Even Roses Have Thorns: Unravelling the Direct Listing Scheme

[By Vishesh Bhardwaj]

The author is a student of National Law University Odisha.

 

INTRODUCTION 

To generate wealth, provide liquidity to investors and raise capital, companies need access to global capital markets. Earlier, Indian firms had been able to raise equity capital from foreign investors either through listing in local stock exchanges or via international listing through depository receipts like American Depository Receipts (“ADR”) and Global Depository Receipts (“GDR”). ADR is used for trading on US stock exchanges while GDR is traded outside the US. 

Recently, the Ministry of Corporate Affairs (“MCA”) notified an amendment brought in Companies Act, 2013 (“Act”)  in 2020 regarding the direct listing of shares of public companies on foreign stock exchanges (“Direct listing scheme”). This amendment in Section 23 of the Act, permits companies specified by the MCA to list their shares directly on foreign stock exchanges. Additionally, an amendment was made to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, complemented by the issuance of the Companies (Listing of Equity Shares in Permissible Jurisdictions) Rules (“Listing rules”), 2024. 

The author through this post aims to highlight the benefits, problems, and gaps in the framework of direct listing scheme. 

ADVENT OF THE SCHEME: A HISTORICAL OVERVIEW 

The inception of the direct listing scheme in India began with the proposal outlined in the SEBI report in December 2018. This report advocated for changes to facilitate the direct listing scheme. Subsequently, the Companies (Amendment) Act 2020 and further amendments provided the legal framework for the scheme, specifying the eligibility criteria for public companies to list on select foreign stock exchanges. 

In July 2021, the introduction of International Financial Services Centres Authority ILS Regulations outlined the regulatory framework for listing companies, including SMEs, startups, and various securities. This laid the groundwork for the direct listing scheme’s implementation. The announcement by the Indian government in July 2023 marked a significant milestone, signalling the direct listing scheme on International Financial Service Centre (“IFSC”) exchanges. A Working Group was formed to oversee the implementation process. 

By October 2023, amendments to the Companies Act were notified to allow the direct listing scheme. The Working Group proposed amendments to existing frameworks and regulations in December 2023 to streamline the implementation process. Finally, in January 2024, MCA and Ministry of Finance notified rules allowing the direct listing scheme in GIFT-IFSC. SEBI began working on operational guidelines to facilitate the smooth functioning of the scheme.  

The rationale for the regulatory changes stems from the belief that permitting Indian companies to list on foreign stock exchanges bolsters global competitiveness, especially in the technology sector. By opening Indian capital markets, innovation and efficiency are promoted, benefiting the financial ecosystem. Furthermore, nurturing finance as a high-value export sector and enticing prominent technology firms to Indian exchanges have the potential to elevate the nation’s global standing and enhance economic relations. 

REAPING THE REWARDS: EXPLORING THE BENEFITS OF THE SCHEME 

The move aligns with the government’s vision to position GIFT-IFSC as a global financial hub and attract foreign capital. The direct listing scheme will boost the global capital of Indian companies. The amendment provides flexibility to certain classes of domestic public companies for direct listing scheme, providing them with access to a broader pool of investors. It also reduces the compliance for listing of shares, like issuing prospectus, and disclosure of share capital and beneficial ownership.  

Within the IFSC, Indian public companies are permitted to issue shares with differential voting rights, empowering them to customize unique share classes for foreign stakeholders. This flexibility augments the company’s capacity to configure its capital in alignment with its requirements, facilitating the retention of shares that grant greater control while divesting those with reduced voting authority. 

From an investor’s standpoint, this classification enables them to select a share class that aligns with their investment objectives and risk tolerance. Additionally, listing shares through an offer for sale on the IFSC involves less stringent norms than listing on recognized stock exchanges in India. This streamlined process reduces compliance burdens, making it easier for promoters and investors to realize liquidity from their holdings. Moreover, it is an additional method to provide an exit to the investors.  

The scheme also benefits the investor as investing through the GIFT-IFSC not only eliminates foreign currency concerns for investors because transactions are handled in foreign currency, but it also allows for extended trading hours on international stock markets, which exceed 20 hours per day. Furthermore, the GIFT-IFSC provides substantial tax incentives under the Income Tax Act,1961, including exclusions from capital gains tax on the transfer of shares in Indian enterprises within its jurisdiction. 

