VENTURING ABROAD: FEASIBILITY STUDY OF MCA’S AMENDMENT ENABLING DIRECT LISTING ON FOREIGN STOCK EXCHANGES

The author is Shubhankar Saran, a student at Gujarat National Law University, Gandhinagar.

INTRODUCTION

The Central government passed the Companies (Amendment) Act, 2020, to rejig current corporate standards and facilitate ease of business. Amongst other things, it permitted the direct listing of Indian companies on foreign stock exchanges. Unlike previous methods of raising offshore funds, direct listing allows competitive advantages and better valuation opportunities. However, it is accompanied by a distinct set of challenges that must be addressed to ensure efficient outcomes. This article aims to provide a sequential analysis of the central government’s direct listing scheme, starting with a brief background on previous practices of raising offshore funds. Subsequently, the article lays down the potential benefits of the scheme. Subsequently, it attempts to delineate potential difficulties associated with direct listing, and finally, it concludes with plausible recommendations for better execution of the scheme.

ALTERNATIVE MEASURES FOR RAISING FUNDS OFFSHORE

It is not uncommon for Indian companies to raise funds offshore. Several methods existed prior to the intimation of allowance of Direct Listing.

Depository Receipts

Depository Receipts (“DRs”) occupied an integral spot in a company’s means of raising offshore funds. Indian Companies began dealing with DRs in the 1990s, with Reliance Industries leading the charge in 1992. SEBI has been proactive in regulating the working of GDRs and clarifying the framework for seamless functioning. Despite the issuance of GDRs/ADRs, a string of regulatory issues arose, ranging from GDR misuse in redrawing illicit black money to manipulation of share prices through GDRs. Relatively, the demand for GDR/ADR has slowed down.

Special Purpose Acquisition Companies

Alternatively, Special Purpose Acquisition Companies serve as one of the prospective inlets for sourcing foreign capital. Typically, a SPAC involves the creation of an entity to merge or acquire an existing company, making it public. Therefore, it does not engage in commercial activities and is referred to as a blank-cheque company.

Foreign Currency Convertible Bonds And Masala Bonds

An FCCB refers to a bond issued in the currency of a foreign jurisdiction rather than that of the issuer company’s currency. Besides, masala bonds also served as an expedient mode of raising offshore funds. These are Indian rupee-denominated bonds issued by Indian companies outside India.

Such multiplicity of sources, amongst several others, have provided decent opportunities for tapping global financial markets. However, they were inadequate to harness the full potential of foreign markets.

FAVOURABLE ATTRIBUTES OF DIRECT LISTING

On the face of it, the scheme holds the potential to increase company valuation and performance in foreign jurisdictions. For instance, Novo, a Danish pharmaceutical giant, pursued a public offer in the USA, which further converted into better share prices in foreign and home jurisdictions. Merton’s “awareness hypothesis” suggests that cross-listing in a particular jurisdiction can accelerate visibility and international corporate prestige, resulting in better valuation prospects amongst peers. Similarly, The “market segmentation” theory supports the benefits mentioned above, emphasizing increased liquidity, a deepened pool for securities, and better valuation both abroad and at home.

Direct listing enables companies to reduce the cost of capital. As suggested by the “investor recognition” theory, a decrease in the “shadow cost” of not knowing about the security causes the cost of capital and investor risk to decline substantially. Pertinently, several other theories uncover the motive behind cross-listing of securities- the legal bonding theory outlines a situation where companies voluntarily subject themselves to foreign regulations and norms, thereby enhancing their value from an investor’s perspective.

FORESEEABLE COMPLICATIONS

A noteworthy accumulation of benefits accrues with direct listing of companies. However, they are accompanied by equally weighty challenges. Numerous accommodative changes in the existing laws are needed. The SEBI Expert Committee Report highlighted substantive areas needing rework to cover the direct listing scheme. However, other regulatory concerns besides the policy issues the Expert Committee Report put forth must also be addressed.

