negotiable and transferable security which represents the securities of a corporate company trading in the stock exchanges of U.S.A.
  • Many non-U.S companies trade their shares on the stock exchanges and financial markets of the USA through ADRs that are denominated and pay dividends in U.S. dollars.
  • These can be traded like the regular shares of the stock. ADRs are the U.S. equivalent of Global Depository Receipts.

Global depository receipt (GDR)

  • Global depository receipt (GDR) is a general term for depository receipts in which a depository bank issues a certificate and purchases shares of foreign companies and creates security on local stock exchange backed by those shares. These are the global equivalent of American depositary receipts (ADRs).
  • The custodian bank that is situated in the country of the issue of depository receipt has the responsibility to keep the shares of GDR safe. It is usually the depository bank that selects the custodian bank which has the responsibility to collect the dividends and forward any notice or information of the issue or to the depository bank which then forwards them to the Global depository receipt holder.
  • GDRs represent the ownership of a specified number of shares of a foreign company which are commonly used for investing in companies from emerging and developing markets by the investors from developed economies.
  • Foreign investors trade in GDRs in several markets which are generally referred to as capital markets. The capital markets are used by investors for trading the long-term debt instruments and for generating capital.
  • The transactions in GDRs in the international stock exchanges have lower associational cost than the other mechanism which the investors use for trading in foreign securities.
  • The price of GDRs are based on the value of related shares, but these are traded independently of the underlying shares. The value of GDR  can be anywhere from a fraction of share to multiple shares. Usually the value of 1 GDR is equal to 10 underlying shares, however, the ratio can vary.
  • The Global depository receipts enable any corporate company to access investors in the capital markets outside the domestic market.
  • GDR can be denominated in any freely convertible currency and can be issued in more than one market.
  • GDRs are traded in international stock exchanges such as London stock exchange, Frankfurt stock exchange, and Luxembourg stock exchange etc.

Global depository receipts (GDRs) issuance by Indian companies

  • The methodology of issuance of global depository receipts by any Indian firm involves the issuance of shares in rupees to the depository bank in a foreign country. The depository bank then issues GDRs against these equity shares to the foreign investors in foreign currency.
  • The domestic custodian bank has the physical possession of the equity shares. In the books of the company, the depository bank is recognised as the owner of the equity shares of the company. The depository bank has all the voting rights given to any equity shareholder.
  • After the amendments in 2005, only the listed companies can issue the global depository receipts in the international markets.
  • GDRs enables the investors to access the capital markets of any foreign company without getting involved in the currency, language or tax laws.
  • The investors who invest in any Indian company through the GDRs are exempted from tax in India unless the GDRs are converted into shares.

Indian depository receipts (IDRs)

  • Indian depository receipt (IDR) is a negotiable and transferable financial instrument denominated in Indian rupees that enables foreign companies to raise funds from Indian stock and financial markets. Indian depository receipts are the Indian versions of similar Global depository receipts.
  • IDRs are created by a domestic depository (that acts as the custodian of securities and is registered with the Securities and Exchange Board of India) against the underlined shares of the foreign issuing company.
  • The foreign issuers of IDRs have to comply with the SEBI (ICDR) regulations, 2009 and have to file a draft prospectus with SEBI.
  • The foreign company will deposit the equity shares to an Indian depository that will issue receipt the Indian depository receipts two Indian investors against these equity shares.
  • The depository receipt holders will get benefits such as dividend, bonus etc., of the underlying equity shares.
  • The Indian depository receipts have to be listed in at least one stock exchange in India having nationwide terminals for which the foreign issuer company has to obtain in principle listing permission from the recognised stock exchanges.

Participatory Notes

Foreign investment in India can be categorised into foreign direct investment (FDI) and foreign institutional investment (FII). The market regulator SEBI has laid down strict guidelines for seeking approval and documentation for FDI. On the other hand, foreign institutional investment is characterized by portfolio investment viz. quick money entering the Indian stock market for the short term due to which there are fewer guidelines on FII. Foreign institutional investors are the investors who invest in assets belonging to a different country other than where they are registered and their organisations are based. In 1992 SEBI had permitted FII to register and participate in Indian stock market trade.
  • Participatory Notes (P-Notes or PNs) are financial instruments issued by registered foreign institutional investors (FIIs) to international overseas investors who want to invest their money in Indian stock exchanges without getting themselves registered with the market regulator, the Securities and Exchange Board of India (SEBI).
  • In other words, Participatory Notes are Overseas Derivative Instruments having Indian stocks as their underlying assets that allow the overseas investors to invest in the stocks listed on Indian stock exchanges without being registered with SEBI. Participatory Notes gained popularity to avoid the formalities of registration and for remaining anonymous.
  • Participatory Notes replicate the performance of underlying stocks and securities without the buyer actually having to own the shares directly. It enables foreign investors to avoid paying taxes and to circumvent domestic regulations in India.
  • Participatory notes are not traded on Indian stock markets and are directory sold to Overseas investors who buy it from the FII to avoid taxation and regulations.
  • The holders of Participatory Notes cannot have any claim on the equity as Participatory Notes are equivalent to the futures contract. Participatory Notes do not have any rights of shareholders as these are traded only for capital gains.

