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written for Outlook Money January-March 2004 Foreign companies can issue and list shares in India directly Derivatives: Tinkering with lot sizes Strenthening shareholding disclosures Casual interpretation of insider trading law Curbing overseas derivatives deals of FIIs |
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Foreign companies can issue and list shares in India directly March 2004 The central government has opened the Indian capital market for foreign companies. The Department of Company Affairs, part of the finance ministry, issued a notification on February 23 laying out rules called 'Companies (Issue of Indian Depository Receipts) Rules, 2004' for this purpose. Under it, any company which is registered outside India and regardless of whether it has any presence in India, can issue shares to you through a new issue and then compulsorily list them on the domestic stock exchanges like NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) where you can buy and sell its shares. The rules, however, lay down conditions and certain eligibility criteria. The foreign company seeking to tap Indian investors will need to have a prior minimum paid-up capital of US$ 500 million (about Rs 2250 crore) and free reserves worth at least Rs US$ 100 million (about Rs 450 crore). It would also have to show profits made—and minimum dividend of 10 per cent per year given—in the preceding five years. Further, its debt borrowings should not be more than twice its equity capital. In addition such criteria laid down in the rules, the foreign company will also have to comply with listing norms that Sebi or the NSE and/or BSE specified for IDR issues. Only new shares can be issued to Indian investors by the foreign companies. These will be called 'Indian depository receipts' (IDRs) though one IDR may not be mandatorily equivalent to just one existing share of the company. A Sebi-registered custodian will act a domestic depository which issues the IDRs. Although not mentioned specifically in the rules, the requirement of listing on NSE and/or BSE would imply that the IDRs are held in demat form by the investors. You will be able to trade only in IDRs on NSE and/or BSE and not in the non-IDR shares of the foreign company listed and traded on the international stock exchanges.But one year after the IDR issue you will be able to convert your IDRs into the underlying share of the company. But such IDRs will get de-listed from the NSE and/or BSE and the shares so acquired will be traded only in that international stock exchange where it gets listed. After an IDR issue, the foreign company would be able to repatriate the proceeds from it issue but will have to publish in an Indian newspaper an audited account of its utilisation. The choice of companies to invest in could broaden for you provided foreign companies avail of the option to issue IDRs to you. Uptil now, subsidiaries of foreign companies registered in India were allowed to be listed on the stock exchanges and one has seen many such companies get delisted. Time will tell whether other foreign companies will be interested in directly tapping the Indian investors. But if they do, invest in them purely on the basis of the merits and de-merits of their management, business activities and financials. Derivatives: Tinkering with lot sizes March 2004 Rather than removing the restriction of a large minimum transaction size for derivatives contracts, the Securities and Exchange Board of India has just limited itself to tinker with existing lot sizes. It has permitted the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) to bring down the minimum lot size of derivatives contract to close to Rs 2 lakh where it had shot up above Rs 4 lakh and rake it up where it has fallen below Rs 2 lakh. When options trading on stocks was introduced in July 2001 and futures trading in November 2001, the NSE and BSE had to comply with a Sebi-imposed minimum transaction size of Rs 2 lakh. This applied at the time of introduction. There were 31 stocks on which options trading were available (last year, another 22 stocks were added to the stock derivatives list). Based on the stock prices at that time, the minimum lot sizes were fixed for each stock. The applicable minimum lot sizes also extended to being the multiplier (if, say, 750 was the minimum lot size then you would have to buy or sell options contract on at least 750 shares and in multiples of 750 thereafter). Take the case of Tata Motors and Hindustan Lever (HLL). In July 2001 these two stocks were quoting at about Rs 60 and Rs 200 which led to their minimum lot—and consequent multiplier—size being fixed at 3300 and 1000 respectively. Last month, Tata Motors and HLL were quoting at around Rs 530 and Rs 175 and so if you bought or sold stock futures or stock options in their minimum lot sizes your transaction size would be Rs 17.5 lakh and Rs 1.75 lakh respectively. As per the new Sebi directive, the minimum transaction size could be brought down by 50 per cent if it was between Rs 4 lakh and Rs 8 lakh and by 75 per cent if it was above Rs 8 lakh, and doubled if it was below Rs 2 lakh. Implementing the Sebi directive, the NSE has announced revision of the existing lot sizes which will take effect from March 15 for