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10/30/10 - Conversion of ADR into shares

At present, ADRs/GDRs of companies such as Infosys and Satyam trade at a

substantial premium to the domestic price, while that of companies such as
Siliverline Technologies and ICICI trade at a considerable discount.

If liquidity in the ADR/GDR market is the sole reason for the high premium/discount,
the Government's decision to permit fungibility will help narrow the difference. How?

Take Infosys whose ADRs trade at a premium to the domestic price. Investors can
now buy shares in the domestic market, transfer them into ADRs and then sell them
on the NYSE for a higher price. As more investors engage in such deals, the price
of the stock in the domestic market will go up, because of the increase in demand.
Likewise, the price of ADRs on the NYSE will fall, as more investors sell their

Now, consider ICICI whose ADRs trade at a discount to the domestic market price.
Investors can buy ADRs, convert them into domestic shares and sell them on the
BSE or NSE. This process will push up the prices of ADRs/GDRs due to the higher
demand, and pull down the prices of ICICI in the domestic market, due to the higher
supply of shares.

But, it is not as if the rupee-equivalent of ADR/GDR prices will be equal to the price
in the domestic market. Why? When investors sell ADRs on the NYSE, the
transaction will not be complete till the dollars are converted into rupees. What if the
dollar falls against the rupee before the transaction is completed? The investor will
receive less rupees for the dollars.

Similarly, when investors buy ADRs and want to sell them in the domestic market,
what if the domestic price falls before the ADRs are converted into shares? The
ADR/GDR and the domestic spot price will still trade at a discount/premium to reflect
this risk. It is just that the price differential will fall substantially.

THE limited two-way fungibility of ADRs/GDRs has become operational, and the
Reserve Bank of India (RBI) on Wednesday issued necessary guidelines following

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approval by the Government.

The approval, which provides investors with greater flexibility, is also seen as
another step towards achieving capital account convertibility.

Under the guidelines, re-issue of ADRs/GDRs would be permitted to the extent of

ADRs/GDRs that have been redeemed and the underlying shares sold in the
domestic market.

Two-way fungibility implies that an investor who holds ADRs/GDRs can cancel them
with the depository and sell the underlying shares in the market. The company can
then issue fresh ADRs to the extent of shares cancelled.

No specific permission of the RBI will be required for the re-conversion. Besides,
investments under foreign currency convertible bonds and ordinary shares will be
treated as direct foreign investment.

Accordingly, the re-conversion of shares into ADRs/GDRs will be distinct from

portfolio investments by foreign institutional investors (FIIs), the RBI said.

The RBI guidelines state that the transactions will be demand-driven and would not
require company involvement or fresh permissions.

The custodian would monitor the re-issuance of ADRs/GDRs within the sectoral cap
fixed by the Government.

The RBI has also said that each purchase transaction will be only against delivery
and payment received in foreign exchange through banking channels.

For this purpose, all SEBI registered brokers will be able to act as intermediaries in
the two-way fungibility of ADRs/GDRs.

The RBI has already given general permission to brokers to buy shares on behalf of
overseas investors on March 2 last year.

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As secondary market operations, the acquisition of shares on behalf of the overseas

investors through the intermediary would fall within the regulatory purview of
Securities and Exchange Board of India (SEBI).

The Central bank has said that since the demand for re-conversion of shares into
ADRs/GDRs would be from overseas investors and not the company, the expenses
would be borne by the investor. The transactions will be governed by the
Income-Tax Act.

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