[By RS Sanjanaa & Sahil Agarwal]
The authors are students of Symbiosis Law School, Pune and Government Law College, Mumbai respectively.
[I.] Introduction
The Indian Government has allowed public companies to directly list and issue their equity shares on international exchanges. This move is aimed at bolstering the Indian economy by allowing companies (especially start-ups and technology companies) to access global markets for the purpose of raising foreign capital at favorable valuations.
For the purpose of allowing direct listing of equity shares at international exchanges, the Government has notified the amendment to Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’) and the Companies (Listing of equity shares in permissible jurisdictions) Rules, 2024 (‘LEAP Rules’). In addition to this, Frequently Asked Questions have also been released pertaining to the Direct Listing Scheme.
In this post, the authors aim to explore the intricacies of the new framework, its development, implications on Indian companies, key challenges with the new framework, and recommendations.
[II.] Overview
[II.A.] Background
Direct listing is essentially one of the two ways in which a company can raise capital by listing its shares on an exchange. The other being an Initial Public Offer (‘IPO’). In a direct listing, the company does not issue any new shares and lists the already existing shares allowing the existing shareholders to trade them via an exchange.
Earlier, Indian companies were allowed to raise foreign capital for their shares only via the route of depository receipts (‘DR’). In order to ease the process of raising foreign funds and to allow direct listing, the Government vide Companies (Amendment) Act, 2020 amended Section 23 of the Companies Act, 2013 and allowed public companies to issue securities for the purposes of listing on permitted stock exchanges in permissible foreign jurisdictions. This change was brought into effect on October 30, 2023. In furtherance to the above, the LEAP Rules were introduced and the NDI Rules were amended. In the meanwhile, the Securities and Exchange Board of India (‘SEBI’) is expected to release its operational guidelines pertaining to direct listing of companies already listed in India.
[II.B.] Key Features
[II.B.1.] LEAP Rules
As per the First Schedule of LEAP Rules, GIFT International Financial Services Centre (‘GIFT IFSC’) has been prescribed as the permissible jurisdiction; and India International Exchange NSE and India International Exchange as the two permissible exchanges. The provisions of the LEAP Rules shall apply to both unlisted and listed Indian public companies which shall be permitted to list on the permissible jurisdiction. Further, as per Rule 4(5) of the LEAP Rules, companies are mandated to stay in compliance with Indian Accounting Standards (in addition to any other accounting standards as may be prescribed by the foreign regulator) even after the shares are listed in permissible jurisdictions.
Rule 5 of the LEAP Rules prescribes for certain kinds of companies which shall be deemed to be ineligible for the purposes of direct listing such as a Section 8 company, a company limited by guarantee and also having share capital, one having a negative net worth, among others.
[II.B.2.] NDI Rules
As per Schedule XI of the NDI Rules, the investment in Indian companies vide such direct listings shall be considered foreign investment for the purposes of foreign exchange laws and shall be subject to the sectoral caps for foreign investment as provided under Schedule I of the NDI Rules. Furthermore, any person resident outside India shall be a permissible holder of such equity shares. In essence, Indian residents are debarred from trading/investing in shares listed in permissible jurisdictions. These permissible holders shall be permitted to invest up to the limit prescribed for the foreign portfolio investors under the NDI Rules (i.e., 10%).
[III.] Critical Analysis
[III.A.] Assessing the Merits
Prior to this amendment, companies were only allowed to raise foreign currency capital primarily through issuing DR. Now with the government expressing its intent to permit the direct listing of Indian companies on international exchanges, this present move is a welcome change towards achieving that.
This would enhance the valuation of companies that are listed on the international exchanges. It raises global investor confidence by signaling ambitions of tapping into a new pool of capital and subjecting them to more transparency obligations. For instance, until 2007 Alibaba was only listed on the Hong Kong Stock Exchange. When it decided to list on the New York Stock Exchange (‘NYSE’), the IPO raised $21.8 billion leading to enhanced valuation of $231 billion. This further diversifies the investor base with a broader range of risk appetites and reduced dependence on domestic markets.
The range of motion also increases when it comes to deals such as mergers and acquisitions of foreign companies. For instance, having U.S. dollar denominated shares simplifies any deal with a U.S. business. Additionally, listing on an international exchange also promotes strategic deals or partnerships with foreign firms through greater market recognition.
Sectors such as technology and start-ups will significantly benefit from this especially since FDI in the technology sector witnessed a 336% rise in April-September 2020. When Spotify (a Swedish company) went public on the NYSE, it closed at $26.5 billion on its first day of direct listing at the NYSE and has since grown over $7 billion with several of its majority investors coming from the U.S. such as Morgan Stanley and Universal Music Group. Additionally, it gave the most detailed disclosure a company has ever given about its business owing to higher transparency obligations. Even established companies operating in other sectors will benefit from this existing demand pool of foreign investors.
