TWO WAY FUNGIBILITY

SCHEME OF ADR AND GDR

CORPORATE FINANCE AND SECURITIES

PROJECT
NINTH SEMESTER

NAME: TANUMOY MAJUMDER

ROLL: 631
SUBMITTED ON:
 ACKNOWLEDGMENT

I have taken efforts in this project. However, it would not have been possible without the kind
support and help of many individuals. I would like to extend my sincere thanks to all of them.

I am highly indebted to my faculty for his guidance and constant supervision as well as for
providing necessary information regarding the project and also for his support in completing
the project.

I would like to express my gratitude towards my parents and my friends for their kind co-
operation and encouragement which helped me in the completion of this project.

I would like to express my special gratitude and thanks to my seniors for giving me their
attention and time.

My thanks and appreciations also go to my colleagues in developing the project and people
who have willingly helped me out with their abilities.

Tanumoy Majumder

Roll-631

2
 TABLE OF CONTENTS

1. RESEARCH METHODOLOGY..4

2. INTRODUCTION.............................................................................................................5

3. BACKGROUND OF THE SCHEME...........................................................................7

4. DEPOSITORY RECEIPTS AND RELATED CONCEPTS............8

5. FUNGIBILITY SCHEME OF ADR AND GDR.............11

6. OPERATIVE GUIDELINES AND PROCEDURES..............15

7. CONCLUSION.................................................................................................................18

8. BIBLIOGRAPHY.............................................................................................................20

3
 RESEARCH METHODOLOGY

AIMS AND OBJECTIVES:

This paper is an attempt to understand the fungibility scheme of ADR and GDR in special
reference to India and how it works and is implemented here.

RESEARCH ISSUES:

1. What are the meaning, type and relevance of ADR and GDR in India and how and when
does it occur?

2. What are the various cases where fungibility takes place and what happens when it does?

SOURCES OF DATA:

Primary and secondary sources of data have been used herein.

MODE OF CITATION:

A uniform mode of citation, as prescribed in the 19th edition of the Bluebook, has been used.

KEY WORDS:

ADR, GDR, fungibility scheme

4
 I. INTRODUCTION

It is the intent and objective of the Government of India to attract and promote foreign direct
investment in order to supplement domestic capital, technology and skills, for accelerated
economic growth1. Foreign Direct Investment, as distinguished from portfolio investment,
has the connotation of establishing a lasting interest in an enterprise that is resident in an
economy other than that of the investor. The Government has put in place a policy framework
on Foreign Direct Investment, which is transparent, predictable and easily comprehensible.

This framework is embodied in the Circular on Consolidated FDI Policy, which may be
updated every year, to capture and keep pace with the regulatory changes, effected in the
interregnum.2 The Department of Industrial Policy and Promotion (DIPP), Ministry of
Commerce & Industry, Government of India makes policy pronouncements on FDI through
Press Notes/Press Releases which are notified by the Reserve Bank of India as amendments
to the Foreign Exchange Management (Transfer or Issue of Security by Persons Resident
Outside India) Regulations, 20003. These notifications take effect from the date of issue of
Press Notes/ Press Releases, unless specified otherwise therein. In case of any conflict, the
relevant FEMA Notification will prevail. The procedural instructions are issued by the
Reserve Bank of India vide A.P. (DIR Series) Circulars. The regulatory framework, over a
period of time, thus, consists of Acts, Regulations, Press Notes, Press Releases,
Clarifications, etc.4

The trend towards the internationalization of financial markets has gained impetus during the
last decades, driven mainly by the sophistication in IT and capital market participants, greater
co-operation between financial regulators, the lowering of capital barriers across national
boundaries and the liberalization of capital markets in emerging economies. Many companies
have been looking beyond their domestic financial markets, in an effort to enhance their

1
Depositary Receipts Handbook 2003 (PDF), http://adr.db.com
2
Marshall, J.F., Bansal, V.K. (1996). Financial Engineering: A complete Guide to Financial Innovation,
Prentice-Hall (India), pp.467-469.
3
Notification No.FEMA 20/2000-RB dated May 3, 2000)
4
Desai, N.M., D'Souza, D. (1998). Legal and Tax Considerations Confronting Indian companies Issuing
GDRs/ADRs. Working Paper: 17, Nishith Desai Associates (Bombay).

5
global presence5. They have intended to raise capital beyond the borders of their home
market with the aim of expanding their offerings and shareholder bases.

