Sebi ruling on StanChart IDR may pave way for conversion

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Sebi ruling on StanChart IDR may pave way for conversion

Sebi on Friday ruled that StanChart need not convert the IDRs into underlying shares (listed on the LSE) after the one-year lock-in that ends this week. Sebi seems to have taken the view that there is enough liquidity in the IDRs and so the company need not redeem the IDRs

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Watch CNBC-TV18 live only on MYTV >> StanChart IDR BSE | NSE 30/05/12 Are Mutual Funds betting on StanChart IDR?

Santosh Nair
Moneycontrol.com

An unintended consequence of the Sebi ruling on the Indian Depository Receipts (IDRs) of Standard Chartered Plc could be that, IDR investors may well get a chance to convert their holding in the underlying shares in a few months from now. That is because the IDRs could lose favour with institutional investors-especially overseas ones-leading to a drop in liquidity, thereby triggering the clause for conversion/redemption.

The market regulator on Friday ruled that Stanchart need not convert the IDRs into underlying shares (which are listed on the London Stock Exchange) after the one-year lock-in that ends this week. The regulator seems to have taken the view that there is enough liquidity in the IDRs and so the company need not redeem the IDRs and give the underlying shares to the holders.

Here is what the Sebi circular said on the rule for conversion/redemption.

"After the completion of one year from the date of issuance of IDRs, redemption of the IDRs shall be permitted only if the IDRs are infrequently traded on the stock exchange(s) in India. For this purpose, IDRs shall be deemed to be 'infrequently traded' if the annualized trading turnover in IDRs during the six calendar months immediately preceding the month of redemption is less than 5% of the listed IDRs."

The trading turnover in Stanchart IDRs over the past six months was around 48% on an annualized basis, making them ineligible for conversion.

The IDRs had become popular with foreign institutional investors, whose holdings rose from 38% to 70% over the last one year. As evident from bulk trades data on the stock exchanges, FIIs were the biggest sellers in Stanchart IDRs on Monday. Many of these investors would have been betting on the Sebi allowing one-way fungibility (freedom to convert IDRs into the underlying at the end of the lock-in period in June) to begin with, and even two-way fungibility at some point. That no longer being the case-at least in the near future--many of the short term investors saw little point in holding on the IDRs.

In the same circular, Sebi has cited the reason for not allowing redemption for now:

"Allowing redemption freely in the absence of two way fungibility could result in reduction of number of IDRs listed, thereby impacting its liquidity in the domestic market."

But liquidity in the IDRs may still be affected, if foreign institutional investors keep away.

Stanchart IDRs were quoting at around Rs 92 on Tuesday morning, a discount of around 20% to the underlying. The widening of the discount (from 8-12%) implies that the large investors are no longer excited about the stock. More than retail or even high-networth investors, foreign institutional investors-with their large ticket size and presence in various markets--are best placed to benefit from fungibility even if the arbitrage gap is not every large.

Stanchart may claim that it has been very pleased with investor interest in the its IDRs, but what could put off potential investors from buying Stanchart IDRs is the feeling that the rules have been changed mid-way through the game.

Falling liquidity in turn could trigger a self-reinforcing cycle of falling prices(distress selling) and further illiquidity (as many investors may hold on, not wanting to sell at a steep discount).

Perhaps, there could still be an opportunity if the discount with the underlying widens further, and the company is allowed to redeem (convert the shares into underlying) the IDRs at a later date. And that may be what the domestic mutual funds who bought the IDRs on Monday are betting on.