FIIs to petition Sebi on new IDR norm

Say it’s an abrupt U-turn, RBI’s Dec clarification said no prior approval needed after a year for conversion into shares

The capital market regulator's recent decision of not allowing fungibility of frequently traded Indian Depository Receipts (IDRs) is set to become a major issue.

Some leading foreign institutional investors (FIIs) and hedge funds that hold Standard Chartered’s IDRs in their portfolio intend to take up this matter with the regulator. They allege the regulators have done an abrupt U-turn after "indicating" for months that fungibility would be allowed after one year of listing.

The root of the matter is a Sebi circular issued last week. It said after the completion of a year from the date of issuance, redemption of IDRs shall be permitted only if these are infrequently traded on the stock exchange(s) in India. This means StandardChart’s IDR holders will not get a chance to convert their holdings into underlying shares after the completion of a year after listing, as these instruments are liquid by Sebi’s criterion.

Currently, StanChart is the only entity that has listed its IDR on the Indian bourses. The impact of Sebi’s direction was clearly visible on Monday, the first trading session after the Sebi circular. The IDRs tanked 20 per cent during the day, to touch an all-time low of Rs 91.75. StanChart IDRs, issued at Rs 104, closed at Rs 95.25 today on the Bombay Stock Exchange.

According to persons with direct knowledge of the matter, some high-profile law firms are currently working on representations likely to be made to the Securities and Exchange Board of India (Sebi) by early next week. One demand is to implement the new norms for companies that list their IDRs in future. Some foreign investors are believed to have already made representations to Sebi.

“We will tell the regulator not to impose the new norms on companies that have already listed their IDRs in India. It should not be with retrospective effect,” said a person familiar with the matter.

RBI impression
The institutional investors are also miffed due to the fact that a Reserve Bank of India (RBI) clarification (in response to a query by some investors) in December 2010 had said that no prior approval would be required to convert IDRs into underlying shares after one year of listing. RBI had not said there would be a “liquidity criterion” applied.

After the clarification, many FIIs and hedge funds structured their deals so as to convert the IDRs into StanChart equity shares after one year of listing, which would be June 10. The IDRs typically traded at an eight to 12 per cent discount to the StanChart shares listed on stock exchanges in London and Hong Kong.

“The clarification was sought in December from the central bank as the one-year period was approaching in some months and institutional investors wanted to place a bet based on the regulatory stand,” said a person privy to the matter. “The RBI did not even indicate that fungibility will not be allowed. In fact the clarification clearly stated that IDRs could be converted into equity shares after one year without RBI approval. This is a complete U-turn.”

In May 2010, when the country's first IDR issue was launched, it was clarified in the prospectus that Sebi and RBI norms state that “automatic fungibility of IDRs is not permitted” though “fungibility of IDRs into the underlying shares would be permitted only after the expiry of the one year period from the date of issue of the IDRs and subsequent to obtaining RBI approval on a case-by-case basis”.

A section of market players say the Sebi stand on non-fungibility of IDRs could stem from the fact that the foreign holding in the instrument was around 70 per cent and allowing such investors to convert IDRs into equity shares would have led to a conversion spree. Incidentally, US and European regulations allow fungibility of American Depository Receipts and Global Depository Receipts, respectively.