[Hrishikesh and Subhasish are students at Gujarat National Law University.]
With the Ministry of Corporate Affairs’ (MCA) issuance of the Companies (Listing of Equity Shares in Permissible Jurisdictions) Rules 2024 (LEAP) and the notification amending the Foreign Exchange Management (Non-debt Instruments) Rules 2019 (NDI Rules), a complete and overarching regulatory framework to enable such direct listing has been clearly established in India, with such a move generating great optimism as one that would transform India’s capital markets and would open up newer avenues to access capital for Indian companies, especially start-ups and other new-age businesses, that would be able to utilize such access to foreign capital to align themselves with global standards in terms of scale, performance and unlock growth opportunities beyond those present and accessible in today’s date.
The authors seek to discuss the background of this development and understand its legal and business implications using, first, an analysis of the soundness of the legal regulatory framework envisaged in the present day, and second, the methodology of a cost-benefit analysis.
Background
The genesis of this development can be traced back to December 2018 when the Expert Committee’s Report for listing of equity shares of companies incorporated in India was published by the Securities Exchange Board of India (SEBI). The report emphasized the potential economic benefits for stakeholders if Indian companies engage in direct equity share listings on international exchange. The report identified regulatory policy hurdles within India's current framework and proposed adjustments to streamline direct listings. The committee specified ten foreign jurisdictions deemed appropriate for Indian entities to conduct direct listings. However, the report did not advocate for the direct listing of Indian entities on stock exchanges established within the International Financial Services Centre (IFSC) in Gujarat International Financial Tec-City (GIFT City) because IFSC in GIFT City is not uniformly recognized as a foreign jurisdiction for dealing in equity shares of Indian companies as per the current position of law and the specified criteria for 'permissible jurisdictions'. This is in contrast with the government's recent notification which allowed public companies in India to get their shares directly listed on international exchanges in the GIFT IFSC, despite the SEBI report advising against such listings in exchanges within the GIFT IFSC. This divergence indicates the strategic vision of the government in leveraging the potential of the IFSC in GIFT City to facilitate foreign capital inflows. Subsequently, in May 2020, the Indian government first indicated its intent to allow direct listing of securities by Indian entities in foreign stock exchanges. However, despite this initial announcement, the absence of a robust legal framework stalled progress on this front for nearly three years, leaving the market in an uncertain state. In March 2022, there was further scrutiny of the plan for direct listing, with reports suggesting a temporary halt to prioritize strengthening the local capital market. This strategy was undertaken by the government to strengthen domestic capital markets.
The Shift Away from Depository Receipts
Previously, Indian companies were restricted to issuing and listing their securities in overseas markets solely through depository receipts (DRs) like American Depository Receipts (ADRs) or Global Depository Receipts (GDRs). This approach involved issuing securities to depositories incorporated in specific foreign jurisdictions, which in turn issued DRs in the company's name to investors. However, only a limited number of companies, such as Infosys, ICICI Bank, and HDFC Bank, have opted for this method and it has remained inaccessible for unlisted startup companies. This limited adoption of DRs by Indian companies stemmed from the stringent and cumbersome regulatory framework, as well as the associated time and costs involved in DR issuance. Indian companies encountered significant hurdles due to the strict regulatory requirements imposed by both domestic and foreign jurisdictions when issuing DRs. Compliance with various regulatory standards, including disclosure requirements, listing rules, and reporting obligations made the process tedious. Additionally, unlike equity shareholders, DR holders typically lack voting rights unless they convert their receipts into underlying shares. Further, SEBI in 2022 has issued a notice to Jindal Cotex Limited, directing the company to pay over INR 14 crores due to alleged manipulation in the issuance of GDRs. This regulatory intervention highlighted the inherent risks associated with DRs, as they are susceptible to fraudulent issuance and manipulation of a company's GDRs associated with DRs since DRs are difficult to monitor. Owing to these reasons, the issuance of DR or ADR was dropping, which affected the foreign direct investment (FDI) inflow to India. But at the same time, relaxing the regulatory framework governing the issuance of DRs came with the risk of increased malpractices. Therefore, recognizing the limitations and risks associated with the existing framework governing the issuance of DRs, the government vide Companies (Amendment) Act 2020 allowed direct listing of shares by Indian companies in stock exchanges of GIFT IFSC.
Regulatory Framework Governing Direct Listing
The regulatory framework governing direct listing underwent significant developments with the enactment of the Companies (Amendment) Act 2020. This amendment introduced Section 23(3) in the Companies Act 2013, enabling the direct listing of certain categories of securities of public Indian companies on permissible stock exchanges in permitted foreign jurisdictions. In pursuant to the amendment, the MCA issued the LEAP Rules, providing clarity to the regulatory framework governing direct listing. These rules delineate the conditions, procedures, and requirements for Indian companies seeking to get their shares listed directly on international exchanges, particularly in the IFSC in GIFT City. Additionally, amendment to the NDI Rules provides the necessary international exchange regulatory framework for such listings. These notifications were issued against the backdrop of the report published by the Working Group in December 2023, which was responsible for recommending a regulatory framework to facilitate the process.
