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Treasury Bills • Treasury Bills are short term (up to one year) borrowing instruments of the Government of India which enable investors to park their short term surplus funds while reducing their market risk. They are money market instruments to finance the short term requirements of the Government of India. • They are auctioned by Reserve Bank of India at regular intervals and issued at a discount to face value. On maturity the face value is paid to the holder. • The rate of discount and the corresponding issue prices are determined at each auction. When liquidity is tight in the economy, returns on Treasury Bills sometimes become even higher than returns on bank deposits of similar maturity. • Any person in India including Individuals, Firms, Companies, Corporate bodies, Trusts and Institutions can purchase Treasury Bills. Treasury Bills are eligible securities for SLR purposes. • Treasury Bills are available for a minimum amount of Rs.25,000 and in multiples of Rs. 25,000 thereafter. They are available in both Primary and Secondary market. • Treasury Bills are issued in the form of SGL - entries in the books of Reserve Bank of India to hold the securities on behalf of the holder. The SGL holdings can be transferred by issuing a SGL transfer form
Type of Treasury Bills: • At present, RBI issues T-Bills for three different maturities: 91 days, 182 days and 364 days. The 91 day T-Bills are issued on weekly auction basis while 182 day T-Bill auction is held on Wednesday preceding non-reporting Friday and 364 day T-Bill auction on Wednesday preceding the reporting Friday. • Advantages of investing in Treasury Bills: • No Tax Deducted at Source (TDS)• Zero default risk as these are (sovereign paper) the liabilities of GOI• Liquid money Market Instrument• Active secondary market tradeability thereby enabling holder to meet immediate fund requirement • Transparency, Simplified settlement • Better returns especially in the short term
Features Form • The treasury bills are issued in the form of promissory note in physical form or by credit to Subsidiary General Ledger (SGL) account or Gilt account in dematerialised form. • Minimum Amount Of Bids Bids for treasury bills are to be made for a minimum amount of Rs 25000/- only and in multiples thereof. Eligibility: • All entities registered in India like banks, financial institutions, Primary Dealers, firms, companies, corporate bodies, partnership firms, institutions, mutual funds, Foreign Institutional Investors, State Governments, Provident Funds, trusts, research organisations, Nepal Rashtra bank and even individuals are eligible to bid and purchase Treasury bills. Repayment • The treasury bills are repaid at par on the expiry of their tenor at the office of the Reserve Bank of India, Mumbai. Availability • All the treasury Bills are highly liquid instruments available both in the primary and secondary market.
Day Count • For treasury bills the day count is taken as 365 days for a year. Yield Calculation • The yield of a Treasury Bill is calculated as per the following formula: • Y = (100-P)*365*100 ------------------ P*D Wherein Y = discounted yield P= Price D= Days to maturity • Example • A cooperative bank wishes to buy 91 Days Treasury Bill Maturing on Dec. 6, 2002 on Oct. 12, 2002. The rate quoted by seller is Rs. 99.1489 per Rs. 100 face values. The YTM can be calculated as following: • The days to maturity of Treasury bill are 55 (October – 20 days, November – 30 days and December – 5 days) • YTM = (100-99.1489) x 365 x 100/(99.1489*55) = 5.70% • Similarly if the YTM is quoted by the seller price can be calculated by inputting the price in above formula.
Primary Market • In the primary market, treasury bills are issued by auction technique. • Secondary Market & Players • The major participants in the secondary market are scheduled banks, financial Institutions, Primary dealers, mutual funds, insurance companies and corporate treasuries. • Other entities like cooperative and regional rural banks, educational and religious trusts etc. have also begun investing their short term funds in treasury bills. • Advantages • Market related yields • Ideal matching for funds management particularly for short term tenors of less than 15 days. • Transparency in operations as the transactions would be put through Reserve Bank of India’s SGL or Client’s Gilt account only • Two way quotes offered by primary dealers for purchase and sale of treasury bills. • Certainty in terms of availability, entry & exit
Treasury Bills - An Effective Cash Management Product • Treasury Bills are very useful instruments to deploy short term surpluses depending upon the availability and requirement. • Even funds which are kept in current accounts can be deployed in treasury bills to maximise returns Banks do not pay any interest on fixed deposits of less than 15 days, or balances maintained in current accounts, whereas treasury bills can be purchased for any number of days depending on the requirements. • This helps in deployment of idle funds for very short periods as well. Further, since every week there is a 91 days treasury bills maturing and every fortnight a 364 days treasury bills maturing, one can purchase treasury bills of different maturities as per requirements so as to match with the respective outflow of funds. • At times when the liquidity in the economy is tight, the returns on treasury bills are much higher as compared to bank deposits even for longer term. • Besides, better yields and availability for very short tenors, another important advantage of treasury bills over bank deposits is that the surplus cash can be invested depending upon the staggered requirements.
