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ADRs/GDRs: SEBI's Tightrope Walk!

Published on Sat, Oct 31, 2009 at 12:38 | Source : CNBC-TV18

Updated at Mon, Nov 02, 2009 at 14:18

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Anchor: This week's The Firm discusses the great Indian depository receipt trick, American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) and the issues regarding voting rights? How will the Securities and Exchange Board of India (SEBI) walk this tight rope?

In September this year, SEBI amended the takeover regulations to provide "...where the ADR/GDR holders are entitled to exercise voting rights on the shares underlying GDRs/ADRs by virtue of clauses in the depository agreement or otherwise, open offer obligations shall be triggered upon crossing the threshold limits set out in Chapter III of the takeover code". This amendment itself raised a big question, what does SEBI mean by '...where the ADR/GDR holders are entitled to exercise voting rights'? Don't all ADRs/GDRs come with voting rights even if depository receipt holders create private agreements with depositories to vote on their behalf, the receipt itself does come with some voting rights.

Hence, the issue of all depository receipts should come under the purview of the code, shouldn't it? To add to the confusion earlier this month, CNBC-TV18 learnt that Sebi's board has asked the regulator to scrutinize all depository agreements to better understand who is exercising voting rights. So what kind of agreements will pass muster with the regulator? To better understand that I am joined by Madhabi Puri Buch, MD and CEO of ICICI Securities and Shameek Chaudhuri, Partner at AZB and Partners.

Here is a verbatim transcript of the exclusive interview with Madhabi Puri Buch and Shameek Chaudhuri on CNBC-TV18. Also watch the accompanying video.

Q: When you issue an ADR/GDR to a depository holder, even if the depository holder signs-off his voting rights to the depository bank, doesn't the fact that you have issued the security with the underlying voting right mean that he has or she has voting rights, and therefore, should anyways come under the code, whether or not he chooses to exercise them or gives the right to exercise them to a depository back?

Buch: The way the regulation came into being was silent on the issue of voting rights and therefore the depository agreement which is a contractual agreement is what determined the rights that the ADR/GDR holders had.

So in the early days there were a few agreements which came into being where indeed the voting rights directly were with the ADR/GDR holders. Subsequently, what became the standard practice was that the ADR/GDR holders' voting rights were exercised by the depository and as a standard norm in favour of the resolutions being approved by the management. Thus, the context is that today as we speak, the large bulk of the agreements have a situation where the ADR/GDR holders as a matter of norm would vote with the management. However, the important thing is that the conversion of an ADR or GDR into the underlying share has no restrictions. So at any point in time, the ADR/GDR holder can acquire the underlying, and therefore, the normal voting rights under any circumstances.

Q: What you are saying is that if you hold ADRs or GDRs that represent 15% or more of the equity or voting rights of a company, you would come under the takeover code whether or not as a depository holder you exercise the rights, give the rights to the depository bank. The very fact is, like you said, since you could convert it into underlying shares at any point in time, you come under the takeover code obligations.

Buch: That is the clarification that is sought at this point in time. So the law at present does not recognize this because the fact is that at this point in time if you ask an ADR or GDR holder "do you have voting rights on this resolution?" he will say "No". So that is precisely the point under debate today and you know that is sought to be clarified and there are very cogent arguments on both sides to argue as to whether indeed it should or should not be.

Q: Which side are you on?

Buch: I believe that the fundamental economic right that the shareholder has indeed needs to be exercised. There is a provision to exercise that and then if you have that right, you should indeed come under the purview of the takeover act. However, the important thing is not the voting right. To my mind, the important thing is the transparency issue around the entire ADR/GDR issuance because of the fact that the depository voting and having all of that holding in bulk and what is behind that depository is not very transparent to my mind that is what needs improvement in our system and that is what is required to be changed.

Q: What is your view on this? Does the depository receipt holder, whether or not he/she exercises the voting right or asks the depository bank to do so still has that voting right? You cannot give it away if you don't have it. Therefore, it should come under the purview of the takeover code?

Chaudhuri: To that extent I differ. If you look at what the deposit agreement--the contract by which the deposit is issued and defines the contractual relationship between the issuer, the depository and the DR holder--states that the DR holder has no voting rights and cannot instruct the depository in any manner whatsoever. It further says that the depository will not vote unless, for example, so acquired by law or they take a legal opinion saying that they are supposed to vote on a particular matter. If they do then they shall, after taking the legal opinion, vote with the management of the company.