Indian Regulations

Rule 6(a) of the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 (“NDI Rules”) enables Persons Resident Outside India to invest in equity instruments of an Indian company in accordance with the conditions mentioned under Schedule I. Rule 1(b) of Schedule I permits equity shareholding in Indian companies listed on Indian Stock Exchanges, and it does not formally recognise foreign listed securities.      Despite the recent amendments to the NDI Rules through the Foreign Exchange Management (Non-debt Instruments) Amendment Rules, 2024 (“NDI Amendment Rules”), it does not deal with securities listed on foreign stock exchanges. Illustratively, the Annexure to the NDI Amendment Rules specifies India International Exchange and NSE International Exchange as recognised exchanges for trading securities. Hence, the scope of NDI Amendment Rules is restrictive and not explanatory for foreign-listed securities. 

Another issue emanating from the scheme can be attributed to currency convertibility. Capital account convertibility eases the conversion of local financial assets into foreign financial assets with minimum restrictions. In the absence of capital account convertibility and no previous interaction of securities issued by Indian companies with foreign stock exchanges, the functioning of rupee-denominated equity shares on foreign stock exchanges remains uncertain, and currency fluctuations owing to externalities remain unaccounted for. Uncertainty surrounding it can tip into complexities in buyback and free float of shares. Illustratively, two Brazilian corporations cross-listed in the USA, namely, Sadia S.A. and Aracruz Celulose S.A. were hurt by billion-dollar losses when the Brazilian Real dived inadvertently vis-à-vis the dollar. Hence, currency-related issues need to be addressed promptly.

Jurisdictional Hassles

It is difficult to overlook the extraterritorial operation of regulatory bodies of various jurisdictions as a crucial obstacle. Overlapping jurisdictions and regulatory body tussles would become more common in the absence of facilitative agreements and mutual understanding. Countries with inconsistent practices would often segue into regulatory actions against the companies. The SEBI Act, 1992 does not expressly vest the SEBI with extra-territorial jurisdiction. However, the Supreme Court (“SC”), while dealing with issues related to GDRs in SEBI v Pan Asia Advisors, affirmed SEBI’s extraterritorial operation. The SC iterated that SEBI has a statutory duty to protect Indian investors’ interests by referring to section 11 of the SEBI Act.

On the American front, the US SC’s concerns regarding the absence of ‘affirmative indication’ of extra-territorial jurisdiction in the statute received a prompt response from the Congress through the addition of Section 929P(b)(2) of Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010. Hence, class action suits brought under Section 10(b) of the Securities Act of 1934 received specific affirmative indications of extraterritorial jurisdiction. Similarly, China has also approved extra-territorial jurisdiction of securities law. Therefore, overlapping extra-territorial application of laws would inevitably result in jurisdictional tussles.

Bilateral Framework

The MoUs entered into by SEBI with other regulatory authorities are built on foundational principles of cooperation and mutuality. However, a bare reading of the MoUs indicates an absence of a framework to facilitate the same. Besides, a particular concern arises concerning enforcing foreign judgements in India. Section 44A of the Code of Civil Procedure (“CPC”) governs the consideration of decrees passed by reciprocating territories. Explanation 1 defines a ‘reciprocating territory’, which suggests territories that the Central Government notifies through a notification in the Official Gazette. The number of countries with which India has a reciprocity agreement does not reconcile with the list of permissible jurisdictions provided by the Expert Committee Report, except the UK and Hong Kong, where Indian securities can be listed. In cases of non-reciprocating territories, a fresh suit (Ref. to the case of Marine Geotechnics) has to be filed for execution of the foreign decree, thus prolonging litigation.

Additional Impediments

In addition, direct listing is punctuated with various other difficulties. The U.K. Sinha Report cautioned against risks stemming from a lack of transparency and fairness in overseas investments. Factors like these can snowball into the failure of Initial Public Offers of Indian Companies. Consequently, companies listing subsequently would inadvertently take a hit in their valuation prospects. Besides, Regulatory overlap between the frameworks of two countries is a significant roadblock to effective implementation. For example, foreign issuers are expected to follow US corporate governance standards. Sarbanes-Oxley Act (“SOX”) lists numerous compliances for foreign issuers in financial reporting and disclosure, detailed audit committee independence, and others. Hence, Indian companies intending to list on NASDAQ and NYSE would be subject to increased compliance costs as they would be required to comply with the American framework and the SEBI proposed framework.

Similarly, a mismatch can arise in the event of differing jurisdictional practices and notable concessions granted to secondary-listed securities by comparison with the regime applicable to primary-listed securities. For instance, Chinese companies have previously located lacunae due to regulatory mismatch to inflate their numbers, thus shorting their stocks in subsequent years. ‘Regulatory arbitrage’ allows companies to overcome jurisdictional boundaries to carry out standard activities without being subject to a jurisdiction’s regulations.