Commercial Paper • Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. • It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers/ to diversify their sources of short-term borrowings and to provide an additional instrument to investors. • Subsequently, primary dealers were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations. • Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. • All eligible participants shall obtain the credit rating for issuance of Commercial Paper either from CRISIL or ICRA or CARE or the FITCH Ratings India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose. • The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.
CP can be issued for maturities between a minimum of 7 days and a maximum up to one year from the date of issue. • Individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. • However, amount invested by single investor should not be less than Rs.5 lakh (face value). • However, investment by FIIs would be within the limits set for their investments by Securities and Exchange Board of India (SEBI). • Bank and FI’s are prohibited from issuance and underwriting of CP’s.
They are unsecured debts of corporates and are issued in the form of promissory notes, redeemable at par to the holder at maturity. • Only corporates who get an investment grade rating can issue CPs, as per RBI rules. • It is issued at a discount to face value. • Has to be mandatorily rated by one of the credit rating agencies. • It is issued as per RBI guidelines. • CP can be issued either in the form of a promissory note or in a dematerialised form through any • of the depositories approved by and registered with SEBI. Banks, FIs, PDs and SDs are directed to hold CP only in dematerialised form. • RBI Guidelines for Issue of Commercial Paper (CP) • A corporate would be eligible to issue CP provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) company has been sanctioned working capital limit by bank/s or all-India financial institution/s; and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s/ institution/s.
All eligible participants shall obtain the credit rating for issuance of Commercial Paper from either the Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies. • The issuers shall ensure at the time of issuance of CP that the rating so obtained is current and has not fallen due for review. • CP can be issued for maturities between 7 days upto one year from the date of issue. • CP can be issued as a "stand alone" product. The aggregate amount of CP from an issuer shall be within the limit as approved by its Board of Directors.
The company must be listed on one or more stock exchanges but the Govt companies are exempted from this stipulation. • An FI can issue CP within the overall umbrella limit fixed by the RBI i.e., issue of CP together with other instruments viz., term money borrowings, term deposits, certificates of deposit and inter-corporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet. • Only a scheduled bank can act as an IPA (Issuing and Paying Agent) for issuance of CP. • The current ratio should be 1.33:1 and debt-equity ratio not more than 1.5:1. • Tangible net worth" means the paid-up capital plus free reserves (including balances in the share premium account, capital and debentures redemption reserves and any other reserve not being created for repayment of any future liability or for depreciation in assets or for bad debts or reserve created by revaluation of assets) as per the latest audited balance sheet of the company, as reduced by the amount of accumulated balance of loss, balance of deferred revenue expenditure, as also other intangible assets.
Advantages: • Simplicity in the offer as large amounts can be raised without having any underlying transaction. • CPs provide flexibility to the company to raise funds in the money market wherever it is favourable. • CPs can raise funds from the inter-corporate market which is not under the control of any monetary authority. • Also, CPs provide cheaper finance to the borrowers and at the same time offer good rate of return to the investors.
Certificate of Deposit • CDs are negotiable money market instrument issued in demat form or as Promissory Notes. • Certificates of Deposit (CDs) is a negotiable money market instrument and issued in dematerialised form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. • CDs issued by banks should not have the maturity less than seven days and not more than one year. Financial Institutions are allowed to issue CDs for a period between 1 year and up to 3 years. • CDs are like bank term deposits but unlike traditional time deposits these are freely negotiable. • CDs normally give a higher return than Bank term deposit. • CDs are rated by approved rating agencies (e.g. CARE, ICRA, CRISIL, and FITCH) which considerably enhance their tradability in the secondary market, depending upon demand.
