Co-authored with Mihir Deshmukh, Associate, Finsec Law Advisors
The International Financial Services Centre Authority (IFSCA) recently issued a circular providing the framework for listing of depository receipts in the Gujarat International Finance Tec-City IFSC that was promptly adopted by INDIA INX and NSE IFSC, the two stock exchanges currently operating in the GIFT IFSC. This framework is complimented by the recent amendment to the Liberalised Remittance Scheme (LRS) of RBI, wherein resident individuals have now been permitted to make remittances up to $250,000 under the LRS to IFSCs set up in India for making investments in IFSCs in securities, other than those issued by entities/companies resident in India. In a press release dated August 9, 2021, the NSE IFSC has announced that trading in select US stocks would be facilitated through the NSE IFSC under the unsponsored depository receipts (DR) route. The NSE IFSC has proposed this scheme under the regulatory sandbox of the IFSCA.
Unsponsored DRs in GIFT IFSC
Asper the IFSCA circular, a DR means a negotiable financial instrument representing underlying securities of a company listed in another jurisdiction.The difference between a sponsored DR and an unsponsored DR is determined by the degree of involvement of the issuer whose securities form the underlying securities for such DRs. Hence, if the issuer company sponsors a DR programme,it enters in a contractual relationship with the depository bank and thus creates a sponsored DR, whereas unsponsored DRs may be floated by depository banks on an analysis of market demands for the shares of such issuers, or on the request of a broker-dealer that has requested such programme.
As unsponsored DRs may be floated without the participation of the issuer company, the public offer route under the IFSCA framework may not be the ideal way for trading such DRs given the listing requirements as per the IFSCA circular.Listing without public offer option under the IFSCA circular may be only viable if the depository bank issuing such DRs gets the issuer of the underlying securities on board to apply for a listing, and comply with the requirements mentioned in the IFSCA circular. Alternatively, the depository bank issuing a DR may opt for the ‘permitted to trade framework’ under the IFSCA circular,wherein a stock exchange in the IFSC may permit trading of DRs listed on a stock exchange in India or a foreign jurisdiction, provided such trading is in compliance with local laws and regulations of the jurisdiction where such DRsand underlying securities are listed, and clearing and settlement of trades is ensured by the stock exchange. It may be noted that the ‘permitted to trade’ framework introduced under Chapter VII of the IFSCA circular has been initially made available on the stock exchanges in the IFSC till December 31, 2023.
Unsponsored DRs in foreign jurisdictions
Unsponsored DRs are mostly traded over the counter by institutional investors. A major reason behind this is the simple fact that as these DRs do not come with an endorsement of the issuer of the underlying securities, and as they are subjected to minimal disclosure requirements, such products are considered unsuitable for retail investors. In the US, depository bank seeking to establish an OTC traded unsponsored DR programme has to ensure that such DRs or the underlying securities are either registered with the SEC, or qualify for the 12g3-2(b) exemption, under which a non-US company is exempted from registering its securities with the SEC, if it fulfils criteria such as being listed in the home jurisdiction, and publishing all shareholder communication on its website etc. On the other hand, certain jurisdictions such as Hong Kong require all DRs to be sponsored to be listed on the HKEX. Furthermore, while explicit differentiation between the requirements for sponsored and unsponsored DRs isn’t provided, jurisdictions such as the UK and Luxembourg require DRs to follow a listing process that requires issuer companies to comply with the prospectus and disclosure requirements.
From the above provisions, it can be gleaned that the access to unsponsored DRs is curtailed for retail investors either in the form of listing requirements or by making these available solely through OTC markets. The IFSCA circular sets off these limitations by either allowing these DRs to be listed without a public offer and thus reducing the cross-listing burden of issuer companies, or by permitting DRs to be traded without listing under the ‘permitted to trade’ framework.
However, while the above provisions greatly increase the scope for listing and trading of DRs in the IFSC, certain involvement and participation of issuer companies is still required for DRs to be traded in the IFSCA framework. Thus, what remains to be seen is the mechanism that may be introduced through the regulatory sandbox which may introduce relaxations for these residua requirements on issuer companies, and alternative obligations that depository banks may be required to comply with. As the unsponsored DR scheme of the NSE IFSC also seeks to utilise relaxations provided under LRS, it would be interesting to see the framework for funding of such trades that may be adopted under the regulatory sandbox.
Thelisting framework for DRs provided under the IFSCA circular and relaxation of the LRS norms signify the steps being taken to include retail investors in the financial evolution that would be brought around through the IFSC(s), and comeat an opportune moment when the country is experiencing an exponential rise in the number of retail investors in the market. The framework for trading of unsponsored DRs and funding of such trades under the LRS that will be implemented through the regulatory sandbox may provide further impetus for inclusion of not just foreign investees but also retail investors seeking new avenues of investment and engagement of capital.
(This article was first published in Financial Express)