Q: You can also do a seemingly public issue with only three or four investors, right? No one is ever going to know unless SEBI starts examining every single transaction?

Chaudhuri: But there have been instances wherein the Reserve Bank of India (RBI) has come back and questioned issuers on the nature of the investors who have come into a particular issuance. Firstly, money from India is coming back into India and the second thing is to promote an access. So there have been issuances and if you have a credible bank who is running the deal, they will never ensure that in the garb of a public issuance you have only one investor or two investors, it will actually be a bonafide book bill which is sent across, a proper book is build and you have a great variety of investors who come in.

Q: So you are saying this has to be subjective that it has to be every agreement that will be examined and on the basis of the merit of that agreement Sebi needs to take a call whether that depository receipt holder is liable under the court to make an offer or not considering if he has 15% of that.

Chaudhuri: Yes.

Q: Do you have an all sort of a view on which agreements will pass muster with SEBI? Can we generalize this at all?

Buch: The regulator would generally prefer to have role based decision making because otherwise the kind of speculation that can happen as to say why something was approved and something was not approved and precedence and so on and so forth and no two situations will be exactly alike.

So I don't think that a regulator would have a policy which says on a case-by-case basis we will approve. It will need to be a role-based decision making and in that role based decision making to my mind the important factors will be of transparency, of disclosure, of who are the investors as you were describing. Moreover, the important thing to remember is that, in principle, SEBI does not have any concerns about shares with differential voting rights. The guidelines, which exist even domestically in India allow for a company to issue shares with differential voting rights, they maybe inferior, provided the dividend is the same. So now the question is that in some ways if you were to think of the ADRs and GDRs as being shares, which have temporarily inferior voting rights, so long as they are held in that form but they are getting the same dividend, they wouldn't have conceptual problem with that.

Q: Then you are contrasting what you said right in the beginning that whether you exercise it or not if you are an ADR/GDR holder holding 15% or more you should come under the takeover code's purview?

Buch: The real issue is when should the takeover code be triggered. The question is in order to determine that you are asking the question as to whether the voting rights are exercisable or not, that is the moot question. Now what I am saying is that it is not just a question of whether you can exercise the rights or not, the question is of parties acting in concert; the question is who are the people who are voting along with the management. So, if for instance, there was a long list of the top ten funds across the globe who have invested in a company and they are choosing to vote by contract with the management, would that be something that would cause concern either to the general investors at large or to the regulator, I would think not. The only circumstance under which this would be a problem is if it was being misused, and therefore, the important thing is the transparency issue.

Q: The Firm is discussing under what circumstances ADR and GDR holders come under the purview of India's takeover regulations. Under consideration are four basic scenarios--when the depository agreement gives depository receipt holders absolutely no voting rights at all? When depository receipt holders are given voting rights and can direct the depository bank on how to vote on their behalf? When as per the agreement with the issuer the depository bank votes en bloc? That is on behalf of all depository receipt holders in favour of the company management's proposal? When as per agreement with the issuer, the depository votes en bloc, which is on behalf of depository receipt holders along with majority shareholders of the issuing company.

Chaudhuri: If you look at the position let's say from the time the takeover code has been there till now, till this recent clarification, what it said is that ADR/GDR holders were excepted from the takeover code. Then you had the informal guidance, which clarified this position and then you had the SEBI amendment.

So, let's look at the position when ADR/GDRs will not, within the purview of the takeover code. At that point in time as well, the deposit agreements that were entered into clearly stated that the deposit holders do not have any voting rights, they cannot instruct the depository in any manner whatsoever, depository shall not vote unless required by norms.

Q: So that is a clear situation. That situation doesn't require any subjectivity, and doesn't come under the code.

Chaudhuri: Yes. That is how it is. Where this triggers in is when you are issuing the ADRs or GDRs with voting rights. That is, you can direct the depository to vote in a particular fashion. If you can do that then that will be the time when you will trigger the code. Otherwise you would not.

Q: Let's assume the depository bank is voting on its own. Which way does the depository bank have to vote for it to be considered having come under the purview of the takeover code?

Chaudhuri: If the depository bank is voting, as is currently the parlance, which is it is voting after taking a legal opinion with the management of the company, then that is fine because that is what has been happening all this while.

Q: Would you agree with that? Do you have to vote with the management or do you have to vote with majority shareholders to pass muster?

