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This post is authored by Daksh Dave, a third-year student of BBA LL.B. (Hons.) at Symbiosis Law School, Noida.
Image Credits: Bloomberg
1. INTRODUCTION
In the year of Bumper Initial Public Offerings (“Bumper IPOs”) in the Indian stock markets, though companies remain satisfied with the current investment statistics achieved, the capital available in global stock exchanges remains unexplored by them. There have only been a few companies, such as MakeMyTrip, that have preferred the not-so-simple route of listing themselves outside India. However, this is all going to change in the upcoming months with the possible introduction of Direct Offshore Listing guidelines allowing the companies, though mostly start-ups, to get their true valuation and investment thereafter.
The direct listing mechanism allows the companies to list themselves on global stock exchanges while being incorporated in India, unlike indirect listing, wherein the companies are forced to incorporate their head office overseas while operating through a branch office or subsidiary in India. This would allow Indian companies to explore better opportunities offshore but the regulatory and compliance hurdles would need to be optimised by the government to make the process free from ambiguity, both for the companies and their potential investors. This article explores the regulatory challenges that a company may face in complying with the listing procedure.
2. IMPOSITIONS IN PLACE BY FEMA AND AMENDMENTS NEEDED THERETO
The Foreign Exchange Management (Non-debt Instruments) Rules, 2019[i] (“NDI Rules”) deal with investment by a person or entity or fund resident outside India. Rules 3 and 5 of the NDI Rules restrict investment by a non-resident in an Indian entity (including Indian Companies, LLPs, Investment Funds, and Investment Vehicles) except in accordance with the Act or Rules prescribed. Investment in Indian companies by a non-resident is regulated by Rule 6 of the NDI Rules. Sub-rule (a) prescribes that the subscription, selling, or purchasing of any equity instrument in any Indian company shall be made in accordance with Schedule 1 of the rules, which in turn restricts the right of a non-resident to purchase securities in an Indian company only from a recognised stock exchange in India. The schedule further provides that the purchase or sale of the instrument(s) can only be made after complying with the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011 (“Takeover Regulations”). The Takeover Regulations provide that when the acquisition of shares is made by way of subscription, the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (“ICDR Regulations”) need to be complied with as well. Hence, the equity shares allotted pursuant to the exercise of options attached to warrants issued on a preferential basis, as well as the specified securities allotted on a preferential basis, are subject to lock-in periods ranging from one to three years.[ii] Further, Regulation 167 of the ICDR Regulations imposes certain exceptions to the transfer of shares as well. Schedule 2 of the NDI Rules re-introduced the sectoral caps on investments by way of subscription of instruments by Foreign Portfolio Investors (“FPIs”). Thus, the companies, w.e.f. F.Y. 2020, can limit the applicable sectoral cap of all the combined investment or holdings by FPIs to a range of 24 per cent, 49 per cent, or 74 per cent of the paid-up equity capital on a fully diluted basis or paid-up value of each series of debentures, preference shares. or share warrants.
The sectoral caps, currently in case of direct offshore listing, do not need to be amended in either the case of FPIs or FDI, as the capital pool in offshore foreign exchanges is evidently larger as compared to that in India, allowing Indian companies to utilise the current sectoral caps by getting a higher valuation. However, Rule 6 read with Schedule 1 of NDI Rules need to be amended to allow the Indian entities to list themselves offshore. This would exempt the prospective foreign investors to deal with ICDR Regulations at the least if the company listed offshore is not listed on any stock exchange(s) in India.
3. THE REGULATORY DILEMMA
The question of direct offshore listing by Indian companies might seem like a lucrative option for many foreign investors and companies, creating a win-win situation for everyone. However, looking at the idea from the perspective of regulatory authorities makes it a much more complicated process. Primarily as a result of not giving a disadvantageous situation to the Indian investors, especially after adopting the dictum of ‘Make in India’ for almost half a decade, wherein the popular sentiment in India focused more on becoming self-reliant. Hence, the option which remains with the regulators is to provide a direct pathway for offshore listing without dealing with the Securities Exchange Board of India (“SEBI”). This is the least complicated procedure through which the companies could list themselves at an offshore stock exchange, recognised by the Ministry of Corporate Affairs (“MCA”). To enable such listing bypassing through the regulations in force by the SEBI namely Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015 and Securities and Exchange Board of India Act, 1992, are essential criteria. Such a prospect would allow the companies to list directly with low compliance costs, thereby resulting in more companies opting for this method of raising capital. However, it would also result in the dilution of market value posed by the Indian stock exchange(s), since most companies looking to raise capital would look at opportunities to list themselves offshore for the exponentially increased valuation. The promoters may prefer offshore listing because it would result in less dilution of the equity held by them. The M&A exits which primarily take place through IPOs would see a major shift in the practice landscape, seeing majority shareholders looking for better exit opportunities offshore. Such exit opportunities would get preference over transfer to other non-resident investors as the process of negotiating the exit structure gets minimized through IPOs without having to compromise the return achieved through the offshore listing.
While the authorities might be hopeful that such an offshore listing mechanism would open the floodgate for overseas companies to list themselves in the Indian stock exchanges, such a dream might be too far-fetched, largely because of the small pool of investors with sufficient capital available in the Indian stock market. Currently, the start-up ecosystem is dominated by Chinese and Indian companies, and therefore, the overseas companies that would consider the opportunity would be companies located in smaller and lesser developed countries than India.