Features of CD: • All scheduled banks (except RRBs and Co-operative banks) are eligible to issue CDs. • They can be issued to individuals, corporations, trusts, funds and associations. • NRIs can also subscribe to CDs, but on non-repatriable basis only. In secondary market such CDs cannot be endorsed to another NRI. • They are issued at a discount rate freely determined by the issuer and the market/investors. • CDs issued in physical form are freely transferable by endorsement and delivery. Procedure of transfer of dematted CDs is similar to that of any other demat securities. • For CDs there is no lock-in period. Discount/Coupon rate of CD is determined by the issuing bank/FI.Loans cannot be granted against CDs and Banks/FIs cannot buy back their own CDs before maturity.
Guidelines for Issue of Certificates of Deposit (CDs) • CDs can be issued by (i) scheduled commercial banks excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI. • Banks have the freedom to issue CDs depending on their requirements. • An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other instruments, viz., term money, term deposits, commercial papers and inter-corporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet. • Minimum amount of a CD should be Rs.1 lakh, i.e., the minimum deposit that could be accepted from a single subscriber should not be less than Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter. • CDs can be issued to individuals, corporations, companies, trusts, funds, associations, etc. Non-Resident Indians (NRIs) may also subscribe to CDs, but only on non-repatriable basis which should be clearly stated on the Certificate. Such CDs cannot be endorsed to another NRI in the secondary market. • Physical CDs are freely transferable by endorsement and delivery. Dematted CDs can be transferred as per the procedure applicable to other demat securities. There is no lock-in period for the CDs.
The maturity period of CDs issued by banks should be not less than 7 days and not more than one year. • The FIs can issue CDs for a period not less than 1 year and not exceeding 3 years from the date of issue. • CDs may be issued at a discount on face value. Banks/FIs are also allowed to issue CDs on floating rate basis provided the methodology of compiling the floating rate is objective, transparent and market-based. The issuing bank/FI is free to determine the discount/coupon rate. The interest rate on floating rate CDs would have to be reset periodically in accordance with a pre-determined formula that indicates the spread over a transparent benchmark. • Banks have to maintain the appropriate reserve requirements, i.e., cash reserve ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.
Hedge Funds • A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk. • An aggressively managed portfolio of investments that uses advanced investment strategies such as leveraged, long, short and derivative positions in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark). • Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year. • Hedge fund strategies vary enormously -- many hedge against downturns in the markets -- especially important today with volatility and anticipation of corrections in overheated stock markets. • The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.
Hedge Funds in India are among relatively new investment opportunities. • The hedge funds history actually dates back to 1949 with credit to Alfred Winslow Jones for inventing hedge funds investing fund. • These are a form of private investment funds at the cost of a performance fee and open to only a limited investors group. • Hedge funds in US are open to only a few accredited investors. These hedge funds basics qualify them to be exempted from direct regulations of the state. • These funds are meant to hedge the investment through various techniques from the potential fluctuations in terms of losses in the markets. • The hedge fund returns do net get affected by the direction of the underlying market.
This type of hedge funds accounting is achieved by: • Investing in the safer areas that are less likely to be affected by drop in markets • Marketing through derivative methods as opposed to direct market exposure • Holding defensive instruments like cash in times of market failure • By taking short as well as long market positions and negating the market exposure • Hedge funds can provide benefits to financial markets by contributing to market efficiency and enhancing liquidity. • They often assume risks by serving as ready counter parties to entities that wish to hedge risks. • Hedge fund can also serve as an important risk management tool for investors by providing valuable portfolio diversification.
As per SEBI, • Hedge funds, including fund of funds are unregistered private investment partnerships, funds or pools that may invest and trade in many different markets, strategies and instruments (including securities, non-securities and derivatives) and are NOT subject to the same regulatory requirements as mutual funds, including mutual fund requirements to provide certain periodic and standardized pricing and valuation information to investors. • Usually, hedge funds: • are organized as private investment partnerships or offshore investment corporations; • use a wide variety of trading strategies involving position-taking in a range of markets; • employ as assortment of trading techniques and instruments, often including short-selling, derivatives and leverage; • pay performance fees to their managers; and • have an investor base comprising wealthy individuals and institutions and relatively high minimum investment limit ( set at US $100,000 or higher for most funds).