Depositary Receipts (DRs) overcome many of the inherent operational and custodial hurdles
of international investing and associated risks. DRs offer different companies new avenue
and flexible mechanism to raise capital outside their home country in an efficient manner. At
the same time they provide invests with international diversification. In this project, initially
we have an overview on the concepts related to DRs including; definition and structure,
issuance and trading mechanics, their different formats, fungibility concept, motives for
cross-listing of companies, advantages of DRs, and finally review of global market for DRs
and its evolution. Then in second part, there is overview of DRs in India and related policies,
main factors affecting Indian companies decisions for cross-listing and their choice of stock
exchanges. In the last part of the chapter, we investigate the efficiency of DRs of Indian
origin companies in providing them with access to more developed and efficient markets to
enhance their capital resources.

The Securities and Exchange Board of India (SEBI), the Indian securities market regulator,
and the Reserve Bank of India (RBI), the Indian central bank, through respective circulars6,
have paved the way for limited two-way fungibility for Indian Depository Receipts (IDRs).
Fungibility in this context refers to the ability of the holder of an IDR to convert it into the
underlying equity security and vice versa. Previously, the existing regulations did not allow
holders of underlying equity shares to convert such equity shares into IDRs. However,
redemption of an IDR into underlying equity shares was permissible subject to the fulfillment
of certain conditions, such as a minimum holding period of one year from the date of issue of
the IDRs and such IDR qualifying as an infrequently traded security on the stock exchange(s)
in India. This regulatory position has now being modified by SEBI and RBI to provide for
limited two-way fungibility for IDRs, similar to the fungibility available in the case of an
American Depository Receipt (ADR) or a Global Depository Receipt (GDR).7

5
Kumar, M. (2006). Depositary Receipts: Concepts, Evolution and Recent Trends, Working Paper Series
(December 2006), Indian Institute of Management (Lucknow).
6
SEBI Circular No. CIR/CFD/ DIL/10/2012 and Reserve Bank of India A.P. (DIR Series) Circular No. 19, both
dated August 28, 2012
7
J. P. Morgan DR Group (DR Advisor Whitepaper) (2008). Un-Sponsored ADR Programs and Their
Implications for Affected Issuers (November 2008), Electronic copy available at: http://adr.com.

6
 II. BACKGROUND OF THE SCHEME

Depositary receipt is defined as negotiable financial instrument issued by a bank to represent

a foreign companys publicly traded securities, which is traded on a local financial market.8
DR is an innovative global finance vehicle and a negotiable certificate, denominated in US
dollars, Euro or in a currency of host country, allowing an issuer to raise capital
simultaneously in two or more markets through a global offering. They may be used in either
the public or private markets inside the U.S. (i.e. American Depositary Receipt or ADR), or
outside the U.S. (i.e. Global Depositary Receipt or GDR).9 They have served to reduce
obstacles to investment between one market jurisdiction and another, facilitate cross-border
trading and settlement, minimize transaction costs, and broaden the companies potential
investor base. They although facilitate funding in a way that the same share is governed by
two very different regulatory regimes, and traded in both regimes without needing any
structuring.

An IDR is basically a security listed on an Indian stock exchange, with its underlying being a
listed security of a foreign incorporated and listed entity. The introduction of IDRs in the
Indian securities market and the legal framework governing them was put in place with the
objective to facilitate capital raising by foreign investors from the domestic market, and at the
same time providing domestic investors an opportunity to make investments in securities of
well-recognised multinational companies listed on developed markets. So far, there is only
one foreign company, Standard Chartered Bank Plc, whose IDRs have been listed on an
Indian stock exchange. The regulatory position with respect to IDRs has been evolving ever
since the regulatory framework governing IDRs was introduced by the Ministry of Corporate
Affairs in 2004.10 The previous Indian regulatory framework allowed redemption/conversion
of IDRs into the underlying foreign security only after fulfillment of the prescribed
conditions. The regulatory change will now enable even the conversion of equity shares of a
foreign issuer into IDRs, to the extent of IDRs that have been redeemed/converted into
underlying shares and sold. The regulatory development allowing limited two-way fungibility
flows from the announcement made by the then finance minister in his budget speech earlier
this year.