the downward revisions in 25 stocks and from March 26 for upward revisions in two stocks (for the rest, there is no change). Hence, the new lot sizes for Tata Motors and HLL are 825 and 2000, making your minimum transaction size in these two stocks to be Rs 4.3 lakh and Rs 3.5 lakh respectively. Despite these revisions, small investors will not be able to use derivatives for hedging because they do not have individual stocks valuing above Rs 2 lakh, nor, in many cases, are even their total portfolio size exceeding Rs 2 lakh. For them the only solution is a complete elimination of minimum lot sizes which, unfortunately, Sebi is not willing to consider. Strengthening shareholding disclosures March 2004 Who exactly are promoters of a company, or who controls a company? Who owns shares for what purpose? An elaborate description of the types of shareholdings is sought to be provided by a Securities and Exchange Board of India-appointed secondary market advisory committee in its report presented to Sebi in early February. The committee's report wants a new and expansive format of shareholding information to replace the existing brief one in clause number 35 of the listing agreement between stock exchanges and companies. Under this disclosure clause, the listed companies are required to file with the exchange the shareholding information within 15 days of the end every calendar quarter. Presently, information has to be provided under two categories of shareholding—promoters and non-promoters. The 'promoters' category includes promoters (domestic and foreign) and persons acting in concert, both as defined under Sebi's takeover regulations. If the proposed change in this clause by the Sebi committee is accepted by the Sebi board, the shareholding of a company will henceforth be categorised as 'controlling/strategic/in-concert' and 'free float/public', instead of 'promoter' and 'non-promoter'. Shareholding by investors—whether domestic or foreign, and whether an individual, institution, corporate, mutual fund, venture fund or private equity fund, bank, central or state government, insurance company, company director or his relative, customer or supplier of a company—would be deemed to be 'controlling' if these investors are in direct or indirect control of the company. It would also include strategic stakes, cross holdings among group companies, equity held by employee welfare trusts, locked-in shares, any shares which would not be sold in the open market in the normal course and any entity's holding which would not be sold without the advice of the entities in control. On the other hand, shareholding of investors whose investment in the company is as a portfolio investment would be considered as free float or public. The committee's proposal also makes it mandatory for details like name and stake of every single shareholder which falls under the 'controlling/strategic' category to be listed in the new disclosure format. Its an improvement over the existing format wherein only those promoters holding more than one per cent stake are required to be named with their stake details. While the proposed new categorisations will definitely make the shareholding information more clearer and appropriate and is a step in the right direction, it will still not do away with all ambiguities. For instance, an investor may have originally invested in the company as a routine portfolio investment but could change suddenly and secretly start holding it with a strategic motive. A company would have no way of knowing this. There is also much more to the listing clauses. The Sebi committee has limited its recommendation solely to the disclosure requirement of shareholding information. The need to know for an investor and therefore the need to disclose by a company spans across multiple areas including all material developments that have a bearing on the company's performance and the timeliness of their disclosure. Investors would benefit adequately if the listing clauses covering these areas were also strengthened. An internal Sebi group strives to bring down high costs of demat accounts for small investors through wise and unwise proposals March 2004 An internal group in Securities and Exchange Board of India set up to consider investor complaints of high cost of operating in demat shares submitted its report to the Sebi management in early February. The group, whose members names have not been disclosed in the report, has come up with a couple of dramatic recommendations. Transaction charge. For one, it would like the two depositories to levy transaction charges on their depository participants (DPs) the value of the transactions and not a flat rate as is the case currently. It, however, wants this to apply to investors whose total trades (buy and sell) during a single day does not exceed a value of Rs 50,000. Till April 2002 the National Securities Depository Ltd (NSDL) charged DPs 0.02 per cent transaction charge for all debits (covering all buy transactions) in the demat accounts and most DPs would charge between nil and 0.1 per cent. For credits (sale transactions) NSDL did not charge DPs, although many DPs levied a charge ranging from nil to 0.05 per cent on the sale value. If you bought shares worth Rs 10,000 in a company and it resulted in a debit in your demat account NSDL took Rs 2 from your DP towards it, and your DP would probably have taken between nil and Rs 10. But from May 2002, after NSDL switched to a flat rate of Rs 10 per debit (credits continued to be charged nothing), it started charging your DP Rs 10, and your DP would have started charging you between nil and Rs 30. Sebi's internal group now wants the pre-May 2002 value-based rate regime to come back for transactions valuing upto Rs 50,000. This would certainly bring down the high transaction costs for small investors. But for transactions valuing above Rs 50,000 the flat rate regime could continue, and here the group did not go into the de-merits of retaining it. Some market participants think that high-value trades by large investors carry a higher cost of risk-management and therefore should also attract a value-based transaction charge, albeit a bit lower than small-value trades. Custody charge. Another major recommendation by the Sebi group is for the payment of custody charge by the companies and not the DPs and investors. Presently, NSDL collects from DPs a flat custody fee of Rs 6 per security type (equity, debenture) of a company per year, while DPs custody's charge to you rangers from nil to Rs 12 per stock (in your demat account) per year. The group feels that huge benefits of dematerialisation accrue to the companies and not just investors as compared to the costs and problems associated with the earlier physical share certificate-based system. It carried out an analysis of costs involved in the physical and demat systems. It recommended that NSDL recovers custody charge not from DPs but from the companies and through a one-time payment of 0.1 per cent of the market capitalisation. While the broad thrust of the group's argument is valid in that companies should bear the custody charge and not the investors, the proposed one-time 0.10 per cent charge on market cap would work out to exorbitant amounts for mainline companies when annualised (see table) It is substantially higher than what NSDL is recovering currently from DPs every year. It would have sufficed for companies to pay that very amount which NSDL gets currently as custody charge from investors. Further, the Sebi group has come out with an unrealistic recommendation of a ban on DPs recovering annual maintenance charges from investors as it ignores DP's operating costs. It would help investors if DPs were told not to levy charges that NSDL does not levy on them. For instance, NSDL does not levy on the DPs any transaction charge for debits (resulting from buy trades) but many DPs levy it on investors. Asking the DPs to do away with such excessive charge heads of DPs would have made for a viable recommendation. Casual interpretation of insider trading law February 2004 The Securities and Exchange Board of India on January 21 cleared Mukesh Ambani, Anil Ambani and the Reliance group of insider trading charges in the two-year old Larsen & Toubro (L&T) case. But a reading of the ruling makes one wonder whether insider trading laws were applied with a casual hand in the case. The ruling was given by a three-member panel comprising of Sebi chairman G.N. Bajpai, Sebi whole-time member A.K. Batra and Sebi member-cum-Reserve Bank of India's deputy governor, K.J. Udeshi. In a short span of two months between September and November 2001, the Reliance group through four of its companies had collectively jacked up its holding in L&T from 3.92 per cent (97 lakh shares) to 10.14 per cent (2.5 crore shares). All these shares were bought through its own broking subsidiary, Reliance Shares and Stock Brokers, on NSE and BSE. The speed of the purchases was evident from the fact that the last 5.3 per cent of purchases took place in just 12 days between November 1 and 12. Immediately afterwards, on November 18, Reliance sold the entire chunk of L&T shares to Grasim India at Rs 306 per share, a large 47 per cent premium over the prevailing market price of Rs 208. Sebi started investigating in the case after it received a complaint in January 2002 that insider trading had occurred. The crux of the issue was that Mukesh Ambani and Anil Ambani, directors in the Reliance group companies, were also on the board of L&T and therefore insiders, and the open-market purchases of L&T shares immediately preceding the deal between Reliance group and Grasim was based on the unpublished price sensitive information of that very impending deal. Sebi's investigation bought out a revealing fact that, on November 6 itself, investment banking firm J M Morgan Stanley had approached Grasim to buy out Reliance's stake in L&T. This hinted at the possibility that even Reliance group was probably aware of such an eventuality and the purchases were made with such an unpublished price-sensitive fore-knowledge. The three-member Sebi panel accepted that this indeed was the case but rejected the contention that the two Ambani brothers and consequently the Reliance group were insiders. It ruled that the Ambani brothers, even though directors on L&T board, were under no legal obligation to disclose the sensitive information to L&T. This contention made the Sebi panel rule out insider trading charges against the Reliance group. Regardless, however, investors need to apply their own understanding on this issue. Is it ok for a director of a company who in his capacity as director of another company has access to unpublished price-sensitive information but is not obliged to disclose this information to his company? The public jury is still out on this. Curbing overseas derivatives deals of FIIs February 2004 A small step has been taken by the Securities and Exchange Board of India to address concerns of black Indian money being routed through overseas derivative instruments being issued by foreign institutional investors (FIIs) and fuelling the rapid rise in stock prices in recent months. It has mandated FIIs not to deal with entities that are not regulated by any relevant regulatory authority in the countries of their incorporation. Overseas or offshore derivative instruments issued by FIIs to other entities are based on their underlying investment in Indian equities, debt or derivatives contracts. These, according to Sebi, include instruments that are termed as participatory notes, equity-linked notes, capped return note, participating return note and investment note. The essence of these instruments is that an entity strikes a derivatives deal with the FII which the FII backs up by buying into Indian shares, bonds or derivatives contracts as the case may be. The general understanding is that an FII buys or sells securities here on behalf of their unitholders like an Indian mutual fund does on behalf of Indian unitholders. Sebi regulations require FIIs unitholders to be regulated by their respective countries' regulatory authorities. But no such requirement existed for the entities behind the complex back-to-back derivative deals based on which FIIs made their purchases or sales in Indian securities. This raised concerns whether these entities were routing slush funds from non-resident Indians or Indian overseas corporate bodies. Belatedly, Sebi has now plugged this loophole. The new Sebi requirement will cover those entities which enter into the derivative deals with FIIs henceforth. For the existing deals, which account for about 25 per cent of all FII equity investments in the Indian market, Sebi has given a long period of five years for it to be unwound. The onus however will be on Sebi to monitor the compliance by FIIs of its new requirement on its derivatives deals with unregulated entities. And as a part of its ongoing regulatory responsibility Sebi would need to scrutinise the antecedents and activities of the regulated entities as well. Demat transaction charges reduced marginally January 2004 The National Securities Depository (NSDL) has, with effect from January 1, reduced the transaction charges on its depository particpants (DPs) from Rs 10 to Rs 8 per debit instruction (arising from sale transactions); credit instructions (arising from purchases) will be charged nothing as before. The DPs, are expected to pass on the reduction to investors whom they levy various charges. Not worthwhile. This latest reduction, however, gives no reason to feel good to most investors. Uptil April 2002, NSDL was charging a value-based transaction charge of 0.02 per cent towards debits. In May 2002, it switched to a flat charge of Rs 12 per debit instruction. A year later this was brought down to Rs 10 and now it is Rs 8. But all this while, many DPs instead of replacing their earlier value-based rates with the new flat rate have been charging both the rates. There are surely a few who levy just the flat-based rate (see table: "Likely impact of NSDL's latest transaction charge reduction" for a comparison between large DPs). The DPs' charges for investors have a mark-up over NSDL's charges levied on them. The move to flat rate regime by NSDL was in itself a regressive one because it jacked up substantially the transaction costs of investors having sale transactions of small values of less than Rs 60,000 each transaction (a flat rate of Rs 12 per sale transaction of value less than Rs 60,000 would result in higher charge compared to the earlier 0.02 per cent). It was also supposed to bring down down the costs for those having sales transactions above Rs 60,000 but with many DPs retaining the value-based charges that never happened. So, will the latest tinkering by NSDL's charges to DPs make the DPs change their tariff rates towards investors? Says Satish Menon, chief operating officer of Geojit Financial Services, a NSDL-registered DP which does not levy a value-based transaction charge: "We have followed NSDL's flat charge structure since day one and the latest reduction of Rs 2 per debit instruction will certainly be passed on to our clients." But those DPs which levy value-based transaction charges in addition to a flat rate charge may reduce only Rs 2 from their flat rate component while retaining their existing value-based rate component. January 2004 The Securities and Exchange Board of India (Sebi), last month, imposed a penalty of Rs 2 crore on foreign institutional investor (FII) Citigroup Global Markets (Mauritius) for failing to disclose the details of the participatory notes issued by it before August 2003. This was confirmed by Sebi chairman, G.N.Bajpai, in a press conference on January 8. In August last year, Sebi had amended its FII regulations to make it mandatory for all FIIs to disclose information about offshore derivative instruments like participatory notes issued where the underlying were Indian stocks or indices. In addition to ongoing disclosure, Sebi had asked FIIs for historical information on these instruments. According to Bajpai "there was a time limit" for such disclosures. Apparently, Citigroup failed to provide, on time, information of participatory notes issued by it uptil July. And thereafter Sebi initiated adjudication proceedings which concluded in December with a fine of Rs 2 crore. Says Bajpai, "It is not that anyone refused to give the information but if a time limit is not met I have the power to take action." Strangely, though, Sebi has not put up on its website—www.sebi.gov.in—the fact that such a penalty was imposed on Citigroup. Orders of Sebi chairman and the Securities Appellate Tribunal are available on its website. But, says Bajpai, "we do not post information of action arising from adjudication proceedings on the website." Last few months have seen concerns about slush funds from within the country fueling the run-away prices on the stock market by being routed through participatory notes issued by FIIs. Media reports in November last year stated that Sebi had provided to the finance ministry a list of about 31 Indian-sounding names of overseas corporate bodies (these bodies were banned from investing in the Indian stock market in the wake of the previous market scam fallout in March 2001) to whom about six FIIs had issued participatory notes. The FIIs issuing such instruments included Citigroup Global Markets (Mauritius), Copthall Mauritius Investment, Goldman Sachs Investment (Mauritius), Merrill Lynch, Morgan Stanley Dean Witter Mauritius and Swiss Finance Corporation (Mauritius). According to latest available Sebi-released data, as of November 30 last year, FII investments in the Indian stock market in the form of participatory notes were as much as about 25 per cent (Rs 24,000 crore) of total net FII investments of about Rs 90,000 crore. This is a significant proportion but Sebi has not provided the monthwise break-up (like it does for overall FII investment figures) of the investments through participatory notes. Given the concerns of these being slush funds, Sebi needs to get more transparent and quickly. January 2004 The Securities and Exchange Board of India on January 6 decided to introduce margin trading system through brokers and securities lending mechanism through stock exchanges. Though it has spelled out the outline of the new systems the detailed modalities have yet to be worked out by Sebi along with stock exchanges. Background. After the Ketan Parekh-induced securities scam was exposed in March 2001 Sebi had, among other measures, banned the carry-forward trading mechanism (popularly known as badla on the Bombay Stock Exchange and ALBM—automated lending and borrowing mechanism—on the National Stock Exchange). This carry-forward system enabled investors to purchase or sell shares without having full funds or shares to back it up. They could simply borrow it through the two exchanges's respective carry-forward systems. On the opposite side, all individuals and entities (other than mutual funds and banks) could lend their funds and shares in the system. Risk remains. The new margin trading and securities lending systems brings back the essential features of the earlier carry-forward trading system but with crucial differences. As before, all investors will be able to borrow funds or shares towards their purchases or sales. But individuals will now be banned from lending funds. Banks and non-banking financial companies (NBFCs) will now be allowed. Brokers will also be permitted to lend funds. The decision to ban individuals from the system is the major difference. Whole-time Sebi member, A.K.Batra, justifies it "as a shift from unorganised sector to an organised one, and also towards international practices." Batra thinks if there are too many players it becomes impossible to monitor them. Some in the market, however, think this reasoning is erroneous. They point out that the major abuses of the earlier carry forward trading system were primarily carried out by brokers (and their associates) and not individual lenders. And brokers (and their associates in entities like NBFCs) could again do the same in the new margin trading system. How it will work. Investors and speculators wanting to finance their purchases will have to enter into a one-time agreement with their brokers. The brokers will then arrange funds for the investors either from his own pocket or from banks and NBFCs. The interest rates will be determined by market forces. If you are financing your purchase you will have to pay the lender, via your broker, an upfront margin of 50 per cent on the value of your purchase. If the share price goes up and your margin amount falls below 50 per cent of the prevailing market value of your purchase you will have to make good the difference by the next trading day. If you fail to do so and your margin amount has gone below 40 per cent the broker will have the right to sell the shares and close out your position. In the shares lending mechanism, investors will be able to offer their shares for lending through the stock exchanges. One needs to wait for more details to come out to properly understand the full implications of the two new systems. |