The term “hedge funds”, first came into use in the 1950s to describe any investment fund that used incentive fees, short selling, and leverage. • Over time, hedge funds began to diversify their investment portfolios to include other financial instruments and engage in a wider variety of investment strategies. • Today, in addition to trading equities, hedge funds may trade fixed income securities, convertible securities, currencies, exchange – traded futures, over the counter derivatives, futures contracts, commodity options and other non-securities investments. • Hedge funds are sometimes called as ‘rich man’s mutual fund’. In addition, other unregistered investment pools, such as venture capital funds, private equity funds and commodity pools, are sometimes referred to as hedge funds.
In many ways, hedge funds are similar to mutual funds. • Both entities issue units or securities to investors, hold pools of securities to diversify investment, have professional asset manager and may, at times, have similar investment strategies. • At the same time, they also differ in a number of ways. • Mutual funds are registered with securities markets regulator and are subject to the provisions of the relevant regulations such as, offer/issue of units/securities, disclosure and reporting requirement, valuation for the purpose of computation of NAV, conflict of interest issue and limit leverage. • Hedge funds are not required to be registered and therefore, are not subject to similar regulatory provisions.
Features: • Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options (can use short selling, leverage, derivatives such as puts, calls, options, futures, etc.). • Hedge funds vary enormously in terms of investment returns, volatility and risk. Many, but not all, hedge fund strategies tend to hedge against downturns in the markets being traded. • Many hedge funds have the ability to deliver non-market correlated returns. • Many hedge funds have as an objective consistency of returns and capital preservation rather than magnitude of returns. • Most hedge funds are managed by experienced investment professionals who are generally disciplined and diligent. • Pension funds, endowments, insurance companies, private banks and high net worth individuals and families invest in hedge funds to minimize overall portfolio volatility and enhance returns. • Most hedge fund managers are highly specialized and trade only within their area of expertise and competitive advantage. • Hedge funds benefit by heavily weighting hedge fund managers’ remuneration towards performance incentives, thus attracting the best brains in the investment business. In addition, hedge fund managers usually have their own money invested in their fund.
Benefits • Many hedge fund strategies have the ability to generate positive returns in both rising and falling equity and bond markets. • Inclusion of hedge funds in a balanced portfolio reduces overall portfolio risk and volatility and increases returns. • Huge variety of hedge fund investment styles – many uncorrelated with each other – provides investors with a wide choice of hedge fund strategies to meet their investment objectives. • Academic research proves hedge funds have higher returns and lower overall risk than traditional investment funds. • Hedge funds provide an ideal long-term investment solution, eliminating the need to correctly time entry and exit from markets. • Adding hedge funds to an investment portfolio provides diversification not otherwise available in traditional investing.
Domestic Hedge Fund • Domestic hedge funds are usually organized (in USA) as limited partnerships to accommodate investors that are subject to U.S. income taxation. • Offshore Hedge Fund • Offshore hedge funds are typically organized as corporations in countries such as the Cayman Islands, British Virgin Islands, the Bahamas, Panama, The Netherlands Antilles or Bermuda. • Fund of Funds • Rather than investing in individual securities, a Fund of Funds invests in other hedge funds. Technically any fund that pools capital together, while utilizing two or more sub managers to invest money in equity, commodities, or currencies, is considered a Fund of Funds.
Hedge Funds by Strategy Types: • Hedge Fund Investment strategies tend to be quite different from those followed by traditional asset managers. Moreover, each fund usually follows its own proprietary strategies which do not always fit within neat definitional categories: • Event driven - funds investing in securities to take advantage of price movements generated by corporate events. This group includes merger arbitrage funds and distressed asset funds. • Global macro – funds that take long and short positions in major financial markets based on views influenced by economic trends and events. • Market neutral – funds where the manager attempts to minimize (or significantly reduce) market risk. This category includes long / short equity funds, convertible bonds arbitrage funds, and fixed income arbitrage.
Hedge Fund Strategies • Directional Trading • Based upon speculation of market direction in multiple asset classes. Both model-based systems and subjective judgment are used to make trading decisions. • Relative Value • Focus on spread relationships between pricing components of financial assets. Market risk is kept to minimum and many managers use leverage to enhance returns. • Specialist Credit • Based around lending to credit sensitive issuers. Funds in this strategy conduct a high level of due diligence in order to identify relatively inexpensive securities. • Stock Selection • Combine long and short positions, primarily in equities, in order to exploit under and overvalued securities. Market exposure can vary substantially.
