[By Vanshika Singh]
The author is a student of Jindal Global Law School.
Introduction
Ministry of Finance and Ministry of Corporate Affairs have been in the news lately as the discussion on listing of Indian equity on foreign stock exchanges is gaining traction. They have announced that the much-awaited framework for direct listing of Indian companies abroad could be introduced later this financial year. It is notably a significant development for the Indian companies as their exposure and opportunities to raise funds in the capital markets is going to expand at a global level. This international exposure brings with itself the need to balance certain pros and cons that the companies must be ready to explore wisely.
Present Means of Raising Funds Internationally
Currently, fund raising by Indian entities can be done in primarily three ways. Firstly, by raising debt in global markets by listing their debt securities via various bonds like masala bonds, foreign currency convertible bonds, etc. Second, by way of issuing depository receipts such as by issuing American Depositary Receipts (“ADR”) or Global Depository Receipts (“GDR”). This is an indirect way of listing on a foreign exchange by entering into an arrangement with a recognised depository facility in the relevant jurisdiction. Another way of issuing equity shares abroad is doing Regulation S (“Reg S”) and Rule 144A offerings under U.S. Securities Act, 1933.
Doing a public issue under Rule 144A requires registration on the relevant foreign stock exchange and adherence to heavy reporting standard in such jurisdiction. Until 2020, listing of Indian companies on foreign exchanges was not permitted let alone standardized, therefore, this method could not be accessed. However, Rule 144A provides an exemption to such registration by allowing private placement of securities to only sophisticated investors, i.e., qualified institutional buyers (“QIBs”) in the U.S. and not the retail investors. The rationale behind the same is that sophisticated investors are resourceful and diligent enough to know the risk of entering an investment, and thereby need little regulation. On the other hand, Reg S offering is done outside the U.S. that allows Indian companies to tap primarily into the European markets such as London or Luxembourg Stock Exchange. An important difference between these two types of offerings is that the Rule 144A route requires higher disclosure and due diligence as compared to the Reg S route. The former requires a negative assurance letter, also known as the Rule 10b-5 letter, from the issuer’ or issuer’s lawyers. It provides a confirmation that nothing has come to their attention that gives them a reason to believe that the statements in the offering documents are untrue or inaccurate. This is a higher diligence standard than what is currently followed in the Indian market and places a higher liability on the entities such as law firms and merchant bankers who may issue such a letter.
Proposed Change
The buzz about this change started way back in 2018 when Securities and Exchange Board of India (‘SEBI’) released its expert committee report for public comments. Amongst other things, the expert committee scrutinized the economic effects of this change on the country and Indian companies. Additionally, they discussed various legal, operational and regulatory nitty-gritties that require a rehaul to implement this change and facilitate Indian companies in listing their equity share directly on foreign stock exchanges. It was clarified in the report that in case of unlisted Indian companies seeking to list aboard, the laws of foreign jurisdictions pertinent to listing will apply while ensuring compliance with Companies Act, 2013 (“Companies Act”). With respect to companies listed in India seeking to list abroad, the companies can expect to continue compliance with the relevant laws they are subjected to India and in case of variation, a comparative analysis of compliance is to be provided by such company. Such onerous requirements can inevitably result in longer timelines for conclusion of raising capital via this method.
In late 2020, MCA, via the Companies (Amendment) Act, 2020 (“Amendment Act”), passed an amendment to S. 23, amongst other sections of the Companies Act to permit a particular class of public companies to list their securities abroad in permissible foreign jurisdictions or jurisdictions as may be prescribed. The permissible jurisdictions include Japan, China, U.S., South Korea, United Kingdom, Hong Kong, France Germany, Canada and Switzerland. This has been a momentous development because India’s current legal framework prohibits the direct listing of equity shares of domestically incorporated companies on international stock markets.
Since the Amendment Act was passed in 2020, various provisions of the same have been notified from time to time but the amendment to S. 23 has not been notified yet. In light of the same, MCA and SEBI are proposing to introduce the much-awaited framework later soon to this allow such foreign listing.
