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 EURO ISSUES: THE ROAD AHEAD
Shishir Mehta'

Introduction - The Broad Concept of Euro Issues

Until about the mid-eighties, India's external debt was mostly public debt
from multilateral institutions like the World Bank, the International Monetary
Fund and the Asian Development Bank. Then Indian corporates resorted to
commercial borrowings, the bulk of it being in the form of syndicated credit.
When the foreign exchange crisis hit the economy in mid-1990, India's credit
ratings plunged below the investment grade and all external funding avenues were
closed. This situation continued until 1992. Following economic liberalization,
Indian companies started exploring the global market once again. Unlike the earlier
period, when syndicated credit was the predominant form of raising external finance,
companies began looking at bonds and euroequities, which are collectively referred
to as "Euro Issues". The two principal mechanisms used by Indian companies are
the Depository Receipts mechanism and Foreign Currency Convertible Bonds
(FCCBs).' The former represents indirect equity investment in the form of Global
Depository Receipts (GDRs) and American Depository Receipts (ADRs), while
the latter is debt with an option to convert it into equity.
Euro Issues are simply means of raising funds in the international market,
and have no special connotation or legal meaning. The term Euro Issue is really a
misnomer, as initially these instruments were aimed at the European market, and
were listed on either Luxembourg or London Exchanges, but now they have
expanded to tap the global market and not just Europe.

GDRs:
The GDR market internationally is relatively recent - it started in the 1990s
and India followed quite quickly with the first GDRs coming in 1992.1 In a GDR
issue, the company issues ordinary shares as per the GDR scheme and delivers

* V Year, B.A., LL.B. (Hons.), National Law School of India University.

1 Broctz, Indian Global Depository Receipts 23 (1996).
2 B Majumdar, Global Finance 217 (1994)
3 GDRs are defined in para 2(c) of the Issue of Foreign Currency Bonds and Ordinary Shares
(through the depository receipt mechanism) Scheme as :"...any instnunent in the form of a
depository receipt or certificate (by whatever name it is called) created by the Overseas
Depository Bank outside India issued to non-resident investors against the issue qf ordinaty
shares...".
.124 Student Advocate [1999

these ordinary shares to a domestic custodian bank. This bank will, in terms of the
agreement, instruct an overseas depository bank to issue securities in the nature of
Global Depository Receipts or Certificates, on the strength of these shares in its
custody, thereby securitizing the ordinary shares. These GDRs are issued to a
non-resident investor against the shares held by the domestic custodian bank.4 In
short, GDRs are essentially instruments created by overseas depository banks,
which are authorized by issuing companies in India to issue them outside the
country.
GDRs are negotiable certificates that usually represent a company's publicly
traded equity and are denominated in US dollars. They are listed on a European
Stock Exchange - often Luxembourg or London. However, Luxembourg is generally
preferred to London because of more stringent disclosure requirements in London.
Further, Luxembourg has more flexible listing requirements and is one of the least
expensive and the most speedy exchanges in Europe. Most of the trading is done
through screen based systems such as SEAQI. Each depository receipt represents
a multiple number of a fraction of the underlying share or alternatively, the shares
correspond to the GDR in a fixed ratio, say 1 GDR = 10 shares.
GDRs may be traded like any other security in an exchange or over the counter.
Transactions in GDRs take place through book entry transfers recorded in the
computerized books maintained by the clearing system. The clearing systems
normally employed'in Europe are EUROCLEAR and CEDEL. In the USA, it is
through the National Depository Trust Company. GDRs can be redeemed at the
price of the corresponding shares of the issuing company ruling on the date of
redemption. For all purposes, GDRs are treated as direct investment in the issuing
companies.