Discount and Finance House of India • Discount and Finance House of India Ltd. (DFHI), a unique institution of its kind, was set up in April 1988, jointly by RBI, public sector banks and financial institutions to deal in short term money market instruments. • It has been established to deal in money market instruments in order to provide liquidity in the money market. Thus the task assigned to DFHI is to develop a secondary market in the existing money market instruments. • The establishment of a discount House was recommended by a Working Group on Money market. • The main objective of DFHI is to facilitate the smoothening of the short term liquidity imbalances by developing an active money market and integrating the various segments of the money market. • The main objectives of DFHI are as follows: • Provide liquidity to money market instruments • Provide safe and risk-free short term investment avenues to institutions • Facilitate money market transactions of small and medium sized institutions that are not regular participants in the market
At preset DFHI’s activities are restricted to: 1. dealing in 91 days and 364 days Treasury Bills2. re-discounting short term commercial bills.3. participating in the inert bank call money, notice money and term deposits and4. Dealing in Commercial Paper and Certificate of deposits.5. Government dated Securities. Treasury bills are issued by Reserve bank of India on behalf of the Government of India. Such bills are sold at fortnightly auctions. The Discount House regularly participates in such auctions. Moreover, it provides a ready market to other institutions/individuals to buy or sell the Treasury Bills. It purchases the same either as outright purchase or on repos basis. Repos mean the right to re-purchase the same bills again. For this purpose the DFHI quotes two way prices with fine spread. Such operations in Treasury Bills impart greater flexibility to banks in their funds management. Moreover, with the creation of a secondary market for treasury Bills, corporate bodies and other institutions could also invest their short term surplus funds in such bills.
Re-discounting of commercial Bills: • The Discount House aims at imparting liquidity to Commercial bills which have already been discounted by banks and financial institutions. • It further re-discounts them and also enables banks and other institutions to re-discount from it such bills. • For this purpose DFHI announces its bid and offers re-discount rates on a fortnightly basis. • Call Money Market and Term Deposit: • DFHI has been permitted by the Reserve bank of India to operate in the inter-bank call money market, both as lender and borrower of overnight call and notice money up to 14 days. • DFHI also renders service to banks in the call money market by arranging or placing funds for banks. • The DFHI is authorized to argument its resources with lines of credit from sector and refinance lines from the Reserves bank, The amount and the rate of interest charged by Reserve Bank on refinance would be flexible, so that Reserve Bank can have its impact on the money market by varying the quantum of refinance and the rate of interest thereon. • The main functions of DFHI are as follows: • To discount, rediscount, purchase and sell treasury bills, bills of exchange and commercial papers • To play an important role as a lender, borrower or broker in the inter-bank call money market • To promote and support company funds, trusts and other organizations for the development of short term money market • To advise governments, banks and financial institutions in evolving schemes for growth and development of money market.
Depositary Receipts • Depositary Receipts • A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company. • The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. • How Does the DR Work? • The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. • The Benefits of Depositary Receipts • The DR functions as a means to increase global trade, which in turn can help increase not only volumes on local and foreign markets but also the exchange of information, technology, regulatory procedures as well as market transparency. Thus, instead of being faced with impediments to foreign investment, as is often the case in many emerging markets, the DR investor and company can both benefit from investment abroad. Let's take a closer a look at the benefits: • For the CompanyA company may opt to issue a DR to obtain greater exposure and raise capital in the world market. Issuing DRs has the added benefit of increasing the share's liquidity while boosting the company's prestige on its local market ("the company is traded internationally"). • Depositary receipts encourage an international shareholder base, and provide expatriates living abroad with an easier opportunity to invest in their home countries. • Moreover, in many countries, especially those with emerging markets, obstacles often prevent foreign investors from entering the local market.
By issuing a DR, a company can still encourage investment from abroad without having to worry about barriers to entry that a foreign investor might face. • For the InvestorBuying into a DR immediately turns an investors' portfolio into a global one. • Investors gain the benefits of diversification while trading in their own market under familiar settlement and clearance conditions. • More importantly, DR investors will be able to reap the benefits of these usually higher risk, higher return equities, without having to endure the added risks of going directly into foreign markets, which may pose lack of transparency or instability resulting from changing regulatory procedures. • It is important to remember that an investor will still bear some foreign-exchange risk, stemming from uncertainties in emerging economies and societies. • On the other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to most foreign currencies. • Giving you the opportunity to add the benefits of foreign investment while bypassing the unnecessary risks of investing outside your own borders, you may want to consider adding these securities to your portfolio. • International Depository Receipt • A negotiable, bank-issued certificate representing ownership of stock securities by an investor outside the country of origin.
