Module 8: Corporate Fund Raising

1. Dematerialisation of Securities: Concepts, Benefits and working machinery of a

Depository

Your investments in shares and debentures can be held in electronic or dematerialised form in a
depository. Depository is an entity which holds securities (shares, debentures, bonds,
government securities, mutual fund units etc.) of investors in electronic form at the request of the
investors.

National Securities Depository Ltd (NSDL) and Central Depository Services (India) Ltd (CDSL)
are the depositories that are licensed to operate in India and are registered with SEBI (Securities
and Exchange Board of India).

Dematerialisation is comparable to keeping your money in a bank account. In demat form, your
physical share certificates are replaced by electronic book entries; purchase of shares are
reflected as credits in your demat account and sales are reflected as debits.

1.1. Who is a depository participant?

 A depository participant (DP) is an agent of the depository through which you maintain
and operate your demat account; the DP provides the interface between you and the
depository.

 Just as banking services can be availed through a branch, depository services can be
availed through a DP. Any financial service provider, including, financial institutions,
banks, state financial corporations, stock-brokers, NBFC etc complying with SEBI’s
norms can be register and function as a DP.

1.2. What are the advantages / benefits of demat?

It is advisable to hold your securities in demat form as it offers many advantages as under:

Primary markets

 Nowadays, public issues are taking place in demat mode. Accordingly, to apply in public
issues, you need to have demat account.

 Allotment of shares in public issue is credited to your demat account and hence there is
no scope of loss of share certificates in transit.

Secondary markets

As per the available statistics at BSE and NSE, 99.9% transactions are taking place in
dematerialised mode only. Shares bought through the stock exchange is credited to your demat
account.
Unlike in physical shares, there is no scope for bad delivery or fake shares. Further, unlike
physical certificates, you do not have to send the shares purchased to the company to transfer it
to your name. Therefore, there is no scope for delay in transfer or for loss of share certificates in
transit. There is considerable reduction in paperwork and transaction cost in demat mode.

You can view all your investments in listed companies or mutual funds in single account. You
receive all the corporate benefits like rights, bonus shares directly into your demat account and
dividend into bank account registered in your demat account.

1.3. Process of conversion of securities into the demat form

Securities specified as being eligible for dematerialization by the depository in its bye laws and
as under the SEBI (Depositories and Participants) Regulations, 1996 (the Regulations) can be
converted or issued in a dematerialized form. The process of conversion of securities into a
dematerialized form or the issuance of the same in a dematerialized form can be explained thus:

1. Firstly, the issuer company, whose securities are eligible for dematerialization, has to enter
into an agreement with a depository for dematerialization of securities already issued, or
proposed to be issued to the public or existing shareholders.

2. The investor is given an option to hold the securities in a dematerialized form and it is his
prerogative to exercise the option to hold the securities in that manner.

3. The depository enters into an agreement with the participants who are the agents of the
depository and co-functionaries in the process of dematerialization of securities.

4. Any person can then enter into an agreement, through the participant, with the depository for
availing the services provided by the depository.

5. Upon the entering into such agreement with the depository, the person has to surrender the
certificate pertaining to the securities sought to be dematerialized to the issuer. This surrender is
effected in the following manner:
(i) The person (beneficial owner) who has entered into an agreement with the participant for
dematerialization of the securities has to inform the participant about the details of the certificate
of such securities.
(ii) The beneficial owner has to then surrender the said certificate to the participant.
(iii) The participant informs the depository about the particulars of the securities to be
dematerialized and the agreement entered into between him and the beneficial owner.
(iv) The participant then transfers the certificate pertaining to the said securities to the issuer
along with the details and particulars of the securities.
(v) These certificates are mutilated upon receipt by the issuer and substituted in the records
against the name of the depository, who is the registered owner of the said securities. A
certificate to this effect is sent to the depository and all stock exchanges where the security is
listed.
(vi) Subsequent to this, the depository enters the name of the person who has surrendered the
certificate of security as the beneficial owner of the dematerialized securities.
(vii) The depository also enters the name of the participant through whom the process has been
carried out and sends an intimation of the same to the said participant.

