Listing & trading unsponsored DRs in the IFSC

 I have an opinion piece, linked here, in the Financial Express with Mihir Deshmukh on the introduction of unsponsored DRs in the GIFT city. 

Here is a more readable version:

The International Financial Services Centre Authority (IFSCA) recently issued a circular providing the framework for listing of depository receipts in the Gujrat International FinanceTec-City IFSC that was promptly adopted by INDIA INX, and NSE IFSC, the two stock exchanges presently operating in the GIFT IFSC. This framework is complimented by the recent amendment to the Liberalised Remittance Scheme (LRS) of the Reserve Bank of India (RBI) wherein, resident individuals have now been permitted to make remittances up to USD 250,000under the LRS to IFSCs set up in India for making investments in IFSCs in securities, other than those issued by entities/ companies resident in India. In a press release dated August 09, 2021, the NSE IFSC has announced that trading in select US stocks would be facilitated through the NSE IFSC under the unsponsored depository receipts (DR) route. The NSE IFSC has proposed this scheme under the regulatory sandbox of the IFSCA. 

Unsponsored DRs in the GIFT IFSC 

As per the IFSCA circular, a depository receipt (DR) means a negotiable financial instrument representing underlying securities of a company listed in another jurisdiction. Further, the difference between a sponsored DR and an unsponsored DR is determined by the degree ofinvolvement of the issuer whose securities form the underlying securities for such DRs. Hence, if the issuer company sponsors a DR programme, it enters in a contractual relationship with the depository bank and thus creates a sponsored DR, whereas unsponsored DRs may be floated by depository banks on an analysis of market demands for the shares of such issuers, or on the request of a broker-dealer that has requested such program. 

As unsponsored DRs may be floated without the participation of the issuer company, the public offer route under the IFSCA framework may not be the ideal way for trading such DRs given the listing requirements as per the IFSCA circular. Similarly, the listing without public offer option under the IFSCA circular may be only viable, if the depository bank issuing such DRs gets the issuer of the underlying securities on board to apply for a listing, and comply with the requirements mentioned in the IFSCA circular. Alternatively, the depository bank issuing a DR may opt for the ‘permitted to trade framework’ under the IFSCA circular wherein, a stock exchange in the IFSC may permit trading of DRs listed on a stock exchange in India or a foreign jurisdiction, provided that such trading is in compliance with the local laws and regulations of the jurisdiction where such DRs and underlying securities are listed, and the clearing and settlement of trades is ensured by the stock exchange. It may be noted that the ‘permitted to trade’ framework introduced under Chapter VII of the IFSCA circular has been initially made available on the stock exchanges in IFSC till December 31, 2023.  

Unsponsored DRs in foreign jurisdictions

Unsponsored DRs are mostly traded over the counter by institutional investors. A major reason behind this, is the simple fact that, as these DRs do not come with an endorsement of the issuer of the underlying securities, and as they are subjected to minimal disclosure requirements, such products are considered unsuitable for the retail investors. In US, depository bank seeking to establish an OTC traded unsponsored DR program, has to ensure that such DRs or the underlying securities are either registered with SEC, or qualify for the 12g3-2(b) exemption under which, a non-US company is exempted from registering its securities with the SEC, if it fulfils criteria such as being listed in the home jurisdiction, and publishing all shareholder communication on its website etc. On the other hand certain jurisdictions such as Hong Kong require all DRs to be sponsored to be listed on the HKEX. Furthermore, while explicit differentiation between the requirements for sponsored and unsponsored DRs isn’t provided, jurisdictions such as UK and Luxembourg require DRs to follow a listing process that requires the issuer companies to comply with the prospectus and disclosure requirements. 

From the above provisions, it can be gleaned that the access to unsponsored DRs is curtailed for the retail investors either in the form of listing requirements, or by making these available solely through OTC markets. The IFSCA circular sets off these limitations by either allowing theseDRs to be listed without a public offer and thus reducing the cross-listing burden of issuer companies and making, or by permitting DRs to be traded without listing under the ‘permitted to trade’ framework. 

However, while the above provisions greatly increase the scope for listing and trading of DRs in the IFSC, certain involvement and participation of the issuer companies is still required for the DRs to be traded in the IFSCA framework. Thus, what remains to be seen, is the mechanism that may be introduced through the regulatory sandbox which may introduce relaxations for these residual requirements on the issuer companies, and the alternative obligations that the depository banks may be required to comply with. Further, as the unsponsored DR scheme of the NSE IFSC also seeks to utilise the relaxations provided under LRS, it would also be interesting to see the framework for funding of such trades that may be adopted under the regulatory sandbox. 

The listing framework for DRs provided under the IFSCA circular and the relaxation of the LRS norms signify the steps being taken to include the retail investors in the financial evolution that would be brought around through the IFSC(s), and come at an opportune moment when the country is experiencing an exponential rise in the number of retail investors in the market. The framework for trading of unsponsored DRs, and funding of such trades under the LRS that will be implemented through the regulatory sandbox may also provide further impetus for inclusion of not just the foreign investees but also the retail investors seeking new avenues of investment and engagement of capital.