ADRs:
The Indian GDRs are based upon the American Depository Receipts. They
are identical from the legal, operational, technical and administrative viewpoints.
In essence, there is little to distinguish between ADRs and GDRs, other than the
fact that the former are more likely to be traded on the New York Stock Exchange
(NYSE) while the latter are traded at London or Luxembourg. ADRs were designed
as an investment vehicle to trade Canadian foreign equity issues in the USA.
Here, the bank holds the underlying shares in one of its branches abroad, usually
in the home country of the issuer. The depository receipts covering those shares

4 Prasanna Chandra, FinancialManagement - Theory & Practice868 (1997).

5 ibid.
Vol. 11 Euro Issues 125

are issued and traded in the American market.6 ADRs issued by one depository
appointed by the company in pursuance of a deposit agreement are called sponsored
ADRs, while ADRs issued by one or more depositories in response to the market
demand but without a formal agreement with the company are known as
unsponsored ADRs. When the banks issue the ADRs at the request of the issuer,
i.e. sponsored ADRs, they are normally registered with SEC. ADRs which are not
sponsored, created at the request of investors ,may not be registered with the SEC.'
An ADR issue can be of three different types.' The choice of which type of
issue should be used depends on the circumstances of the issuer. The amount to be
raised, profile sought by investor, success of previous issues, political considerations
and choice of accounting standards play a role in such a decision. ADRs at Level
1 are traded on the US 'over the counter' market. They are often the first step for
the issuer to enter the public equity market and the disclosure requirements to the
United States Securities and Exchange Commission (SEC) are minimal. The
company issuing such ADRs need not comply with the Generally Accepted
Accounting Principles (GAAP). However, such companies are not allowed to raise
capital or list shares on a national exchange. Issue of ADRs at Level 2 requires
significantly more disclosure, allowing the issuer to register ADRs in either the
NASDAQ, American or New York Stock Exchange. The company issuing the
ADR must meet the listing requirements of the particular exchange. Further, the
company must reconcile the information to GAAP. At Level 3, ADRs represent
public offerings to raise new money. These ADRs must be registered with SEC
and must comply with the listing requirements of the appropriate exchange and
with GAAP.
An ADR can also be raised under Rule 144A of the Securities Act. When an
issuer raises capital under this rule, the issue is restricted to QualifiedInstitutional
Buyers (QIBs) as defined by the SEC, for a period ranging from 2 to 3 years. 9 No
sales of these ADRs are performed in the first two years and this is followed by
one year of sales in small amounts, known as 'dribble'. Thus, a company can
access US and other markets by privately placing depository receipts with QIBs.

FCCBs (Eurobonds):
FCCBs are essentially debt instruments, with the option to convert them into
a predetermined number of equity shares. These are international equity linked

6 A fee is charged by the bank for issuing the receipt and handling charges Several banks such
as Citibank, Bank of New York and Bank of America issue ADRs.
7 H.R.Machiraju, International FinancialMarkets and India 254 (1997).
8 ibid.
9 id.
126 Student Advocate [ 1999

debt instruments or bonds, which are issued to investors throughout the world.
The investor receives a fixed rate of interest, and has the option to convert the
bond into a fixed number of equity shares at the option of the holder. Till such
time, it can be traded on the basis of the market value of the underlying equity
share of the company.'0 A convertible bond will have most of the features of a
rormal bond, along with certain additional terms and conditions pertaining to the
convertible features. Most of the FCCBs of Indian Companies have been
Euroconvertible issues or what are commonly known as Eurobonds.
The FCCBs are issued in accordance with the scheme or guidelines of the
Government. They are subscribed to by non-residents in foreign currency and are
ultimately convertible into ordinary shares of the issuing company. The main
advantage of FCCBs over Depository Receipts is that they are easier to market,
and the issuing company can claim tax deduction on interest payment towards the
debt." Moreover, there is no immediate dilution in the earning per share (EPS) of
the issuing company." During the initial flurry of enthusiasm about Indian paper,
some companies have been able to raise funds on very attractive terms via the
FCCB route. Recently, the Government has been very cautious in permitting debt
issues in view of the already large volume of outstanding external debt. By and
large, borrowings are not permitted for maturities of less than three years, and
priority is given to certain issuers, e.g. power projects. However, many observers
feel that under the current market circumstances, investors are likely to be more
receptive to Indian debt than to equity issues."
Advantages of Euro Issues
Going in for Euro Issues is advantageous for both the issuing company and
the investors. From the point of view of the company, Euro Issues are a cheap
source of foreign exchange without any exchange risk. In case of depository receipts,
the revenue raised would be in the form of equity and not debt, so there would be
no question of debt servicing. 4 Moreover, in terms of cost, Euro Issues are more
economical than local issues.'- Many companies also go in for these issues to