Buch: There are two things. One is if we were to look at the stock of agreements, which is there to date, there is a grandfather clause so to speak to say that this was issued at a certain time with a certain understanding of how it would work if you want to change that with retrospective effect.

Q: I don't think they are trying retrospective, so there is no anxiety on that count. How will fresh agreements be written?

Buch: So, if we were to remove that entire set of agreements and say that that will continue the way that it is and we were only look at the fresh issuances. I think the view that would be taken is exactly the legal view to say that if you have the discretion--it doesn't matter in what form or manner you exercise that discretion. If you have the discretion then you are subject to the takeover.

Q: But who has that discretion? Is it the depository receipt holder or the depository bank?

Buch: The holder.

Q: Assuming that the depository receipt holder doesn't have any discretion. He has no right to vote and it is the depository bank that is taking a view to vote this way or that.

Buch: It is not the depository bank. Under the depository agreement, it is already determined.

Q: I am saying which particular way comes under the code. If the issuer insists that the depository bank has to vote along with management, is that collusion with what if the management of that company is a promoter led management? Is that in some sense persons acting in concert with promoters, does that come under the code in any fashion? That is what I am trying to understand. If the issuer has said no, as a depository bank you will vote along with majority shareholders. If the promoter is one of the majority shareholders or has the bulk of shareholding, how will it be construed?

Chaudhuri: To that extent, again just going by historical evidence of how the agreements have worked is that you have had a depository participant who has voted with the management or with the board of the company, whatever be it, and it seems to have passed muster because SEBI has not come back in to question those for the very fact that the initial issuances of the DR happen, then that didn't have any voting rights. So, if it was fine let's say four years back it should be fine even today.

Buch: I'd just like to add one more dimension to this. There is an opportunity here through the whole ADR/GDR structure, which we wouldn't want to lose as a country, which is to say that there are certain sectors in the economy, which we consider as sensitive sectors where ideally we would want to ensure that the national interest is protected and therefore the exercise of control, etc. is within the boundaries.

I am saying that the whole ADR/GDR structure with that flexibility to determine how the voting will happen gives you an opportunity to attract capital into the country into those sensitive sectors without losing control.

Q: If this confusion prevails, does it hurt the efficacy of this product to be able to achieve everything that the corporate sector has put to use to over the last 10-12 years? Will depository banks say, I don't want to get into this legal mess or which way I need to vote, which way I don't, every time I vote I have to get SEBI clearance, it is too complicated and depository receipt holders say I don't know when I would be liable to takeover code obligations? Will it hurt the efficacy or the utility of this instrument in any fashion?

Buch: I would say that for the very large cap firms where really the individual holders would rarely cross the threshold, I think it would be an academic question because an investor would really look at it and say, do I really expect to cross this threshold and he would say, realistically not. To that extent he would say I am therefore immune, no matter what the guideline says.

In the smaller firms it would make a difference. I think to that extent, it would impact the decision making that people would have. In that context, it is important to understand why do some people, since they have the flexibility to go into the underlying shares, actually continue to hold ADRs and GDRs.

There are two things. One is that to a certain extent, they have immunity from the foreign exchange moved. So, in their books they are holding it denominated in dollars, and therefore, they are not carrying the currency risk, which is important to them. Some of the investors are mandated as part of their mandate to invest in shares of securities, which are listed only on their exchanges. So, to that extent, our corporates would be to a certain extent be handicapped that they simply cannot access those investors because they don't have a mandate.

So, I am saying there are certain advantages to this entire instrument. But I would argue that to a large extent the whole QIP instrument that has come in and has now become exceedingly popular, has to a large extent many of the advantages that an ADR/GDR issuance had other than these two.
To that extent, would it be a crippling effect? I think not, particularly for the largecaps it may not matter at all. But the smaller firms would perhaps feel the difference.

Q: Really how many large companies face the situation of one GDR holder holding 50% and more? It is a very rare situation? Will it hurt the instrument there?

Chaudhuri: No. I think what the SEBI is trying to protect is preferential allotment of depository receipts to one particular investor. Nowadays you have these private equity deals whereby you just allocate ADRs or GDRs. To block those kinds of deals, SEBI is coming out with this. But if it is a bonafide public issuance, I don't see why it should affect the issuer at all because you have banks that will check and ensure that it is dispersed to a wide variety of bonafide investors.