8
http://dictionary reference.com
9
American Depositary Receipts. htm, http://thismatter.com
10
Depositary Receipts Handbook 2003 (PDF), http://adr.db.com

7
 III. DEPOSITORY RECEIPTS AND RELATED CONCEPTS

Depositary receipt is defined as negotiable financial instrument issued by a bank to represent

a foreign companys publicly traded securities, which is traded on a local financial market.11
DR is an innovative global finance vehicle and a negotiable certificate, denominated in US
dollars, Euro or in a currency of host country, allowing an issuer to raise capital
simultaneously in two or more markets through a global offering. They may be used in either
the public or private markets inside the U.S. (i.e. American Depositary Receipt or ADR), or
outside the U.S. (i.e. Global Depositary Receipt or GDR). They are marketed internationally,
mainly to financial institutions. They have served to reduce obstacles to investment between
one market jurisdiction and another, facilitate cross-border trading and settlement, minimize
transaction costs, and broaden the companies potential investor base. They although
facilitate funding in a way that the same share is governed by two very different regulatory
regimes, and traded in both regimes without needing any structuring12.

DRs Issuance and Trade Mechanism13

In order to establish a DR program, issuer selects a depositary, a custodian bank and an

advisory team constituted of lawyers, accountants, and investment bankers. While the
advisory team plays a crucial role during the initial floatation and listing process of the DR
program, the role of the depositary and the custodian bank is crucial even after the initial
floatation and listing process gets over.14 They are responsible for managing the issue on an
on-going basis. The issuer appoints custodian bank in consultation with the depositary bank.
The issuer and the depositary bank enter into a depositary agreement that sets forth the terms
of the DR program. The agreement stipulates the rights and responsibilities of the issuer,
depositary and the investors investing in the DR program. The issuer, on an on-going basis,
deals only with the depositary bank in regards to payments, notices or rights/bonus issues
related to the DR issues. The depositary agreement, as a general rule, sets forth an obligation
of the depository to provide notice of shareholder meetings and other information about the

11
http://dictionary reference.com. See also J.P. Morgan DR Group, Global Depositary Receipts Reference
Guide, available at: http://adr.com and Kumar, M. (2006). Depositary Receipts: Concepts, Evolution and
Recent Trends, Working Paper Series (December 2006), Indian Institute of Management (Lucknow).
12
J.P. Morgan DR Group, Global Depositary Receipts Reference Guide, available at: http://adr.com.
13
Kumar, M. (2006). Depositary Receipts: Concepts, Evolution and Recent Trends, Working Paper Series
(December 2006), Indian Institute of Management (Lucknow).
14
Holicka, K. (2004). International Financing-Focused on GDR and ADR, Masters Thesis, Univerzita Karlova
v Praze (Charles University in Prague).

8
issuer company to the investors so as to enable them to exercise their shareholders rights.
While for GDR investors voting rights rests with the depository bank, ADR investor are
allowed to exercise their voting rights in individual capacity. Depositary bank is also
responsible for secondary market transfers/cancellations of DRs.15 The depositary agreement
also set out the amount payable as administration fee from the issuer for the services offered
by the depositary. Depositary Receipts are issued by a depositary bank and backed by
underlying shares of issuing companies.16 For this purpose the Depositary bank purchase a
number of shares of the foreign security usually by a broker who has purchased the shares in
the open market and deposit them in a trust established for this purpose (mostly a local
custodian).17 The depository bank then issues a single-class securities representing interest in
trust. The investor holding the DR has the ownership interest in trust which is different from
the ownership of the foreign security. The trust owns the underlying foreign securities. In an
intra-market transaction, the transaction is settled in the same manner as any other security
purchase. Intra-market trading accounts for approximately 95% of all Depositary Receipt
trading in the market and does not involve the issuance or cancellation of a Depositary
Receipt.18 Accordingly, the most important role of a depositary bank is that of Stock Transfer
Agent and Registrar. It is therefore critical that the depositary bank maintain sophisticated
stock transfer systems and operating capabilities. A cross-border transaction in DRs is
executed to take advantage of the price differentials between the DR prices and the prices of
equivalent underlying domestic shares. Besides, lack of liquidity in DR markets also prompts
the cross-border transactions. 19

The implicit option in DRs allows the holders to cancel them up to the issuing or depository
bank, where upon the shares they representing will be released to the investor in the home
market. In fact holders convert it into the number of shares it represents. The underlying
shares are already listed in the domestic stock exchange and the depository releases them
from its original inventory. The exchange facility ensures a price linkage between the two
markets. Additionally, the Depositary Receipt holder would be able to request delivery of the