10 F.G. Fisher III, Eurobonds 86 (1988).

11 M. Mobius, The Investor's Guide to Emerging Markets 112 (1994).
12 The popularity of FCCBs over Depository Receipts is reflected in the fact that in 1993, while
US $320.9 million was raised through equity by Indian companies, US $515.5 million was
raised through FCCBs.
13 Nishit Kotecha, "The Two-tier Indian GDR Market", Business World, 14-27 December, 1994,
p. 112.
14 Nachiket Mor, Accessing Global Markets 136 (1998).
15 According to a study conducted by SEBI, the cost of issuing paper in the Indian market
through a rights issue is about 9.6% of the issue, in terms of transaction costs and jobber
spreads, whereas the international cost of issuance is only about 3-5%.
Vol. 11I Euro Issues 127

enhance their international corporate image. This prestige factor is often seen as
the first step to going global. Connected to this are the market spin offs, which
benefit the company after the launch of an issue, in the form of publicity and
enhanced corporate image which may indirectly help the company to develop its
export potential.'" In fact, in the long run this may enable the company to obtain
funds at better terms especially if its performance has been good. Finally, Euro
Issues help increase the company's investor base, thereby increasing the liquidity
of its shares and making it more attractive to investors.
Simultaneously, foreign investors are attracted to Indian paper for mainly
two reasons. Firstly and most importantly, they offer them higher returns. Indian
shares, by and large, in spite of the political uncertainty, the lack of transparency
in the Indian capital market and the current weaknesses of Indian industry, still
offer much higher returns as compared to investment in US stocks" Secondly,
apart from the high returns, investment in Indian paper helps the foreign investors
to diversify their portfolios. This is done in order to hedge against risk, by not
placing all their eggs in one basket.'I By doing so, the loss caused by the reduction
in the value of stocks in one particular country is offset by the gains on stocks in
other countries.

Guidelines for Issue of GDRs and FCCBs

Companies seeking to raise funds abroad through Euro Issues need prior
permission from the Ministry of Finance. The Government of India issued
guidelines for issue of GDRs'1 and FCCBs in November 1993 and announced
modifications to these guidelines in May 199420, March 1995" and June 1996.22
The GDRs and FCCBs issued against ordinary shares are treated as direct
foreign investment and the aggregate of the foreign investment made either directly
or indirectly (through GDRs) should not exceed 51% of the issued and subscribed
capital of the issuing company. A GDR may be issued for one or more underlying
shares or bonds. GDRs can be denominated in any freely convertible foreign
currency. However, the ordinary shares underlying the GDRs and the shares issued

16 Merrill Lynch Guide on Depository Receipts 211 (1995).

17 In the long run, the average rate of return on the S&P 500 index is around 0.93% a month,
while the corresponding number for India is around 1.6%.
18 Supra n.16, p. 217.
19 No separate guidelines have been issued for ADRs. Consequently, the guidelines for GDRs
also apply to ADRs.
20 Issued on 11/5/1994.
21 Issued on 25/3/1995.
22 Issued on 19/6/1996.
128 Student Advocate [1999

upon conversion of FCCBs of the issuing company, are to be denominated only in

Indian currency.
In 1995, relaxation of the requirements with regard to the issue of GDRs/
FCCBs and the utilization of their remittances into India were made. Consequently,
companies were permitted to remit funds into India in anticipation of the use of
funds for approved end uses. In 1996, banks, financial institutions (FIs) and non-
banking financial institutions (NBFIs) registered with the RBI were also made
eligible for Euro Issues

The Road Ahead - Bumpy or Smooth?

It has been some time since the Indian capital market has been introduced to
Euro Issues. Gone are the days when Euro Issues were considered a novel and
innovative way of raising finance. In fact, this is the right time to take stock of the
utility value of Euro Issues and to analyze their future prospects.
The Indian experience with regard to Euro Issues has been disappointing
from the point of view of the value of the securities. Over the past seven years,
most of the Indian GDRs have been traded at values below par. Except for a brief
period in 1994, the market for GDRs has never looked very healthy.
It is true that Euro Issues are a very convenient way for Indian companies to
raise capital abroad. By securitizing their shares, the companies are able to
circumvent the additional disclosure requirements, listing requirements, RBI
approvals etc., which would be required if the shares were to be directly issued
abroad. However a lot of questions remain unanswered and several lacunae are
yet to be filled.

