Two-way fungibility may not be enough to develop IDR market

The market may have reacted positively to the government’s decision to allow two-way fungibility in Indian depository receipts (IDRs) but that may not be enough to help develop the market for this instrument.

With a view to deepening the capital markets, Finance Minister Pranab Mukherjee in Budget 2012-13, proposed allowing two-way fungibility for IDRs, subject to a ceiling. The fresh guidelines on IDRs are expected from the stock market regulator Securities and Exchange Board of India (Sebi) in due course.

Although two-way fungibility is a step in the right direction, market experts believe. But the ceiling on convertibility and other unfavourable regulations will act against the development of the Indian IDR market, they point out.

Fungibility allows IDRs to be swapped for the underlying stock listed overseas.

“We have to see what comes in the fine print. The IDR market can only become vibrant if there are no restrictions,” said a top official with a leading investment bank.

No foreign company, besides Standard Chartered, has come forward to raise capital from the Indian market through the IDR route, thanks to unfavourable regulations, including absence of two-way fungibility. Also, insurance companies, which are one of the biggest institutional investors in the country, are not allowed to invest in IDRs. For investors in IDRs, the tax treatment too, is different compared to other listed Indian shares.

All these factors have hurt the Standard Chartered Plc IDR, the lone company with depository receipts in India. The London-based lender successfully raised nearly Rs 2,500 crore by selling IDRs in May 2010. However, the buyers of the IDR were not as successful as the receipts have traded at a huge discount to their underlying shares.

Despite gaining 20 per cent on Friday on the fungibility proposal, the IDRs are still 25 per cent cheaper to the underlying shares, which are traded in London.

The discount had widened to as much as 40 per cent and volumes had shrunk following Sebi's move in June 2011, which disallowed IDRs to be redeemed for the underlying shares.

Following Pranab Mukherjee’s proposals, the StanChart IDR gained nearly 20 per cent to Rs 93.8 on the National Stock Exchange. Meanwhile, the lender’s shares in London closed at Rs 1,320 (GBP 16.7). Ten Standard Chartered IDRs equal one share. Experts say further gains could be limited as it is unlikely the government will allow complete convertibility since it could see investors redeeming most of the IDRs for the underlying due to the huge discount.

The subdued response to the lone IDR issue by investors here will be a big dampener for more such issuances.

Market observers say foreign entities will not be attracted towards issuing IDRs until the Standard Chartered IDRs trade at par with their foreign shares.

“Being the only IDR in the market, it will be the benchmark. Companies will have to price their IDRs at a similar discount to Standard Chartered IDRs to attract investors. Foreign firms, instead, would opt to raise money in the home market by giving just five per cent discount to their existing price,” said the banker.