The second and the most viable option is to make Dual-Listing, which refers to listing by two separate entities operating as a single entity, on different stock exchanges as against cross-listing, wherein a single entity lists across different stock exchanges. This could be achieved by listing first on the Bombay Stock Exchange (“BSE”) or National Stock Exchange (“NSE”) and only thereafter listing on the approved stock exchange. The concept of dual-listing is the most viable option as the companies can first tap into the local stock exchanges to satisfy their capital requirements. This can be achieved by filing a red herring prospectus, which does not contain any details about the pricing and is generally used for the purpose of price discovery. Thereafter, if the existing investment does not fulfil the objective of the listing, the opportunity to access capital available in the offshore stock exchanges can be explored. While it should be taken into consideration that simultaneous listing cannot be a viable option because of the presence of multiple regulators from whom clearances are to be obtained at multiple stages, any delay in clearances would act as a barrier in listing at both the stock exchanges. The other issues posed by first listing on a foreign offshore listing is the possibility of an unsuccessful IPO, such as the requirement of the listed stock of at least trading at $4 on the National Association of Securities Dealers Automated Quotations (“NASDAQ”) and the New York Stock Exchange (“NYSE”), failing which would delist the entity from the stock exchange. If such a company first lists at an offshore stock exchange and subsequently fails to raise the capital, it could have a detrimental effect on the valuation of the subsequent listing on the Indian stock exchanges. The dual listing of securities can take place in a two-fold manner, firstly, through the issuance of similar type of securities in both the jurisdictions, thereby not diluting the price discovery and market value of the securities in either of the jurisdictions; secondly, through the issuance of different sets of securities offshore. The dual listing could also allow the already public listed companies to capitalise on the opportunity to list offshore without increasing the cost of compliance by going through SEBI (Delisting of Equity Shares) Regulations of 2009. However, for private companies, this would mean complying with the provision(s) of Sections 25 and 26 of the Companies Act, 2013[iii], which prescribes for the filing of a prospectus containing the necessary details in India and for example, the Securities Act of 1933 and Securities Exchange Act of 1934 in the case of the United States.
Thus, dual-listing without any substantial relaxation in compliance with the regulatory framework in the country does not seem to be a viable option in terms of time and cost of compliance, not to mention the number of amendments that would have to be passed to enable such a mechanism. The probable solution could be allowing the companies that wish to list themselves to file a single prospectus in compliance with the desired stock exchange and replicate the same while listing them in the NSE/BSE. This could ease the compliance level and help in preserving the market values posed by the Indian stock exchanges, but cannot act as one magic solution to every challenge ahead, namely with respect to the rigid FDI norms in place. Dual listing is more favourable in the sense of allowing equal opportunities to Indian investors who would otherwise not be able to invest in the Indian company. Equal opportunity is an important aspect since Indian entities raising capital only through foreign investment would be using resources available in the country, which is why offering equity only to foreign investors is unfavourable. If this aspect can be ignored, the advantages of allowing companies to list themselves directly at offshore stock exchanges pose fewer regulatory challenges, thereby making it a value proposition for the authorities, company, and investors.
The listing of Indian companies through either of the above-mentioned routes poses complexities with respect to taxation by non-residents in Indian entities. Following the existing FDI/FPI routes would attract capital gains tax, but the investment through offshore stock exchanges would be subject to the taxation regime in the respective country. Nevertheless, one aspect which remains unexplored is allowing investors to invest in Indian companies that are listed offshore. This would solve the fiasco with regard to regulatory challenges induced by dual-listing, giving Indian investors an equal opportunity to invest in Indian companies, but this can only be achieved with equal assistance and co-operation with target foreign jurisdiction.
4. CONCLUSION
With the amendment to Section 23 of the Companies Act, 2013,[iv] the government has broadened the scope for public companies to list themselves in foreign jurisdictions, allowing them to capture larger investments and gain better valuation(s). The amendment to the definition of “listed companies”, as defined under Section 2(52) of the Act,[v] enabled the Central Government to exempt certain classes of companies from being termed as “listed”. The second development with respect to offshore listing was notified recently by the MCA, wherein it provided that public companies that have not listed their equity shares in any stock exchange in India but have listed them in a stock exchange as may be notified by the government in any foreign jurisdiction under Section 23(3) of the Act, shall not be termed as a listed company.[vi] When the developments are read together, it can be interpreted that such class of companies would no longer need to comply with the Securities Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. The conclusion which can be drawn is that the government is not in favour of the dual-listing route, but this would mean that Indian investors would not be provided with the right to invest in this class of companies. This could be a small setback while looking at the larger outlook that provides access to more capital and easy expansion opportunities, but caution should be taken and only a small number of companies should be allowed to list directly offshore in a financial year. However, the regulatory complications discussed in the article remain a big hurdle for the authorities to overcome in order to actually allow the companies for offshore listing without burdening them with the massive increase in the cost and time spent on compliances.
Endnotes:
[i] Issued under Foreign Exchange Management Act, 1999, § 46(2), No. 42, Acts of Parliament, 1999. [ii] Regulation 5A read with Regulation 13(4) of SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011. [iii] Read with Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 and Companies (Prospectus and Allotment of Securities) Rules, 2014. [iv] Inserted by Companies (Amendment) Act, 2020, §5, No. 29, Acts of Parliament, 2020. [v] Inserted by Companies (Amendment) Act, 2020, §2, No. 29, Acts of Parliament, 2020. [vi] Amendment w.e.f. 01.04.2021 vide the Companies (Specification of definition details) Second Amendment Rules, 2021 in Rule 2A in Companies (Specification of definitions details) Rules, 2014.