What if you want to invest in stocks in companies based overseas? Traditionally, you would have done this through your Demat account and a bank account with funds in the country you want to invest. The Reserve Bank of India allows investments in equity instruments up to $200,000. However, this might turn out to be a complex process.
Alternatively, you would have tried through a domestic mutual fund (MF) that invests its corpus overseas in a foreign fund, which invests in international companies or directly in scrips. However, this too tends to be a tad complicated process as MFs are affected by currency exchange risks. In this case, your investments in local currency get converted into global currency before they are released in the international markets.
And then came up, a new investment instrument in the stock market- Indian depository receipts (IDRs). You can invest in this to get a long-term reward. It functions like an equity share, albeit a little differently. The Indian stock market trades shares of companies that are listed in India. The companies could be Indian or foreign, but they must significant business in India, for Indians to buy their shares.
However, if you want to own shares of international firms such as Microsoft, Google or Apple, you might then opt for Indian Depository Receipts.
What is an Indian Depository Receipt?
An IDR is in Indian rupees and is created by a domestic depository (custodian of securities registered with SEBI (Securities and Exchange Board of India). It is issued against the underlying equity of the company to enable foreign companies to raise funds from the Indian securities Markets. As foreign companies are not allowed to list on Indian equity markets, IDR is a way to own shares of those companies. These IDRs could be listed on the Indian stock exchanges. Through the IDRs, you could directly invest money into international companies.
These are foreign companies that have subsidiaries working in India. Since these offshoots are not listed, the firms offer shares to Indian investors. Standard Chartered Plc is the first company to come out with an IDR issue.
Indian Depository Receipts are based on American Depository Receipts introduced in 1927. Securities and Exchange Board of India (SEBI) first operationalised the rules of IDRs. The Reserve Bank of India (RBI) issued operations under the Foreign Exchange Management Act.
The Indian depository receipts had their inception on the BSE and the NSE on June 11, 2010.
Who is eligible to issue Indian Depository Receipts?
The foreign issuing company shall have pre-issue paid-up capital and free reserves of at least US$ 50 million and have a minimum average market capitalisation (during the last three years) in its parent country of at least US$ 100 million. It should have a continuous trading record or history on a stock exchange in its parent country for at least three immediately preceding years. It should have a track record of distributable profits for at least three out of immediately preceding five years. It should be listed in its home country and not been prohibited from issuing securities by any regulatory body and has a good track record concerning compliance with securities market regulations. The size of an IDR issue shall not be less than Rs 50 crores.
An overseas custodian bank is a banking company outside India. It has a place of business in India. It acts as custodian for the equity shares of issuing company against which Indian depository receipts are proposed to be issued in the underlying equity shares of the issuer is deposited. A domestic depository is a custodian of securities registered with SEBI and authorised by the issuing company to issue IDRs. A merchant banker is registered with SEBI who is responsible for due diligence and through whom the draft prospectus for issuance of the Indian depository receipt is filed with SEBI by the issuer company.
IDR issue process
As per SEBI guidelines, the Indian depository receipts will be issued to Indian residents much the same way as domestic shares are issued. The process involves the issuer company making a public offer in India, and residents can bid precisely the same way as they bid for Indian shares. The issuing process is the same. The company needs to file a draft red herring prospectus (DRHP), which would be examined by SEBI. After SEBI gives its approval, the company sets the issue dates and files the document with the Registrar of Companies. Following this, the company goes ahead with marketing the issue. The issue is kept open for a fixed number of days, and investors can submit their application forms at the bidding centres. The investors bid within the price band, and the final price would be decided after the closure of the issue. The receipts would then get allotted to the investors in their Demat account as is done for equity shares in any public issue.
IDR taxation and equity shares
There is a fair bit of similarity between IDR and equity shares. IDR holders almost have the same right as shareholders. You could vote for or against a company, get dividend, bonus or rights issue as and when the company declares.
However, IDRs are not taxed in the same manner as equity shares. Your IDR gains will be taxed at your income tax rates if you sell an IDR within a year of purchase. The tax rates will be 10% without indexation and 20% with indexation, for exits made after a year.
Despite its many visible advantages, IDRs involve currency risk for the underlying shares in another country. Fluctuations in the exchange rate could impact the value of the dividend payment. There are also other risks involved as the country where the foreign company is located could face unprecedented events such as a recession, pandemic, bank failures, or political upheaval. Also, there are risks with attending securities that are not backed by a company. The depository receipt may be withdrawn any time, and the waiting period for the shares being sold and the proceeds distributed to investors may be lengthy.