Expected Impact of this Change
This much awaited change will not only result in increase in competitiveness for Indian companies but also bring better valuation to companies, increase and diversify the investor base, and most importantly provide an alternate source of capital for Indian companies. Moreover, companies that want to list their securities on international stock exchanges with sophisticated expertise and resources can expect to receive more accurate valuations for their assets as compared to the current valuations in India. This is because it will expose them to niche investors who have sectoral and institutional expertise, and are therefore better equipped to assess such shares on its own merit and also comparatively. The ability of Indian businesses to access larger, more diverse pools of money and cheaper costs of capital will serve to bolster their competitiveness in industries like technology and internet sectors where this change will lead to strategic advantages by overlooking geographical distances. Additionally, having more foreign investors on board may invite more robust international corporate governance practices, induce maximization of efficiency and fast-paced innovation to catch up with global competitors. It will also encourage embracing best practices, international cooperation and improve peer to peer benchmarking.
At the same time, cross-listing may make Indian companies vulnerable to volatility of international markets and increase the risk of mass selling due to markets crisis abroad. Moreover, listing abroad means any activity by the company comes under the scrutiny of the respective jurisdiction’s regulator as well. As a precaution, being familiar with legal consequences in case of breach is of utmost importance. The framework for listing abroad is much awaited to address important questions like this for parties’ protection but also determination of implications like tax imposition on cross-border listings to make this decision.
With more tech-based companies proliferating in India, it is an opportune time to bring this change as the country has been proving its potential in global capital markets. India’s recent listing on JP Morgan Chase’s emerging market bond index is an indication of the international recognition of India’s potential as a stable country which is taking a step towards being a leader on the global front. Moreover, retail investors worldwide may also feel more confident in investing in Indian entities as there are increasing projections of India being a lucrative market for investment in the coming decades.
However, the difference in investment culture can play a role in affecting investment decisions by retail investors abroad as India is one of the few countries with concentrated shareholding in the hands of few, and intricate involvement of family owned and controlled business. For instance, the demanded standards for corporate governance might differ between jurisdictions. Certain foreign investors might have specific demands concerning the standard and frequency of disclosures, independence of auditors, shareholder rights, board composition, etc. Navigating such expectations can be difficult for Indian organizations that are used to distinct governance styles and must adapt to align with the varied expectations. Likewise, understanding the nuances of a company’s strength, the promoters’ suitability, performance parameters, etc., might be beyond the ability of a retail investor to understand as they do not possess the vast resources as institutional investors. Moreover, information asymmetry when it comes to understanding the context in which Indian companies operate maybe difficult to comprehend as a foreign retail investor. For example, such investors may find it challenging to comprehend the cultural, social. political, and economic developments that affect a company’s performance and how they subsequently affect international markets.
Nevertheless, with every change comes an opportunity to adapt to it as well. This is a welcome shift for development of the Indian capital market as we can expect a robust mechanism for investor protection, consequently resulting in increased investor confidence as well. Chenyan Yi, in a recent study of Chinese companies listing abroad, observed that in complying with Chinese GAAP, Hong Kong Regular Financial Reporting Standards and International Accounting Standards, the companies found loopholes to inflate their numbers that resulted in years of shorting of their stocks due to fraudulent misreporting of financials. Therefore, there is dual responsibility on the regulators to pay heed to such loopholes and on companies to avoid such activities as it lowers investor confidence. Consequentially, the intermediaries facilitating public offerings, especially the legal fraternity, can expect much more stringent disclosure requirements and higher liability for misstatements in prospectus with the exposure to global standards and participants when dealing with capital markets. Considering the risks are high, we could see an Indian version of a 10b-5 letter or a negative assurance letter coming up as a result of this development.
The expert committee report in 2018 also delved into the possibility of foreign companies listing on the Indian stock exchanges. It may a good idea for MCA to explore this idea and integrate the global capital market in both directions as the investor interaction with capital markets in India is seen to be increasing in the last few years. Recently, Jishnu Bhattacharjee, managing director of Nexus Venture Partners, remarked that as the threshold for listing in the US rises higher, estimated $2-3 Billion, and investors here start to accept technology-based listings, Indian markets appear as the best alternative for many software players to go public as Indian companies with even less than $1 Billion can pick up the public money. However, the hurry to open up and integrate with global market must not come at the cost of investor protection. Any policy decision must come while bearing in mind that, as of 2019, the Indian financial literacy rate is only of 27% and investment decisions may be motivated by other factors other than pure economic reasons. Accordingly, MCA and SEBI must tread carefully by keeping in mind the dual objective of development of market and investor protection.