INDIAN DEPOSITORY RECEIPTS (IDRs) • As per the definition given in the Companies (Issue of Indian Depository Receipts) Rules, 2004, IDR is an instrument in the form of a Depository Receipt created by the Indian depository in India against the underlying equity shares of the issuing company. • In an IDR, foreign companies would issue shares, to an Indian Depository (say National Security Depository Limited – NSDL), which would in turn issue depository receipts to investors in India. • The actual shares underlying the IDRs would be held by an Overseas Custodian, which shall authorise the Indian Depository to issue the IDRs. The IDRs would have following features: • Overseas Custodian : It is a foreign bank having branches in India and requires approval from Finance Ministry for acting as custodian and Indian depository has to be registered with SEBI. Approvals for issue of IDRs : IDR issue will require approval from SEBI and application can be made for this purpose 90 days before the issue opening date. Listing : These IDRs would be listed on stock exchanges in India and would be freely transferable. • RBI has operationalised IDRs under the exchange control regime.
Eligibility conditions for overseas companies to issue IDRs: • Capital : The overseas company intending to issue IDRs should have paid up capital and free reserve of atleast $ 100 million. • Sales turnover : It should have an average turnover of $ 500 million during the last three years. • Profits/dividend : Such company should also have earned profits in the last 5 years and should have declared dividend of at least 10% each year during this period. • Debt equity ratio : The pre-issue debt equity ratio of such company should not be more than 2:1. • Extent of issue : The issue during a particular year should not exceed 15% of the paid up capital plus free reserves. • Redemption : IDRs would not be redeemable into underlying equity shares before one year from date of issue. • Denomination : IDRs would be denominated in Indian rupees, irrespective of the denomination of underlying shares. • Eligible companies resident outside India may issue Indian Depository Receipts (IDRs) through a Domestic Depository. In case of raising of funds through issuance of IDRs by financial/banking companies having presence in India, either through a branch or subsidiary, the approval of the sectoral regulator(s) should be obtained before the issuance of IDRs.
Fungibility: Automatic fungibility of IDRs is not permitted. (fungability: A good or asset's interchangeability with other individual goods/assets of the same type A good or asset's interchangeability with other individual goods/assets of the same type) • The proceeds of the issue of IDRs shall be immediately repatriated outside India by the eligible companies issuing such IDRs. The IDRs issued shall be denominated in Indian Rupees. • NRIs are allowed to invest in the IDRs out of funds held in their NRE / FCNR(B) account, maintained with an Authorised Dealer / Authorised bank. • Benefits : In addition to other avenues, IDR is an additional investment opportunity for Indian investors for overseas investment. • Foreign companies: Any foreign company listed in its home country and satisfying the eligibility criteria can issue IDRs. • A company which has significant business in India can increase its value through IDRs by breaking down market segmentations, reaching trapped pools of liquidity, achieving global benchmark valuation, accessing international shareholder base and improving its brand’s presence through global visibility. • Also, differences in tax structure, regulatory restrictions and informational constraints between the countries may also help in creating economic benefits. • Similarly, the foreign entities of Indian companies may find it easier to raise money through IDRs for their business requirements abroad.
Investors: IDRs can lead to better portfolio management and diversification for investors by giving them a chance to buy into the stocks of reputed companies abroad. • Employees: Foreign companies which do not have a listed subsidiary in India can give employee stock options (ESOPs) to the employees of their Indian subsidiaries through the IDR route. This will enable the local employees to participate in the parent companies’ success. For Example, Microsoft USA may want to give ESOPs to employees of Microsoft India, which is not listed in India, by floating an IDR for Microsoft USA and earmarking a percentage of the same for its Indian employees. • Regulator: IDRs will lead to more liquid capital markets and a continuous improvement in regulatory environment, thereby increasing transactional revenues for the regulator. • Why have IDRs not taken off? • In spite of all the benefits, IDRs have not really taken off. Some of the reasons for this lack of interest in IDRs are: • Stringent eligibility norms: The stringent eligibility criteria, disclosure and corporate governance norms, though in the investor’s interests, compare unfavorably with listing norms on other tier II global exchanges such as Luxembourg, London’s Alternate Investment Market and Dubai. • This could result in higher compliance costs for mid-sized companies seeking to tap the Indian capital markets. • No automatic fungibility, no arbitrage opportunities for investors and issuers: The GDR/ADR holders enjoy two-way fungibility option (conversion of GDR/ADR into underlying shares and vice versa) while investors in IDRs can exercise the option only after one year (as per regulation). • Even after one year, retail investors are required to sell off the shares obtained by redemption in the foreign stock exchange where they are listed.