Grey Areas in a GDR/ADR Issue

One of the biggest problems of GDRs/ADRs is the lacuna in the Takeover
Code with regard to them. Many companies prefer to raise capital through these
issues, since they have no voting rights until redeemed for the underlying share.
Companies therefore feel that by placing large chunks of equity abroad through
GDRs/ADRs they can protect themselves against takeovers. However this is a
very shortsighted approach, as there is no check on the acquisition of shares secretly -
through GDRs, which when redeemed for the underlying shares, could lead to a
takeover.
The Takeover Code, 1996 mandates a public offer if a holder of 10% of the
equity wishes to purchase more shares. There is no such requirement for GDRs,
and it is a backdoor means for takeovers. Foreign buyers can secretly amass a
large portion of the equity, redeem it, and cause a takeover. The only check is the
Vol. 11I Euro Issues 129

51% limit set by the FIPB. However, this is not a very effective provision, and
there is a need to amend the Takeover Code to close this loophole.
As far as the Companies Act is concerned, there is nothing in it to indicate
that the provisions with regard to prospectus etc. for local issue will apply to
GDR/ADR issues. Companies send a copy of the prospectus to the Registrar of
Companies (ROC), but since GDRs and ADRs are not mentioned in the Act, there
is really no statutory liability for anything mentioned in the prospectus.
Next, the restriction on foreign shareholding is a potentially serious problem
for GDR/ADR, which are equity linked issues, because if the 51% limit has been
reached when a foreign investor decides to convert his receipts, the company will
not be able to issue or transfer all the shares. Of course, this problem should not
arise-if proper planning has been done. At present, this point may not be relevant
to the majority of the potential issuers. However, if the secondary market is to
open to foreign investors, the problem could become a real one and should be
considered by the issuers right now.
One more threat is that the holders of GDRs/ADRs can force the management
to act in a certain way. The threat of redeeming the GDRs/ADRs, and thereby
flooding the Indian market with a lot of shares, could eventually translate into a
fall in the value of the share.
Euro Issues as a Source of Money Laundering
Collecting corporate finance through Euro Issues can be a method of money
laundering. Almost $5.5 billion have come into India through the Euro Issue
Route till now. However, it is suspected that almost half this money is in reality
Indian black money which was parked abroad and which has been re-routed back
into India.' For example, a company A has $100 million black money in a Swiss
bank. Now it requires money for its operations in India. However, officially, it
cannot use the money in the Swiss bank. Therefore, instead of raising outside
capital at the market price, it will float a GDR, and reroute its own money, through
a lot of fake companies floated abroad, back into India.
This practice, is in a way good for India, as it serves as an indirect way of
converting black money into white money. However, whether it is good for the
country in the long run is yet to be seen.
Are Capital Markets Moving out of India?
With all the advantages of Euro Issues that have been pointed out earlier, the
question arises as to whether they will result in the flight of capital markets out of

23 This is the view of some Government officials with whom the author interacted.
130 Student Advocate [1999

India. In light of the political uncertainty, and the currency crisis in South East
Asia, along with the recent slump of the Rupee, this is an unlikely prospect in the
near future.
However it is more probable that this anomaly will correct itself if SEBI
introduces tougher new guidelines to restore domestic investor confidence, and
therefore decreases the need to offer domestic issues at large discounts. This
would eliminate the cost advantage of Euro Issues.
Apart from this, by their very nature Euro Issues favour large, high profile,
blue chip companies, as compared to small companies, whose securities will
continue to be mainly traded in domestic markets. If one examines the supply
side of GDR issues of these companies, there are no real restraints barring
government intervention. If the GDR market for these companies is to grow then,
it will be a result of increased efficiency in the local market, and an in-depth
understanding of the GDR issue by the investor.
Therefore there is no real threat that Euro Issues will result in the flight of
capital markets out of India. In fact they represent an opportunity for integration
with the global markets. As more and more GDR issues come out, Indian stocks
will feature more prominently in investment portfolios, and more weightage will
be given to Indian stocks by fund managers, which will result in greater investment
in India. Thus, Euro Issues represent not a threat, but an opportunity.

