19 August 2009

Are American Depository Receipts shares?

Today's Economic Times reports RBI is considering American Depository Receipts (ADRs) as 'quasi equity' not carrying voting rights and therefore not be considered as FDI.

This view perpetuates the deeply flawed view taken by SEBI as well, that ADRs/GDRs do not carry voting rights 'till converted into shares'. In fact, ADRs and GDRs do carry voting rights. They are as much shares as are Indian shares held in Indian depositories. To step back, ADR/GDRs are convenient means of holding equity of another country without worrying about the logistics of buying those shares overseas using an overseas broker, converting dividends into local currency etc. For this purpose two sets of 'depositories' are used (to take the example of an Indian company with listed ADRs) in India which effectively holds say 10 million shares of that company and thus taking them out of circulation from the Indian market. Simultaneously, the foreign depository issues ADR/GDR securities for the same number (though often they are issued in a ratio - say 1 ADR to represent 2 shares) to depository receipt holders in the US market. These DR holder have all of the same rights as an Indian shareholder e.g. right to receive dividend, right to vote and right to residual value on liquidation of the company.

As far as the right to vote is concerned, it is governed by the contract between the DR holder and the depository. There are four types of contract terms which could govern a) the depository will take instruction from the DR holder and vote according to that wish b) the depository will vote according to what is in the best interest of the shareholders c) the depository will vote in favour of existing management d) the depository will not vote the shares. Only in the last case are votes not exercised. However, even then, the shareholder has the power to vote the shares - it is just that he has contracted away the power to someone else who will abstain from voting. This is similar to an Indian shareholder who agrees with another person (say a promoter) by way of a shareholder agreement that he will not vote the shares.The law cannot be influenced by the terms of a private agreement on voting arrangements particularly as there is no need for votes not to be exercised by the depository.

SEBI's treatment of ADRs/GDRs as not having voting rights particularly where it gives exemptions from the applicability of the takeover regulations is wrong in principle. The regulations treat ADR/GDRs are securities without voting rights and thus exempt them from the applicability of the tender offer requirements on substantial acquisition. This is particularly perverse where the ADR/GDRs are held by the promoter group itself and they get all the rights without the obligation to make a tender offer to shareholders on large acquisitions. It mixes up the power of voting rights with its actual exercise. It is hoped the RBI does not now make the same mistake in its analysis and mis-brand ADR/GDRs are quasi equity or as equity without voting rights.

No comments: