Indian Economy, 5th edition (68 page)

ESOP

The Employee
s
tock Ownership
p
lan (ESOP) enables a foreign company to offer its shares to employees overseas. It was allowed in India (February 2005) provided that the MNC has minimum 51 per cent holding in its Indian company. Earlier a permission from the RBI was required for such an option.

SBT

Screen Based Trading (SBT) is trading of stock based on the electronic medium, i.e., with the help of computer monitor, internet, etc. First such trading was introduced in New York in 1972 by the bond broker
Cantor Fitzgerald.
India introduced it in 1989 at the OTCEI. Now it is carried out at all exchanges.

Derivatives

Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner.

The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the “underlying”.

In the Indian context the
Securities Contracts (Regulation) Act, 1956
[SC(R)A]
defines derivative
to include –

(a)
A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.

(b)
A contract, which derives its value from the prices, or index of prices, of underlying securities.

Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A and are allowed to be traded on the floors of the stock exchanges.

Indian Depository Receipts (IDRs)

As per the
definition
given in the
Companies (Issue of Indian Depository Receipts) Rules, 2004,
IDR is an instrument in the form of a depository receipt created by the Indian depository in India against the underlying equity shares of the issuing company. In an IDR, foreign companies would issue shares, to an Indian depository (say the National Security Depository Limited – NSDL), which would in turn issue depository receipts to investors in India. The actual shares underlying IDRs would be held by an Overseas Custodian, which shall authorise the Indian depository to issue of IDRs.

Just try to understand in a simple way. An IDR is a mechanism that allows investors in India to invest in listed foreign companies, including multinational companies, in Indian rupees. IDRs give the holder the opportunity to hold an interest in equity shares in an overseas company. IDRs are denominated in Indian Rupees and issued by a Domestic Depository in India. They can be listed on any Indian stock exchange. Anybody who can invest in an IPO (Initial Public Offer) is/are eligible to invest in IDRs.
In other words, what ADRs/GDRs are for investors abroad with respect to Indian companies, IDRs are for Indian investors with respect to foreign companies.

But one question comes in mind. How does investing in IDRs differ from investing in shares of foreign company listed on foreign exchanges? Indian individuals can invest in shares of foreign companies listed on foreign exchanges only upto $200,000 and the process is costly and cumbersome as the investor has to open a bank account and demat account outside of India and comply with Know Your Customer (KYC) norms of respective companies. It also involves foreign currency risks. IDR subscription and holding is just like any equity share trading on Indian exchanges and does not involve such hassels.

StanChart is the
first
and the
only
issuer of IDRs in Indian markets which came out with its IDR issue in May 2010 through which it had raised Rs. 2,500 crore on high demand from institutional investors and was listed on the Bombay Stock Exchange and National Stock Exchange. Ten StanChart IDRs represent one underlying equity of the UK-listed bank. StanChart IDRs were due to come up for redemption on June 11, 2011.

Sebi
came out with the new guidelines in June, 2011which ruled that after the completion of one year from date of issuance of IDRs, redemption of the IDRs will be permitted only if the IDRs are infrequently traded on the stock exchange in India.
Sebi
rules make it clear that if the annual trading turnover in IDRs in the preceding six calendar months before redemption is less than 5 per cent, then only the company could go into for redemption of IDRs. The regulator had said that the company issuing IDRs would have to test the frequency of trading the instrument on the bourses on a half-yearly basis ending June and December every year.

Shares ‘at Par’ and ‘at Premium’

An ordinary share in India, in general, is said to have a
par value (face value)
of Rs. 10, though some shares issued earlier still carry a par value of Rs. 100. Par value implies the value at which a share is originally recorded in the balance sheet as ‘equity capital’ (this is the same as ‘ordinary share capital’).
SEBI guidelines for
public issues
by new companies established by individual promoters and entrepreneurs, require all new companies to offer their shares to the public
at par,
i.e. at Rs 10. However, a new company set up by existing companies (and of course existing companies themselves) with a track record of
at least five years
of consistent profitability are allowed to issue shares at a
premium.

When a company issues shares at a premium, it is able to raise the required amount of capital from the public by issuing a fewer number of shares. For example, while a
new company
promoted by first time entrepreneurs intending to raise say, Rs. 1 crore, has to offer 10 lakh ordinary shares at Rs. 10 each (at par), an
existing company
may raise the same amount by offering only 2 lakh shares at Rs. 50 each (close to the market value of its shares). The latter is said to have issued its share at a ‘
subscription price
’
of Rs. 50 (Rs. 10 in the case of the former company), at a premium of Rs. 40 (being the excess of subscription price over par value). In such a situation in India, the company’s books of accounts will show Rs. 10 towards
share capital account
and Rs. 40 towards
share premium account
. It means that the higher the premium, the fewer will be the number of shares a company will have to service. For this very reason, following the policy of free pricing of issues in 1993, many companies came out with issues at prices so high that in many cases they were higher than their market prices, leading to under-subscription of such issues. The companies are, however, learning fast about the pitfalls of high pricing of shares and it is only a matter of time before the issue prices become more realistic.

In India, no company is allowed to issue shares at a
discount
, i.e., at a price below par. Again, in India, once a company has issued the shares, it cannot easily reduce its capital base, (i.e.
buy back
or
redeem
)
its own shares.