POSSIBLE RECOURSE

Bilateral Framework

Insights from other jurisdictions can be convenient in developing a robust framework. The U.K. Sinha Committee Report proposed the registration of entities offering market-related securities in overseas markets with SEBI. Arguably, a cooperative mechanism between regulatory authorities should form the bedrock for overseeing the mechanism of Direct Listing. MoUs with SEBI can act as a stepping stone in achieving plausible bilateral technical frameworks. Previous instances of such a framework can be traced to surveillance-sharing agreements between the US and foreign security stock exchanges linked to or on which securities trade.

Further, the Multijurisdictional Disclosure System (“MJDS”), entered into by the SEC and Canadian regulatory authorities, serves as an appropriate example of mutual recognition. MJDS has segued into the harmonisation of frameworks in the US and Canada. Besides notably, to offset the drawbacks transpiring from the passage of the Holding Act, China and the USA entered into a Statement of Protocol Agreement, thereby evolving a specific and accountable framework for the Public Company Accounting Oversight Board (“PCAOB”) in conducting inspections and investigations of Chinese Accounting Books. Such mutually facilitative acts should be kept in scope while enacting regulations.

Efficient Signalling

Additionally, the Sahoo Committee (Phase II Part I) had recommended that explicit signalling of Indian provisions overriding provisions of the foreign jurisdictions be given. On similar lines, support can be drawn from the Tafara-Pearson framework, which advances the idea of outlining regulatory exemptions and preconditions. A legal comparability assessment followed by the weaving of essential elements in a bilateral arrangement would eliminate confusion and streamline regulatory oversight. Through its ‘substitution compliance’, the USA promotes such arrangement, subsequently ensuring unhindered enforceability of mechanisms.

Arbitration as a Recourse

Another avenue is arbitration in securities disputes. Justice O’Connor in Shearson/American Express, Inc. v. McMahon pointed out that securities arbitration, in light of streamlined procedures and limited judicial scrutiny, is sufficient in ensuring statutory obligations are met. Even though it is conditioned in the USA, a similar framework can be developed in India to promote arbitration in securities law. Considering the number of benefits attached to arbitration, ranging from tailoring procedures to fit the circumstances to anonymity in proceedings, arbitration presents itself as a viable option. China has been an active promoter of arbitration in securities disputes. Article 163 of the Notice on the Implementation of the “Mandatory Provisions of Articles of Associate of Companies Seeking Overseas Listing” requires a compulsory arbitration clause. Disputes concerning companies listed in Hong Kong would be arbitrated under HKIAC or the China International Economic and Trade Arbitration Commission.

Enforcing Foreign Decrees And Judgements

With respect to the enforcement of foreign decrees and judgments, a reference to the Convention on the Recognition and Enforcement of Foreign Judgements in Civil or Commercial Matters (“2019 Hague Judgement Convention”) becomes imperative in adopting an internationally streamlined procedure for the recognition of judgements. India can signal its commitment to cooperation by signing and ratifying the 2019 Hague judgement Convention. Besides, the Indian SC can adopt a de jure reciprocity approach, which the Chinese adopted. This approach moves beyond the conventional requirement of a formal reciprocating agreement. It posits the likelihood of enforcement and recognition of the home country’s judgements in the foreign jurisdiction based on the legal provisions and judicial practice of the same. Hence, the courts may presume a reciprocal relationship.

CONCLUSION

The finance theory suggests that law has an invariable impact on publicly traded firms, as reflected in stock prices, and legal frameworks play a critical role in the expansion of stock markets. Direct Listing opens convincing avenues for Indian companies to tap into global markets, but as highlighted, it comes with its own set of incentives and difficulties. Considering India’s tryst with foreign markets through previous practices, direct listing emboldens the overall framework. Though on a cautionary note, multiple issues still emanate from the half-baked framework. Renowned frameworks of different countries posit as reliable clues for developing practices related to direct listing on foreign exchanges- China and the USA offer resilient mechanisms that India can adopt to create a sturdy framework. By incorporating necessary changes and adopting established practices, India can exploit the full potential of direct listing, enabling its companies to flourish globally.