Reasons for investing through participatory notes

  • Participatory Notes provide anonymity to the investor as the entity investing in Participatory Notes are not registered with SEBI. This enables large hedge funds to trade and carry out their operations without having to disclose their identity. One other hand, foreign institutional investors have to compulsorily get registered with SEBI.
  • Participatory notes provide ease of trading as these are like contract notes transferable by endorsement and delivery due to which investing through P notes is very popular among FIIs to avoid the hurdles of knowing your customer norms.
  • Participatory Notes provide tax saving and several investors route their investment through participatory notes to avoid tax laws.
  • Participatory notes have been used for the purpose of money laundering in which the host of Indian money launderers first take the money out of the country through hawala and then invest it back in the country using Participatory Notes. The promoters of companies use participatory notes to bring back the unaccounted money and manipulate their stock prices.
  • Apart from India, several other Markets allow investment through Participatory Notes that include Shenzhen and Shanghai markets for China A-shares, MENA markets and Korea.

Participatory Notes crisis 2007

  • On October 16, 2007, SEBI proposed to curb Participatory Notes that accounted for around 50% of foreign institutional investment at that time. This was because it was not possible for SEBI to know that who owns the underlying securities and hedge funds through P-notes that could cause volatility in the Indian stock markets.
  • The proposals of SEBI were not clear which lead to knee jerk crash of the stock market on October 17, 2007. Sensex crashed by 1744 points within a minute of the opening of trade which led to the automatic suspension of trade for 1 hour.
  • The Finance Minister clarified that government would not immediately ban Participatory Notes after which the market staged a remarkable come back on that day. However, the volatility continued for the next few days.
  • On October 22, SEBI clarified it's proposal about a curb on participatory notes and announced it's proposal about a curb on participatory notes and announced that funds investing through participatory notes where most welcome to register as FIIs whose registration process would be made easier and faster.
  • On October 27 2007, SEBI issued fresh rules set according to which the FIIs cannot issue fresh participatory notes and existing exposures where to be wound up within the next 18 months. After this announcement, the stock market improved and Sensex crossed the 20,000 mark on October 29, 2007.
  • Later on, SEBI removed the restrictions on issuing participatory notes on the backdrop of economic slowdown.

Trends on the investment through participatory notes

  • The absolute value of investments through participatory notes reached a record Rs 4.5 lakh crore in October 2007 that are counted for 55% of foreign institutional Investments.
  • The fund flow through participatory notes had hit nine and half year low of rupees 66,587 crores in mid-2018 which was the lowest level since March 2009, when the investments through P-notes stood at rupees 69,445 crores.
  • The fund inflow through participatory notes climbed to rupees 79,513 crores by the end of December 2018 after SEBI relaxed norms for clubbing of investment limits by foreign portfolio investors ( foreign institutional investors).

Steps taken by SEBI to regulate participatory notes

  • In October 2007, SEBI issued fresh regulations according to which FII cannot issue fresh participatory notes and the existing participatory notes would have to be to be wound up in the next 18 months. A year later the restrictions on participatory notes were removed due to the financial crisis.
  • From January 2011, the new rules of SEBI required the FII to follow know your customer (KYC) norms and had to submit the details of transactions. This caused a decline in the issuance of participatory notes.
  • In April 2014, SEBI banned unregulated entities in foreign countries from subscribing to participatory notes.
  • Later on, in 2016, SEBI mandated that in addition to KYC norms, the anti money laundering rules will be applicable to the participatory note holders. SEBI also issued fresh norms on the transferability of participatory notes between two overseas investors and also increased the frequency of submitting the report on participatory note issuers.
  • In July 2017 SEBI in its fresh regulations, banned foreign portfolio investors from issuing participatory notes for investments in equity derivatives. The FPIs can issue participatory notes to foreign investors if equity derivative investments are used for hedging their equity shares.
  • In April 2017 in another move by the regulator SEBI to stop round-tripping and money laundering, the non resident Indians, as well as residents, were banned from investing in participatory notes.


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