From the perspective of investors, investing in Indian companies in GIFT IFSC provides immense tax benefits than a DR route including exemptions on capital gains from the transfer of equity shares in GIFT IFSC. Moreover, it eliminates currency risk for the investors as the stocks are traded on foreign currency. This also facilitates easier cross-border investment allowing even non-resident Indians and entities from land bordering countries to invest pursuant to government approval.
Additionally, as stated by the World Economic Forum, foreign investors are keen in exploring India but lack sufficient information. This amendment would remove this hurdle with disclosures being issued in particular reference to the international stock exchange listing through the IFSCA (Issuance and Listing of Securities) Regulations, 2021. In furtherance, the additional trading hours to aid investors from all jurisdictions also aids in furthering the cause.
[III.B.] Scrutinizing the Challenges
[III.B.1.] Operational and Market Challenges
Liquidity of stocks is primarily determined through the number of participants, diversity of investors, and market maturity. In this case, the law excludes Indian investors from trading on the stocks listed on the international exchange. In case of companies that are not dually listed, this leads to reduced demand and limited trading activity. Moreover, the market depth may be shallower, making it harder to execute sizable trades without affecting prices. Besides, limiting Indian investors may lead to reduced overall efficiency of price discovery due to under-represented valuation metrics.
The currency risks associated with this are also significant since the listing operates on foreign currency. The value of securities denominated in a foreign currency can be affected by changes in exchange rates which has an impact on valuation and the shares denominated in Rupees. This becomes more important if the exchange rate between the two currencies is volatile, which also changes investor perception on investments. This further adversely affects accounting and reporting in financial statements for the company.
Market recognition is also a hurdle in this process, especially since GIFT IFSC in itself is relatively new. Start-ups in particular with their limited track record and being inherently riskier investments rely on market trust to attract investments. With investors viewing GIFT IFSC as having higher risks, this could impact the capital raising process.
The potential impact of global economic conditions is also crucial. In case of economic uncertainty, investors would prefer established markets than emerging markets. A domestic investor base would not rely on currency fluctuations as much in times of a global turndown. Besides, government interventions provide insulation which would mostly benefit domestic investors.
Lastly, amidst these complexities, tax implications also warrant careful consideration. Firstly, income from stocks listed on the GIFT IFSC are exempt from capital gains tax which is otherwise applicable on income from stocks listed in India. With a substantial amount of direct tax flowing in through tax on capital gains (6.4% of the total direct tax in the financial year 2021-22), this exemption can cause a significant loss to the exchequer if Indian companies list solely or majorly on the international exchange as investors would prefer stocks with less tax burden. Secondly, income from dividends earned by non-resident investors from investment in Indian companies are generally taxable at the rate of 20% as per Section 115AD of the Income Tax Act, 1961 when listed on a national exchange. However, as per Section 115AC, the income from dividends on Global Depository Receipts (‘GDRs’) is taxed at the rate of 10%, keeping in mind that they are listed on an international exchange. Now, in this direct listing scheme, it is unclear as to whether the dividend income from stocks would be eligible at the 10% rate as is the case with GDRs since they are also listed on an international exchange. If they are, then that would further hamper the amount of tax liable to be collected as opposed to the usual 20% taxation regime as mentioned above.
[III.B.2.] Structural and Listing Dynamics
Direct listing vis-à-vis the DR route also calls for certain implications. Firstly, gaining recognition on a new exchange may pose challenges in comparison to well-established global exchanges. DRs are often listed on major global exchanges, providing companies with immediate visibility and recognition among international investors. Secondly, the compliance requirements are lesser for DRs as direct listing necessitates the company to oblige with dual requirements, especially when it is listed on both the national and international exchanges.
Furthermore, as stated, the capital raised through direct listing is subject to the FDI sectoral caps. On one hand, sectors that have been traditionally excluded from FDI will continue to be limited in their access to foreign capital. On the other hand, industries with restricted FDI allowances are likely to exhibit diminished overall appeal to this scheme, resulting in minimal to negligible interest in participating in GIFT IFSC.
[IV.] Conclusion
The introduction of this scheme marks a pivotal stride towards global market integration for India. It holds immense potential to unlock new avenues of capital, foster visibility for Indian businesses, and produce greater revenue for the government. However, it comes with its own set of challenges such as liquidity concerns and currency risks, among others which require attention to ensure long-term success of the scheme.
Allowing domestic investors to participate in the trading would be the foremost amongst them all. In the report of the working group, it was stated that to ensure better liquidity, mutual funds shall be allowed to participate in direct listing with a separate limit for IFSC. The same can be added in the upcoming operational guidelines by SEBI. Furthermore, currency risk management mechanisms must be implemented. For investors, hedging of these risks through currency forwards and futures is suggestible. Moreover, periodic regulatory assessments must be conducted to identify areas for improvement. Specific incentives for start-ups and innovation-driven sectors must be provided and vigilant monitoring of the global economic conditions must be done. A comprehensive understanding of global economic trends will help anticipate challenges and adapt the direct listing framework accordingly.