15
Kumar, M. (2003). A Study Of the Determinants and Impacts of Indian ADRs and GDRs, Thesis for the
degree of Doctor of Philasophy, Shailesh J. Mehta School of Management, Indian Institute of Technology
(Bombay).
16
J.P. Morgan DR Group, Global Depositary Receipts Reference Guide, available at: http://adr.com.
17
Citibanks Information Guide to American Depositary Receipts, (1995). available at: http://citibank.com.
18
Marshall, J.F., Bansal, V.K. (1996). Financial Engineering: A complete Guide to Financial Innovation,
Prentice-Hall (India), pp.467-469.
19
Moel, A. (2000). The Role of American Depositary Receipts in the Development of Emerging Markets,
Working Paper, Harvard Business School, (September 2000). Available at: amoel@hbs.edu

9
actual shares at any time. When executing a Depositary Receipt trade, brokers seek to obtain
the best price by comparing the Depositary Receipt price in host country to the equivalent
price of the actual shares in the home market. The continuous buying and selling of
Depositary Receipts in either market tends to keep the price differential between the home
market and host markets to a minimum.

In order to provide a regular trading market for DRs, in offering of new shares, part of which
will be sold as Depositary Receipts, the company will deliver part of shares to the custodian.
The depositary bank will then issue the corresponding Depositary Receipts and deliver them
to the members of the underwriting syndicate. This pool of DRs provides a regular trading
market where Depositary Receipts can then be issued, transferred or cancelled. The success
of DR programs depends on various factors among which the most crucial factors may be
classified as:20
The experience of lead investment banker
The pricing of issue
The road shows for institutional investors and analysts.

20
Kumar, M. (2006). Depositary Receipts: Concepts, Evolution and Recent Trends, Working Paper Series
(December 2006), Indian Institute of Management (Lucknow).

10
 IV. FUNGIBILITY SCHEME OF ADR/GDR

The regulatory framework governing IDRs now enables the conversion of equity shares into
IDRs, which was previously not allowed. Such conversion will be limited to the pool of IDRs
which were redeemed/converted into underlying equity shares by the original holders of
IDRs.21 This condition appears to have been borrowed from the ADR/GDR guidelines, which
allow dual fungibility to the extent of headroom created through redemption of these
depository receipts, and thus creates a level playing field from a regulatory perspective
between ADRs/ GDRs and IDRs.22

Fungibility, in general, means interchangeability of any security of a class. As it mentioned

before, the investors can convert their DRs into underlying shares in the companys home
market and sell their shares in that market. Fungibility provides the option for converting DR
into underlying shares. In an efficient market, two assets with identical attributes must sell for
the same price. On similar grounds, an identical asset trading in two different markets should
also trade at the same price. If the prices differ, a profitable opportunity arises to sell the asset
where it is overpriced and buy it back where it is under-priced and this gives rise to arbitrage
opportunities.23

In a two-way DR program there is unrestricted flow between the market for DRs and
underlying shares in the domestic market. This means investors in any company issuing DRs
(ADRs/GDRs) can freely convert the DRs into underlying domestic shares. They can also
reconvert the domestic shares into DRs, depending on the market movements for the stock. In
fact, two-way fungibility provides investors and companies with the option to cancel and
reissue of DRs according to the existing opportunities. The two way fungibility provides the
company with the ability to:24
Increase the number of outstanding DRs,
Increases liquidity of international investor market due to more available DRs,

21
Majumdar, S. (2007). A study of international listing by firms of Indian origin, ICRA Bulletin, Money
&Finance (February 2007), pp.57-89
22
Deuche Bank, Two way fungibility, Electronic copy available at: http://adr.db.com.
23
Majumdar, S. (2007). A study of international listing by firms of Indian origin, ICRA Bulletin, Money
&Finance (February 2007), pp.57-89
24
Miller, D.P. (1999). The Market Reaction to International Cross-listings: Evidence from Depositary Receipts,
Journal of Financial Economics 51, pp.103- 123.