A key objective of the regulatory framework governing direct listing is to ensure and protect the integrity and reputation of these international exchanges, which is ascertained by imposition of certain eligibility criteria on companies intending to list their securities in international exchanges. Exclusion of "companies under scrutiny or investigation for financial irregularities, companies whose promoters or directors are classified as wilful defaulters or fugitive economic offenders”, among others, is some of the key qualifiers that have been imposed to further this objective that guarantee the financial stability and trustworthiness of all eligible entities. However, such attempts at exclusion based on ongoing inspection or investigation may warrant reconsideration due to various reasons.
First, mere initiation of an inspection or investigation does not conclusively establish wrongdoing on part of the company or its promoters. Second, the exclusion of companies under scrutiny or investigation may inadvertently penalize companies that are undergoing legitimate business challenges or facing temporary setbacks. Third, there may be instances where individuals are wrongly accused or where disputes are still pending resolution. This could impede the company's ability to access alternative sources of capital. Therefore, while maintaining robust eligibility criteria for listing on international exchanges is essential, there is a need for a more nuanced approach that takes into account the specific circumstances of each case. This could involve establishing clear guidelines for assessing the impact of ongoing inspections or investigations on the company's suitability for listing, as well as providing opportunities for companies to demonstrate their commitment to compliance and rectify any deficiencies before being considered for listing.
SEBI's role in overseeing direct listing is also crucial, as the listed public Indian companies have to ensure compliance with operational guidelines which will be issued by the SEBI. SEBI (International Financial Services Centres) Guidelines 2015 (IFSC Guidelines) define the permissible securities and activities within IFSCs, including the listing of equity shares of companies incorporated outside India. In exercise of its powers under Section 11(1) of the SEBI Act 1992, the SEBI has the authority to include “equity shares of a company incorporated in India" in the list of "permissible securities" under Clause 7 of the IFSC Guidelines. SEBI's IFSC guidelines further elaborate on the process and requirements for Indian companies intending to list their shares on IFSC exchanges. Finally, the IFSCA (Issuance and Listing of Securities) Regulations 2021 (ILS Regulations) introduced by the IFSCA establish the framework for direct listings, which covers various aspects ranging from the initial listing process to the subsequent disclosure and reporting obligations.
Cost-Benefit Analysis of Direct Listing
Direct listing of equity shares in international stock exchanges of GIFT IFSC presents several potential benefits for Indian companies and the overall capital market ecosystem. However, it is important to be mindful of the challenges that might accompany it.
First, direct listing offers Indian firms expanded reach to a wider pool of global investors, thereby broadening their shareholder demographic and potentially boosting liquidity levels. However, listing on international exchanges can be volatile and unpredictable. Fluctuations in exchange rates, geopolitical events, and macroeconomic factors may impact investor confidence and stock performance, posing risks to shareholder value and stability.
Second, compared to traditional methods like issuing DRs, direct listing may offer a streamlined regulatory process, diverging from the constraints associated with the stringent regulatory framework governing DRs. However, in cases where it involves dual-listed companies, both in domestic stock exchanges and international stock exchanges in GIFT IFSC, the companies ensure compliance with the regulatory requirements of both jurisdictions. This dual regulatory burden may increase operational costs and administrative overheads, particularly for smaller firms with limited resources.
Third, by accessing international markets, companies can tailor their offerings to suit the preferences and risk profiles of global investors, thereby optimizing their capital allocation and maximizing shareholder value. However, this flexibility may fragment a company's shareholder base, diluting domestic ownership and influence. This fragmentation could complicate corporate governance, decision-making processes, and shareholder communication, potentially leading to conflict of interests between the domestic and international shareholders.
Fourth, the current direct listing framework leaves a major gap in investor protection. Under normal circumstances, once its securities are listed in a stock exchange, a company is exposed to heightened scrutiny and stricter standards with respect to investor protection. However, such requirements only apply to listed companies, which are restricted to companies listed in recognized stock exchanges. However, the international exchanges to be used for direct listing via IFSC do not meet this criteria, which may lead to a situation wherein a company that has listed its securities on these international exchanges would still be considered an unlisted company and would thus, be exempt from the stringent investor protection standards envisaged under the Companies Act 2013 and other statutes.
Way Forward
India’s regulatory shift towards fostering direct listing of securities of Indian companies in international stock exchanges marks a significant milestone and is indicative of the maturing of India’s capital market. With the continuous development of the regulatory framework, the regulators must turn their focus to continually keeping pace with the global best standards. This can be achieved through greater clarity with regards to sensitive issues like investor protection which remains uncertain under the current regime. aligning the regulatory framework to be able to respond to geopolitical and macroeconomic fluctuations, fragmentation of shareholder base of companies, dual regulatory burden in cases of dual-listed companies. With the redressal of statutory and practical shortcomings, the direct listing route would present itself as an attractive and effective means of raising capital for Indian companies.