This means that ordinary share capital is a more or less permanent source of capital, which normally a company is never under an obligation to return to the investors, because a shareholder who wishes to
disinvest
(i.e., get back the invested capital) can always do so by selling the shares to other buyers in the secondary market. Also, in India, a company receives no tax benefits for the dividends distributed. In other words, dividends are paid by the companies out of the earnings left after taxes and they get taxed once again at the hands of the investors.

FOREIGN FINANCIAL INVESTORS

Through the Portfolio Invesment Scheme (PIS), the foreign financial investors (FIIs) were allowed to invest in the Indian stock market – the FIIs having good track record register with SEBI as brokers. FIIs make investments in markets on the basis of their
perceptions
of expected returns from such markets. Their perceptions among other things are influenced by –

•
the prevailing macro-economic environment;

•
the growth potential of the economy; and

•
the corporate performance in competing countries.

Increased FII inflows into the country during the year 2012 helped the Indian markets become one of the best performing in the world in 2012, recovering sharply from their dismal performance in 2011. At the end of December 2012,
1,759
FIIs were registered with SEBI with their net FII flows to India at US $ 31.01 billion
10
.These flows were largely driven by equity inflows (80 per cent of total flows) which remained buoyant, indicating FII confidence in the performance of the Indian economy in general and Indian markets in particular. The economic and political developments in the
Euro zone area
and
United States
had their impact on markets around the world including India. The resolution of the
fiscal cliff
11
in the US had a positive impact on the market worldwide including in India. Further, reform measures recently initiated by the government have been well received by the markets.

New Rules for Foreign Investment

To promote the flow of foreign funds into the economy the RBI, on
January 24, 2013,
further liberalised the provisions of investment in India’s security market –

•
FIIs and
long-term investors
12
investment limit in Government Securities (G-Secs) enhanced by US $5 billion (to US $ 25 b).

•
Investment limit in corporate bonds by the above-given entities enhanced by $5 billion (to $50 billion).

•
The RBI also relaxed some investment rules by removing the maturity restrictions for first time foreign investors on dated G-Secs (earlier a three–year residual maturity was must for first time foreign investors). But such investments will not be allowed in short-term paper like Treasury Bills.

•
Foreign investors restricted from investing in the ‘money market’ instruments – certificates of deposits (CDs) and commercial paper (CPs).

•
In the total corporate debt limit of $50 billion, a sub-limit of $25 billion each for infrastructure and other than infrastructure sector bonds has been fixed.

•
Rules requiring FIIs to hold infrastructure debt for at least one year has been abolished.

•
The qualified foreign investors (QFIs) would continue to be eligible to invest in
corporate debt securities
(without any lock-in or residual maturity clause) and
mutual fund debt schemes
, subject to a total overall ceiling of $1 billion (this limit of $1 billion shall continue to be over and above the revised limit of $50 billion for investment in corporate debt).

•
As a measure of further relaxation, it has been decided to dispense with the condition of one year lock-in period for the limit of $22 billion (comprising the limits of infrastructure bonds of $12 billion and $10 billion for non-resident investment in IDFs) within the overall limit of $25 billion for foreign investment in infrastructure corporate bond.

•
The residual maturity period (at the time of first purchase) requirement for the entire limit of $22 billion for foreign investment in the infrastructure sector has been uniformly kept at 15 months. The five-year residual maturity requirement for investments by QFIs within the $3 billion limit has been modified to three years original maturity.

ANGEL INVESTOR

A new term in India’s financial market, introduced in the
Union Budget 2013-14
which announced that SEBI will soon prescribe the provisions by which the
angel investor
can be recognised as
Category I AIF
13
venture capital funds.

Angel investor
is an investor who provides financial backing to entrepreneurs for ‘starting their business’. Angel investors are usually found among an entrepreneur’s family and friends but they may be from outside also. The capital they provide can be a one-time injection of seed money or ongoing support to carry the company through difficult times – in exchange they may like owning share in the business or provide capital as loan (in case of a loan they lend at more favorable terms than other lenders, as they are usually investing in the
person
rather than the viability of the business). Other than investible capital, these investors provide technical advices and also help the ‘start-up’ business with their lucrative contacts.

They are focused on helping the business succeed, rather than reaping a huge profit from their investment. Angel investors are essentially the
exact opposite
of a venture capitalist in their ‘intention’ (who has high profit prospects as their prime focus). But in one sense both – an
angel investor
and a
venture investor
–serve the same purpose for the entrepreneur (who is in dire need of investible capital).

QFI
s
SCHEME

In Budget 2011-12, the government, for the first time, permitted qualified foreign investors (QFIs), who meet the know-your-customer (KYC) norms, to invest directly in Indian mutual funds. In January 2012, the government expanded this scheme to allow QFIs to directly invest in Indian equity markets. Taking the scheme forward, as announced in
Budget 2012-13
, QFIs have also been permitted to invest in corporate debt securities (CDSs) and MF debt schemes subject to a total overall ceiling of US $ 1 billion.

In
May 2012
, QFIs were allowed to open individual non–interest-bearing rupee bank accounts with authorized dealer banks in India for receiving funds and making payment for transactions in securities they are eligible to invest in. In
June 2012
, the definition of QFI was expanded to include residents of the member countries of the Gulf Cooperation Council (GCC) and European Commission (EC) as the GCC and EC are members of the Financial Action Task Force (FATF).