11
 Increase the share price DRs due to increased demand, and more flexibility in
acquiring companies overseas.
In the presence of two-way fungibility system, there are buy and sell orders above and below
the prices at which stocks or DRs are transacting (depth). The provided flexibility to buy and
sell leads to increase in the volume of orders and transactions (breadth). And the liquidity in
transactions provides better price discovery process25. As the result of two-way fungibility it
is expected that any price deviation of two identical assets (i.e. DR and reference stock), lead
to a profitable opportunities. Obviously, arbitrageurs can easily step in and exploit the
opportunity till the point at which there is no profit opportunity, keeping the prices in the two
markets from diverging by more than arbitrage transaction costs. There are restrictive DR
programs where the number of DRs from the initial overseas offering poses a limit. So, DRs
can be cancelled and reissued, but only up to the initial offering size. The one-way DR
programs are the most restrictive, DRs that are issued may be cancelled over time but
subsequent re-issuance is not permitted. Therefore it leads to gradual reduction in the number
of DRs.26
During 2002-2003 the guidelines were issued for two-way fungibility. The DR programs
were initially started in India as one-way programs. Under the one-way fungibility, once a
company issued DR, the holder could convert the ADR/GDR into shares of the Indian
company, but it was not possible to reconvert the equity shares into ADR/GDR. Over a
period of time, these programs resulted in decline of the outstanding balance of DRs, leading
to lower liquidity of DRs for the international investors. The process of global financial
integration received a major impetus when two-way fungibility for Indian DRs was
introduced in 2002, whereby converted local shares could be reconverted into GDR/ADR
subject to sectoral caps. The 2002 amendment to the issue of Foreign Currency Convertible
Bonds and Ordinary Shares (through DR mechanism) Scheme, 1993, opened the door to the
limited two-way convertibility of DRs, through which the reissuance of DRs once cancelled
is permitted but restricted by the initial offering size. This has been done with the aim of27:
Facilitating market forces to trigger a realignment of prices,

25
Baker, H.K., Nofsinger J.R. & Weaver, D.G. (2002). International CrossListing and Visibility, Journal of
Financial and Quantitative Analysis 23, pp. 495- 521.
26
Stulz, R.M. (1999). Globalization, Corporate Finance, and the Cost of Capital, Journal of Applied Corporate
Finance 12, pp. 8-25.
27
Lang, M.H., Lins, K.V. & Miller, D.P. (2003). ADRs, Analysts, and Accuracy: Does Cross Listing in the U.S.
Improve a Firm's Information Environment and Increase Market Value? Working Paper, University of North
Carolina.

12
 Minimizing the widely divergent premium/discount levels prevailing between DR
prices and the domestic stock prices,
Providing an active DR market, particularly with considering the GDR market that
has been largely inactive for the past couple of years.
The result of limited two-way fungibility guidelines of the RBI was that, not only
corporations and depository banks could create DR, but also investors owning DRs have the
option to break them into ordinary shares, or purchase ordinary shares to convert them back
into DRs. In fact, it enabled a non-resident investor to purchase local shares of an Indian
company through an Indian stock broker and convert them into DRs that were eligible to be
traded on the international stock exchanges. However, the reconversion of broken DR into
new DRs is the subject to FDI limitation.28 The equity shares in India could be converted to
DRs only to the extent of the headroom (i.e. the number of DRs cancelled and converted
into underlying Indian equity or maximum number of DRs that can be issued on demand
from foreign investors). According to these guidelines transactions will be demand-driven
and would not require company involvement or fresh permissions. All SEBI registered
brokers would act as intermediaries in the two-way fungibility of DRs. A foreign investor is
permitted to place an order with an Indian stock broker to buy local shares, with an intention
to convert them into depository receipts. The stock broker has to apply to the domestic
custodian bank for verification and approval of the order. Once the approval is granted, the
broker purchases local shares on the Indian stock market and delivers them to the domestic
custodian for further credit to the overseas depository. The overseas depository issues
proportional Depository Receipts to the foreign investor.29

Under the existing regulations, prior to the amendment, no re-issuance of Depository receipts
was permitted. Investors could only cancel the depository receipts and avail of the underlying
shares or take back the proceeds by selling the underlying shares. Hence over a period of
time, the outstanding balance of depository receipts would get reduced thereby reducing the
liquid float of depository receipts to the international investors. Under the new amendments,
investors desirous of holding depository receipts can purchase shares from the Indian stock
market, through a registered broker and submit them for conversion into Depository

28
Lins, K.V., Strickland, D. & Zenner, M. (2000). Do Non-US Firms Issue Equity on US Stock Exchanges to
Relax Capital Constraints? Working Paper, University of Utah.
29
Doidge, C., Karolyi, G.A. & Stulz, R.M. (2003). Why Are Foreign Firms Listed in the U.S. Worth More?
Journal of Financial Economics, Vol. 71, No.2.