Two-way fungibility enables an investor to benefit from any arbitrage opportunities arising due to exchange rate fluctuations or quotation differences on the two stock exchanges. • An IDR investor is denied of this opportunity. • Also, the issuer is required to immediately repatriate the rupee funds through IDR proceeds back to the home country. • By not allowing them to park their rupee funds in India, they cannot take advantage of any interest arbitrage opportunity. • Also, given the fact that rupee is not a floating currency, it would entail conversion into dollars or other hard currency and then being repatriated. • This would exert pressure on the rupee. • Lack of clarity on taxation issue: It is not very clear whether IDRs are exempt from capital gains tax; this could be a potential roadblock. • As per current Income tax laws, securities which are held for more than 1 year are exempt from capital gains tax and for less than 1 year tax is 15%. • Treating IDRs at par with shares for taxation purpose till the new tax code comes into effect in 2011 will help promote IDRs. • Indian Financial Markets still quite volatile: Developed countries have less political flux, which lends stability to their financial markets. • Also, Indian markets are perceived to be rumour driven which leads to heightened volatility.
Global Depository Receipt • A bank certificate issued in more than one country for shares in a foreign company. The shares are held by a foreign branch of an international bank. The shares trade as domestic shares, but are offered for sale globally through the various bank branches. • A financial instrument used by private markets to raise capital denominated in either U.S. dollars or euros. • A negotiablecertificateheld in the bank of one country representing a specific number of shares of a stock traded on an exchange of another country. • Every publicly traded company issues shares – and these shares are listed and traded on various stock exchanges. Thus, companies in India issue shares which are traded on Indian stock exchanges like BSE (The Stock Exchange, Mumbai), NSE (National Stock Exchange), etc. • These shares are sometimes also listed and traded on foreign stock exchanges. • But to list on a foreign stock exchange, the company has to comply with the policies of those stock exchanges. • Many times, the policies of these exchanges in US or Europe are much more stringent than the policies of the exchanges in India. • This deters these companies from listing on foreign stock exchanges directly. • This is what happens: The company deposits a large number of its shares with a bank located in the country where it wants to list indirectly. The bank issues receipts against these shares, each receipt having a fixed number of shares as an underlying.
These receipts are then sold to the people of this foreign country (and anyone who is allowed to buy shares in that country). • These receipts are listed on the stock exchanges. They behave exactly like regular stocks – their prices fluctuate depending on their demand and supply, and depending on the fundamentals of the underlying company. • These receipts, which are traded like ordinary stocks, are called Depository Receipts. • Each receipt amounts to a claim on the predefined number of shares of that company. • The issuing bank acts as a depository for these shares – that is, it stores the shares on behalf of the receipt holders. • What is the difference between ADR and GDR? • Both ADR and GDR are depository receipts, and represent a claim on the underlying shares. The only difference is the location where they are traded. • If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. • If the depository receipt is traded in a country other than USA (usually the European markets), it is called a Global Depository Receipt, or a GDR.
How can one use an ADR / GDR? • ADRs and GDRs are not for investors in India – they can invest directly in the shares of various Indian companies. • But the ADRs and GDRs are an excellent means of investment for NRIs and foreign nationals wanting to invest in India. • By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the Indian financial market – since ADRs and GDRs are traded like any other stock, NRIs and foreigners can buy these using their regular equity trading accounts. • Global Depository Receipt (GDR) - certificate issued by international bank, which can be subject of worldwide circulation on capital markets. • GDR's are emitted by banks, which purchase shares of foreign companies and deposit it on the accounts. • Global Depository Receipt facilitates trade of shares, especially those from emerging markets. Prices of GDR's are often close to values of realted shares. Very similar to GDR's are ADR's. • Indian GDR/ADR • Bajaj Auto (GDR) • Dr. Reddys (Both) • HDFC Bank (Both) • Hindalco (GDR) • Tata Motors (ADR) • Patni Computers (ADR)