6. Once the aforesaid process of dematerialization is carried out, the depository has the
responsibility to maintain all the records pertaining to the securities that have been
dematerialized.

1.6. What is a Depository Receipt?

A depositary receipt is a negotiable financial instrument issued by a bank to represent a foreign

company's publicly traded securities. With a depositary receipt, a custodian bank in the foreign
country holds the actual shares, often in the form of an American depositary receipt (ADR),
which is listed and traded on exchanges based in the United States, or a global depositary
receipt GDR, which is traded in established non-U.S. markets such as London and Singapore.

When a foreign-listed company wants to create a depositary receipt abroad, it typically hires
a financial advisor to help it navigate regulations, a domestic bank to act as custodian and
a broker in the target country to list shares of the firm on an exchange, such as the New York
Stock Exchange (NYSE), in the country where the firm is located.

ADRs typically trade on the American Stock Exchange (AMEX), the NYSE or the Nasdaq.
ADRs provide investors with the benefits and rights of the underlying shares, which may include
voting rights, and open up markets investors would not have access to otherwise. For example,
ICICI Bank Ltd. is listed in India and is typically unavailable to foreign investors. However, the
bank has an ADR issued by Deutsche Bank that is traded on the NYSE, which most U.S.
investors can access.

Pros and Cons of a Depository Receipt

Depositary receipts let U.S. investors purchase shares in foreign companies in a more convenient
and less expensive manner than purchasing stocks in foreign markets. Also, U.S. investors may
use depositary receipts to diversify their portfolios on a worldwide scale.

However, many depositary receipts are not listed on a stock exchange and are illiquid or traded
only by institutional investors. Also, the liquidity of trading unsponsored depositary receipts is
low, and the securities are not backed by a company. Investors may lose their entire principal.
The depositary receipt may be withdrawn at any time, and the waiting period for the shares being
sold and the proceeds distributed to investors may be long. The bank may impose a substantial
administration fee for each depositary receipt holder, reducing any potential gain from the
receipt.

1.5. Workings of a Depository: Models and Types of Ownership

1.5.1. The two models of the depository system are:

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1. Dematerialization, wherein, by operation, there is no physical scrip in existence as neither
the individual who owns the shares nor the depository keeps scrips. The depository maintains the
electronic ledger of the securities under his control.

2. Immobilization, wherein the physical scrips are held in the depository vaults, supporting the
book entry records kept on the computer.

1.5.2. Two types of ownership are contemplated under the depository system are:-
1. A registered owner is the depository who holds the securities in his name.
2. A beneficial owner is the person whose name is recorded as such with the depository. Though
the securities are registered in the name of the depository actually holding them, the rights,
benefits and liabilities in respect of the securities held by the depository vest in the beneficial
owner.

The depository model is based on the deposit of securities by the owner of the securities with a
certified depository. Subsequently, an entry is made in the name of the said owner, manifesting
his ownership of the securities upon which the person depositing the securities becomes the
beneficial owner in respect of the said securities. The service provided in relation to this by the
depository is that of recording of allotment of securities or transfer of ownership of securities in
the record of the depository.

2. Various instruments of raising finance

a) Indian Depository Receipts (IDR)

IDR stands for Indian Depository Receipts. 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.
An IDR is a way for a foreign company to raise money in India. In an IDR, foreign companies
would issue shares,
to an Indian Depository, which would in turn issue depository receipts (IDR) to investors in
India. The actual shares underlying the IDRs would be held by an Overseas Custodian, which

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A provisional certificate of money subscribed to a bank or company, entitling the holder to a formal certificate
and dividends
 shall authorize the Indian Depository to issue the IDRs. To that extent, IDRs are derivative
instruments because they derive their value from the underlying shares.

IDR are issued by a domestic depository in India and denominated in Rupees. It represents an
ownership interest in a fixed number of underlying equity shares of the Issuing Company. These
shares are called Deposited Shares.

Standard Chartered Bank created history in the Indian Capital Market by becoming the first
foreign company to come up with an IDR issue.