13
Receipts.30 The purchased underlying shares would then get added with the shares lodged as
underlying shares against depository receipts with the local custodian. This would not only
increase the number of outstanding depository receipts, but also increase the available float in
the international markets for investors. However, the regulation amendment currently only
permits reissuances collectively upto the original amount of Depository receipts that were
issued during the IPO. For eg, if the original issuance was 15 mln DRs in say, 1995, and
outstanding number as on date was 12 mln DRs, then as per the amendment, investors can
collectively seek reissuances of 3 mln DRs only. The regulations also states that the re-
issuance should not violate the foreign sectoral cap restrictions and hence any request for
conversion of shares into DRs would require the clearance from the local custodian. The
headroom available for re-issuance is monitored by the custodian of the underlying shares in
coordination with the depository bank, Company Secretary and the NSDL. Head Room =
Number of ADRs / GDRs originally issued minus number of GDRs / ADRs outstanding
further adjusted for ADRs / GDRs redeemed into underlying shares and registered in the
name of non-resident investor(s).31

30
Choi, F. D. S., Stonehill, A. (1982). Foreign Access to U.S. Securities Markets: The Theory, Myth and Reality
of Regulatory Barriers. Investment Analyst (July 1982), pp. 17-26.
31
Keefe,V. (1991). Companies Issue Overseas for Diverse Reasons. Corporate Financing Week, Special
Supplement (25-Nov.-1991), pp 1-9. See also Nigam, A. (1989). Canadian Corporations and Governments,
Financial Innovations and International Capital Markets. A report prepared for the Economic Council of
Canada.

14
 V. OPERATIVE GUIDELINES AND PROCEDURES

Re-issuance of ADR/GDR would be permitted to the extent of ADRs/GDRs which have been
redeemed into underlying shares and sold in the domestic market. The arrangement is
demand driven with the process of reconversion emanating with the request for acquisition of
domestic shares by non-resident investor for issue of ADRs/GDRs. Investments under the
Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt
Mechanism) Scheme, 1993 is treated as direct foreign investment.32

Accordingly, the transaction under the reconversion arrangement will be distinct and separate
from FII portfolio investments. The transaction will be effected through Securities and
Exchange Board of India (SEBI) registered stockbrokers as intermediaries between foreign
investors and domestic shareholders. A general permission has been conveyed by Reserve
Bank of India (RBI) through a Notification33 authorising such stock brokers to acquire
domestic shares on behalf of the overseas investors for being placed with the domestic
custodian. For this purpose all SEBI registered brokers will be able to act as intermediary in
the two-way fungibility of ADRs/GDRs. RBI has conveyed general permission through a
Notification No.FEMA.41/2001-RB dated 2nd March 2001 for these brokers to buy shares on
behalf of the overseas investor. As a secondary market transaction, the acquisition of such
shares through the intermediary on behalf of the overseas investors would fall within the
regulatory purview of SEBI. The Custodian would monitor the re-issuance and furnish a
certificate to both RBI & SEBI to ensure that the sectoral caps are not breached. RBI would
monitor the receipt of certificates from the Custodian to this effect.34 The domestic custodian
who is the intermediary between overseas depository on the one hand and Indian company on
the other will have the record of the ADRs/GDRs issued and redeemed and sold in the
domestic market. The domestic custodian will also be required to ascertain the extent of
registration in favour of ADR/GDR holders/non-resident investor based on the advice of
Overseas Depository to the Domestic custodian for the underlying shares being transferred in
the books of account of the issuing company in the name of the non-resident on redemption

32
Keefe,V. (1991). Companies Issue Overseas for Diverse Reasons. Corporate Financing Week, Special
Supplement (25-Nov.-1991), pp 1-9.
33
No.FEMA.41/2001-RB dated 2nd March 2001
34
Lang, M.H., Lins, K.V. & Miller, D.P. (2003). ADRs, Analysts, and Accuracy: Does Cross Listing in the U.S.
Improve a Firm's Information Environment and Increase Market Value? Working Paper, University of North
Carolina.