Do Euro Issues Have a Future?

The success of the Infosys issue in 1998 indicates that notwithstanding the
current economic and political crisis, international investors will continue to invest
in Indian paper if the quality is good. It also indicates that the GDR and ADR
market is likely to be confined only to larger players in the future. It indicates that
the GDR market is still a potential gold mine for companies, if the quality of the
issue is good and the market is alive.
In the future it is unlikely that smaller issues will be picked up at a discount
by global investors, as the number of good, well planned issues will rise. It is
likely that smaller issues will be privately placed with a number of strategic
investors, who have a long term interest in the company.
There have been suggestions that as foreign direct investment becomes easier,
GDR and ADR issues will slowly disappear. While there is some merit in this
argument, the advantages of GDRs to companies will remain, and international
investors will still be attracted by GDR issues of good companies.
Nevertheless, once the government makes the Rupee fully convertible on
capital account - which is inevitable, sooner or later - the need to raise finance
Vol. 11 Euro Issues 131

through GDRs will no longer remain. This is because, when foreign investment
can come in directly by selling shares abroad, then why should a company try to
get it in indirectly through GDRs?

Rationale of the Government's Policy on Foreign Investment

If foreign investment is so essential for the development of India, then why is
the government not allowing companies to directly sell their shares abroad? Why
is it following such an indirect way to bring in foreign investment?
Perhaps, it is only a matter of time before the government will do this. Just
now the Indian economy is in a transitional phase from a state- controlled economy
to a market economy. Consequently, the government wants to keep a watch on
how much foreign exchange is coming in and leaving the country. If the government
allows free foreign investment, it will not be able to control how much funding
should go into which sector of the economy. Once this phase is over, and the
foreign exchange reserves and the fiscal deficit stabilizes to international standards,
the Rupee will be made fully convertible on capital account and such backdoor
methods of getting in foreign exchange and investment will not be required.

Recommendations
The increasing number of GDR failures is a cause of concern. Are GDRs
failing because of faulty pricing on the part of lead managers? This is partly true,
as in the VSNL case24 , but much of the problem in the GDR market is that of
oversupply. Therefore, only high quality GDR issues will succeed, and smaller
companies will get pushed out of the market. This is an inevitable market correction
mechanism, which is happening now.
But not everything can be left to the market. There is need for some regulation
to protect investors, and prevent smaller players from losing out. There is need for
some statutory framework to guide the issuance and mechanism of issue of GDRs
in terms of the role of the lead manager, etc. It should encompass provisions on
disclosure norms, punishment for mistakes in the prospectus, etc. This will increase
investor confidence in GDRs. Also there is a need for some government guidelines
on the issue of GDRs at a premium to prevent failures. This should be in the
nature of guidelines, which give flexibility to the issuer, rather than rigid price
controls, which would be counter-productive.

24 The failure of the VSNL GDR was essentially due to faulty estimations by their lead managers,
as a result of which, in the final projections, VSNL was not in a position to raise enough
finance as it had expected, through the issue. Consequently, the issue was deferred.
132 Student Advocate [1999

Such a statute should also close the loopholes pointed out earlier with reference
to takeovers, and also deal with the grey areas examined above with reference to
the provisions of the Companies Act. Such legislation would go a long way in
regulating GDR issues, and would restore investor confidence, which could be the
first step to a future revival in the GDR market.
At the level of the companies, care should be taken to adopt a good strategy
while going in for an Euro Issue. Most of the unsuccessful GDRs have been a
result of faulty planning and wrong timing by companies. It is imperative that
these mistakes are not repeated. While going in for an Euro Issue, it is important
to have good market intelligence on international investors' attitudes. For this
extensive pre-marketing and investor education before the issue are very essential.
Timing of the issue is also important. The company should enter the market
preferably when the interest rates are low in the international market and should
maintain a high payout ratio for a period 2-3 years preceding the year of issue of
GDRs. It should be noted that the foreign investors seem to place considerable
weightage on the reputation of the company as seen from the significance of
classification of their shares as 'A' group or 'B' group on the BSE.2 ' Therefore,
the company should undertake marketing campaigns to improve its reputation
among foreign investors just before the issue of GDRs.

25 Supra n.16, p. 273,