Standard Chartered Bank (SCB) took about 18 months of planning before coming out with its
Indian depository receipt (IDR) issue and creating history in the Indian capital markets on May
25, 2010.
SCB had to work out a number of issues in terms of establishing the regulatory framework
around the issue and obtaining the necessary clearances from the Securities and Exchange Board
of India and the Reserve Bank of India. The biggest challenge was to explain to investors how
IDR works and how to make investors think about it as an investment proposition.
In this case, Standard Chartered Bank, Mumbai was the domestic depository, and it has
appointed Bank of New York, Mellon as its overseas depository.

IDRs has the following features:

a) Overseas Custodian: It is a foreign bank having branches in India and requires approval from
Finance Ministry
for acting as custodian and Indian depository has to be registered with SEBI.
b) Approvals for issue of IDRs: IDR issue will require approval from SEBI and application can
be made for this purpose 90 days before the issue opening date.
c) Listing: These IDRs would be listed on stock exchanges in India and would be freely
transferable.
d) Eligibility conditions for overseas companies to issue IDRs:

1. Capital: The overseas company intending to issue IDRs should have paid up capital and
free reserve of at least $ 100 million.
2. Sales turnover: It should have an average turnover of $ 500 million during the last three
years.
3. Profits/dividend: Such company should also have earned profits in the last 5 years and
should have declared dividend of at least 10% each year during this period.
4. Debt equity ratio: The pre-issue debt equity ratio of such company should not be more
than 2:1.
5. Extent of issue: The issue during a particular year should not exceed 15% of the paid up
capital plus free reserves.
6. Redemption: IDRs would not be redeemable into underlying equity shares before one year
from date of issue.
7. Denomination: IDRs would be denominated in Indian rupees, irrespective of the
denomination of underlying shares.
8. Benefits: In addition to other avenues, IDR is an additional investment opportunity for
Indian investors for overseas investment.
9. Minimum issue size: $500 million
e) Dividends related to IDR: IDR stands for a particular percentage share of one equity share.
The dividend declared by the IDR issuer will be apportioned according to the IDR holdings, and
distributed to the IDR holder by the depository.
f) Taxation related to IDR: The current tax provisions put IDRs at a distinct disadvantage when
compared with other shares listed on Indian stock exchanges. Dividend tax will be assessed at
30% (plus 10% surcharge) on all the dividends from IDRs.
Short term capital gains: On Indian stocks, the short term capital gains is charged at 15%,
however in the case
of IDRs, the short term capital gains will be charged at 30%.
Long term capital gains: On stocks in India, there is no tax on long term capital gain. But in the
case of IDRs –
investors will need to pay a 20% long term capital gains.
The Direct Tax Code which is expected to be implemented next year will change a lot of things
and eliminate most of the above referred differences.

b) American Depository Receipts (ADR)

Globalization is the dissolution of barriers to trade and the tendency of the world's businesses to
integrate customs and values. Globalization is making it increasingly easy to travel, correspond
and even invest in other countries.

Investing money in your own country's stock market is relatively simple. You call your broker or
login to your online account and place a buy or sell order. Investing in a company that is listed
on a foreign exchange is much more difficult. Would you even know where to start? Does your
broker provide services in other countries? For example, imagine the commission and foreign
exchange costs on an investment in Russia or Indonesia.

However, now there is an easy way around this through American depositary receipts (ADRs).
More than 2,000 foreign companies provide this option for U.S. and Canadian investors
interested in buying shares. In this tutorial, we'll explain how this investment vehicle works and
help you sort out whether it could be a good choice for your portfolio.

Introduced to the financial markets in 1927, an American depositary receipt (ADR) is a stock
that trades in the United States but represents a specified number of shares in a foreign
corporation. ADRs are bought and sold on American markets just like regular stocks, and are
issued/sponsored in the U.S. by a bank or brokerage.
ADRs were introduced as a result of the complexities involved in buying shares in foreign
countries and the difficulties associated with trading at different prices and currency values. For
this reason, U.S. banks simply purchase a bulk lot of shares from the company, bundle the shares
into groups, and reissues them on either the New York Stock Exchange (NYSE), American
Stock Exchange (AMEX) or the Nasdaq. In return, the foreign company must provide detailed
financial information to the sponsor bank. The depositary bank sets the ratio of U.S. ADRs per
home-country share. This ratio can be anything less than or greater than 1. This is done because
the banks wish to price an ADR high enough to show substantial value, yet low enough to make
it affordable for individual investors. Most investors try to avoid investing in penny stocks, and
many would shy away from a company trading for 50 Russian roubles per share, which equates
to US$1.50 per share. As a result, the majority of ADRs range between $10 and $100 per share.
If, in the home country, the shares were worth considerably less, then each ADR would represent
several real shares.