15
of the ADRs/GDRs.35 The custodian is also required to verify with the Company
Secretary/NSDL if the total cap is being breached if there is a percentage cap on foreign
direct investment. On request by the overseas investor for acquisition of shares for re-
issuance of ADRs /GDRs, the SEBI registered Broker will purchase a given number of shares
after verifying with the custodian whether there is any Head Room available: Head Room=
Number of ADRs/GDRs originally issued minus number of GDRs outstanding further
adjusted for ADRs/GDRs redeemed into underlying shares and registered in the name of the
non-resident investor(s). The domestic custodian would notify the extent up to which
reissuance would be permissible the redemption effected minus the underlying shares
registered in the name of the non-resident investor with reference to original GDR issue and
adjustment on account of sectoral caps/approval limits. The Indian Broker would receive
funds through normal banking channels for purchase of shares from the market. The shares
would be purchased in the name of the Overseas Depository and the shares would need to be
purchased on a recognized stock exchange. Upon acquisition the Indian Broker would place
the domestic share with the custodian; the arrangement would require a revised custodial
agreement under which the custodian would be authorized by the company to accept shares
from entities other than the company. Custodian would advise overseas depository on the
custody of domestic share and that corresponding ADRs/GDRs may be issued to the non-
resident investor. Overseas depository would issue corresponding ADRs/GDRs to the
investor. The domestic custodian in addition would have to ensure that the advices to the
overseas depository is issued on the first come first serve basis i.e. the first deposit of
domestic /underlying shares with a custodian shall be eligible for the first re-issuance of
ADRs/GDRs to the overseas investors. The custodian would also have to ensure that ordinary
shares only to the extent of the depletion in ADR/GDRs stock are deposited with it. This can
be readily ensured by adopting a system similar to the trigger mechanism adopted for FIIs. 36

Once the trigger mechanism is reached, say at 90% of the depletion in the ADR/GDR stock,
each buying transaction of domestic shares would be complete only after the custodian has
approved it.37 A monthly report about the ADR/GDR transaction under the two-way
fungibility arrangement is to be made by the Indian Custodian in the prescribed format to

35
Lins, K.V., Strickland, D. & Zenner, M. (2000). Do Non-US Firms Issue Equity on US Stock Exchanges to
Relax Capital Constraints? Working Paper, University of Utah.
36
Biddle, G.C., Saudagaran S.M. (1991). Foreign Stock Listings: Benefits, Costs, and the Accounting Policy
Dilemma. Accounting Horizons, (September 1991), pp. 69-80.
37
Baker, H. K. (1992). Why U.S. Companies List on London, Frankfurt and Tokyo Stock Exchanges. Working
Paper, American University (Washington D.C.).

16
RBI and SEBI38. The Broker has to ensure that each purchase transaction is only against
delivery and payment thereof is received in foreign exchange. The Broker will submit the
contract note to the Indian custodian of the underlying shares on the day next to the day of the
purchase so that the Custodian can reduce the Head Room accordingly. Copy of the Contract
Note would also need to be provided by the custodians to RBI and SEBI. The Broker will
also ensure that a separate rupee account will be maintained for the purpose of buying shares
for the purpose of effecting two-way fungibility. No forward cover will be available for the
amounts lying in the said rupee account. The ADs will be permitted to transfer the monies
lying in the above account on the request of the Broker. The custodian of the underlying
shares and the Depositories would coordinate on a daily basis in computing the Head Room.
Further, the company secretary of each individual company would provide details of non-
resident investment at weekly intervals to the custodian and the depository. The custodian
would monitor the re-issuance and furnish a certificate to both RBI & SEBI, to ensure that
the sectoral caps are not breached. RBI would monitor the receipt of certificates from the
custodian to this effect.39

The re-issuance would be within the already approved/issued limits and would only
effectively mean transfer of ADRs/GDRs from one non-resident to another and accordingly
no further approval mechanism be insisted upon. In the limited two way fungibility
arrangement, the company is not involved in the process and is demand driven i.e request for
ADRs/GDRs emanates from overseas investors. Consequently, the expenses involved in the
transaction would be borne by the investors, which would include the payments due to
overseas intermediary/broker, domestic custodians, charges of the overseas and domestic
brokers. The tax provision under Section 115 AC of the Income Tax Act 1961, which is
applicable to non-resident investors investing in ADRs/GDRs offered against issue of fresh
underlying shares would extend to non-resident investors investing in foreign exchange in
ADRs/GDRs issued against existing shares under these guidelines, in terms of the relevant
provisions of the Income Tax Act 1961.40

38
Students Newsletter of The Institute of Chartered Accountants of India, Vol. 10, No. 12, May 2007, pp.13
39
RBI Annual Report, 2005-06
40
Desai, N.M., D'Souza, D. (1998). Legal and Tax Considerations Confronting Indian companies Issuing
GDRs/ADRs. Working Paper: 17, Nishith Desai Associates (Bombay).