PROBLEMS AND GAPS: THORNS OF THE SCHEME 

The regulatory framework governing investments in the IFSC has a lot of complexities. Despite listing the securities on international stock exchanges, the status of public unlisted companies remains unchanged. As per Section 2(52) of the Act, a listed company is defined as one that has listed its securities on any recognized stock exchange. However, international stock exchanges are not recognized for this purpose under Section 4 of the Securities Contract Regulation Act, 1956. So, despite listing their securities on these exchanges, unlisted companies will be exempted from the obligations and compliances mandated for listed companies under the Act. This gap may result in a lapse in investor protection, as the obligations intended to safeguard investors will not be enforced for these companies. 

The SEBI (Substantial Acquisition of Shares and Takeovers) (“SAST”) Regulations, 2011 are only applicable to a listed company. As the status of a public unlisted company will not change, the regulations will not be applicable here. This exposes the public companies to the risk of hostile takeovers, as competitors could potentially acquire securities without the regulatory safeguards provided by the takeover code. The absence of structured protections may pose challenges for permissible holders seeking to exit in the event of a hostile takeover. As international investments through IFSC evolve, there is anticipation that SEBI will address and provide clarity on these aspects to mitigate the associated risks and ensure a robust regulatory framework for such transactions. 

The issue of compliance requirements and the delineation between Foreign Direct Investment (“FDI”) and Foreign Portfolio Investment (“FPI”) presents a challenge, as investments made within the IFSC are not subject to the regulations of the FEMA. This is because IFSC is not recognized as a part of India. Now, the companies are not required to register with IFSC and can also directly engage with India International Exchange or NSE International Exchange, which eventually results in foreign investment in India, adding on to the regulatory challenges. The provisions of the listing rules are problematic for eligible investors as they have to go through an additional licensing process just so they can conform to FPI compliance. If a permissible holding crosses 10% then such Indian public company operating in IFSC may need to comply with FDI norms. Conversely, if it is below 10%, then FPI’s regulatory framework becomes enforceable. This distinction serves to complicate the regulatory environment governing investments in the IFSC. 

Notably, the impact of direct listing on Depository Receipts (“DR”) also needs to be seen. DR enabled investors to trade shares of foreign companies on their local stock exchanges. Listing through ADR and GDR has significantly decreased, with no company opting for this route since 2018 due to regulatory changes. Moreover, the government is planning to directly list on foreign exchanges after IFSC.  ADR and GDR were beneficial as it had less disclosure rules and better valuation of shares.  Even though ADR and GDR have their fair share of benefits, in all probability there will be an inadvertent demise of ADR and GDR in India.  

CONCLUSION AND WAY FORWARD 

The direct listing scheme is poised to bring significant benefits to companies. This advancement will give a more precise valuation to Indian companies, bringing them at par with global standards of scale and performance. Moreover, it is anticipated to bolster foreign investment inflows, unlocking unprecedented growth prospects, and substantially broadening the investor base. However, while such listings offer numerous advantages to companies, they also come with ample of challenges and gaps that need to be addressed. 

Before Indian companies can use this approach to list on international exchanges, it’s essential to have comprehensive regulations that align with the present laws. Clear rules are crucial, especially when it comes to investments and preventing hostile takeovers. This clarity is needed to reduce risks and establish a strong regulatory system. Is the reduction in compliance requirements intended to encourage smaller and medium-sized companies to list their securities, or are future amendments to the Act on the horizon? Nonetheless, amidst this uncertainty, it is essential to establish some compliances to ensure investor protection.  

To begin with, regulatory bodies should work towards amending the existing framework to recognize international stock exchanges for the purpose of defining listed companies under the Securities Contract Regulation Act, 1956. This would ensure that companies listing on these exchanges are subject to the same obligations and compliances mandated for listed companies on domestic stock exchanges, thereby enhancing investor protection. Additionally, SEBI should extend the applicability of regulations such as the SEBI (SAST) Regulations, 2011 to public unlisted companies operating within the IFSC to safeguard against hostile takeovers and provide structured protections. Moreover, efforts should be made to integrate investments made within the IFSC into the regulatory purview of the FEMA to streamline compliance requirements and clarify the distinction between FDI and FPI. This could involve establishing specific guidelines and regulations tailored to investments within the IFSC, ensuring that they adhere to FEMA requirements without necessarily defining the IFSC as part of India for regulatory purposes. 

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