There are three different types of ADR issues:

 Level 1 - This is the most basic type of ADR where foreign companies either don't
qualify or don't wish to have their ADR listed on an exchange. Level 1 ADRs are found
on the over-the-counter market and are an easy and inexpensive way to gauge interest for
its securities in North America. Level 1 ADRs also have the loosest requirements from
the Securities and Exchange Commission (SEC).

 Level 2 - This type of ADR is listed on an exchange or quoted on Nasdaq. Level 2 ADRs
have slightly more requirements from the SEC, but they also get higher visibility trading
volume.

 Level 3 - The most prestigious of the three, this is when an issuer floats a public
offering of ADRs on a U.S. exchange. Level 3 ADRs are able to raise capital and gain
substantial visibility in the U.S. financial markets.

The advantages of ADRs are twofold. For individuals, ADRs are an easy and cost-effective way
to buy shares in a foreign company. They save money by reducing administration costs and
avoiding foreign taxes on each transaction. Foreign entities like ADRs because they get more
U.S. exposure, allowing them to tap into the wealthy North American equities markets.

Brief
ADR is an acronym for American depositary receipt.
ADRs trade just like stocks but represent shares of a foreign company trading on a foreign
stock exchange.
ADR shares float on supply and demand, just like a regular stock.
 There are three types of ADRs - Level 1, Level 2 and Level 3. Levels 1 and 2 are listings in
the U.S., while Level 3 ADRs are public offerings to investors.
Remember that there are other risks associated with buying ADRs, including inflationary
risk, political risk and exchange rate risk.

c) Global Depository Receipts

A global depositary receipt (GDR) is a bank certificate issued in more than one country
for shares in a foreign company. The shares are held by a foreign branch of an international
bank. The shares trade as domestic shares but are offered for sale globally through the various
bank branches. A GDR is a financial instrument used by private markets to raise capital
denominated in either U.S. dollars or euros.

A GDR is very similar to an American depositary receipt (ADR). GDRs are called EDRs when
private markets are attempting to obtain euros.
GDRs may be traded in multiple markets, generally referred to as capital markets, as they are
considered to be negotiable certificates. Capital markets are used to facilitate the trade of long-
term debt instruments, primarily for the purpose of generating capital. GDR transactions in the
international market tend to have lower associated costs than some other mechanisms that can be
used to trade in foreign securities.

Shares Per Global Depositary Receipt

Each GDR represents a particular number of shares in a specific company. A single GDR can
represent anywhere from a fraction of a share to multiple shares, depending on its design. When
multiple shares are involved, the receipt value shows an amount higher than the price for a single
share. Depository banks manage and distribute various GDRs and function in an international
context.

Trading of Global Depositary Receipt Shares

Companies issue GDRs to attract interest by foreign investors, providing a lower-cost
mechanism in which these investors can participate. These shares are traded as though they are
domestic shares, but they can be purchased in an international marketplace. Often, the actual
shares that are allocated within the GDR are put in the possession of a custodian bank as
transactions are processed, ensuring both parties a level of protection while facilitating
participation.

The purchase and sale of GDRs are managed through brokers representing the buyer, generally
from the home country, and seller within the foreign market. The actual purchase of the assets
are multi-staged, involving a broker in the investor's home, a broker located within the market
associated with the company that has issued the shares, a bank representing the buyer and the
custodian bank.
If an investor desires, GDRs can be sold through their brokers as well. They can be sold as is on
the proper exchanges, or they can be converted into regular stock for the company. Additionally,
they can be canceled and returned to the issuing company