17
 VI. CONCLUSION

DR is an example of financial engineering activity in the field of creation of new products

(financial instruments) and strategies which can be used for enhancement of capital
resources. In fact, with identifying the needs from both sides (issuers and investors), and
knowledge regarding the associated risks, financial engineering shape any type of asset, in
formalized form to address different requirements. Financial Engineering as an important
profession within the financial services industry has been providing wide varieties of
financial instruments and strategies to address the end users requirements. While some of
these products have been successful and accepted in marketplace and have achieved
widespread uses, some have failed and discontinued. The new products to succeed must
feature distinguishing characteristics of product itself, the underlying market and potential
size of demand for such characteristics and the regulatory environment. The distinction of the
value of new financial products is the main factor to provide demand and growth of market
for the innovative products.41 The review of market for DRs programs shows remarkable
growth in worldwide DRs markets which has been driven by increasing demand for this
instrument. The fast growth of market for DRs, increasing number of countries and
companies engaged in DRs, particularly from emerging countries assert the success of this
innovative product to overcome some limitations in cross country investment; provision of
wider capital base; changing the pattern of risk and reducing it; and providing safer equity
baked by companies shares, all in an efficient manner. Particularly, for fast growing
emerging countries, DRs have approved to be an efficient tool for providing extra sources of
capital through international markets. In other words, the ability of DR programs to meet
different requirements of investors and issuers has been the main force behind the increasing
demand for this instrument. The success of DRs programs in providing different beneficial
effect form the investors and issuers point of view, as explained, can not be denied. 42 Along
with all incentives behind the use of DRs, the access to more efficient and developed market
can be an important motive for companies specially from emerging markets to enhance their
capital resources and diversify their investor basis. These markets are characterized by
naturally wide investor bases interested in investment in foreign companies shares while
avoiding the risks associated in direct investment in their markets, better performance, and
higher liquidity. To investigate the efficiency of DR for providing companies with access to
41
Gujrati, D.N. (1995). Basic econometrics, McGrow-Hill, 3rd edition, pp.718- 724.
42
Grossman, S.J., Stiglitz, J.E. (1980). On the Impossibility of Informationally Efficient Markets, American
Economic Review, 70, pp. 393-408.

18
efficient and developed markets, we examined the efficiency of host markets for the sample
DR programs of fourteen Indian companies. The results of the study of host markets for the
DR programs have been consistent with the random walk idea, asserting the efficiency of the
markets. In fact, using DRs has enabled the companies to tap developed and efficient
international market at lower cost and risks to enhance their capital resources. The efficiency
of DR as an instrument used for tapping efficient international market may become more
clear where by the end of 2008, four stock exchanges (NYSE, NASDAQ, LSE, LuxSE )
accounted for 94% of all new sponsored Dr programs listed on exchanges, and 98% of total
Sponsored DR listed on exchanges. During the same period, 97% of worldwide trading value
of DRs, have been in three exchanges viz. NYSE, NASDAQ, and LSE.43

The rise of global finance has removed geographic boundaries for companies, enabling them
to raise capital in markets across the world. Issuance of depository receipts is an innovative
mechanism, especially for companies that are targeting to raise capital from a market other
than the market of their primary listing. Depository receipts provide mutual benefits to
issuers, investors and the host market. Companies get to raise capital from willing investors,
diversify their investor base and fulfill strategic objectives, such as brand recognition.
Investors get to invest in companies in which they otherwise could not have easily invested,
diversifying their portfolios in the process. Ultimately, markets tend to become more efficient
as increased access for investors through multiple listings enhances liquidity and improves
price discovery. The regulatory change brought about to allow limited two-way fungibility is
a step in the right direction, and it should make IDRs relatively more marketable. However,
the results are more likely to be visible only when the other challenges faced by the Indian
capital market are addressed.

43
Fama, Eugene and Kenneth French (1988). Permanent and Temporary Components of Stock Prices, Journal
of Political Economy, 96, pp. 246-273.

19
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20
 Majumdar, S. (2007). A study of international listing by firms of Indian origin, ICRA
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RBI Annual Report, 2005-06
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Efficient Markets, American Economic Review, 70, pp. 393-408.
Fama, Eugene and Kenneth French (1988). Permanent and Temporary Components
of Stock Prices, Journal of Political Economy, 96, pp. 246-273.

21