What Are Global Depository Receipts? How Are They Manipulated?

Another day. Another scam. Another loan defaulter facing the regulatory scanner.

Hyderabad-based Sujana Group, owned by the industrialist and Rajya Sabha MP Sujana Chowdary, has been a chronic defaulter of bank loans for the last few years. The group and all its associated companies have a combined debt of ₹7,500cr ($1bn) and are currently being investigated by multiple enforcement agencies.

Yesterday, the Economic Times reported on yet another scam that the Sujana Group seems to be caught in. It involves the manipulation of Global Depository Receipts (GDR) issues.

The SEBI has been probing and penalising GDR frauds for quite some time. In 2017, the regulator passed six orders penalising various entities involved, most prominent among whom was Arun Panchariya, the founder of Pan Asia (a merchant banking firm), who was at the centre of the scam.

Turns out that the Sujana Group followed Panchariya’s script to a T while issuing GDRs and defrauded the markets.

We’ll get into that shortly. But first, here’s a run-through on how GDRs work.

Globalised Investment Vehicles

To put it simply, a GDR is a bank certificate issued in one country for shares in another country.

Say, you are an Indian company that wants to raise capital from outside India. How would you sell your equity shares directly to overseas investors?

You approach a “depository bank” which is based overseas. The company issues shares to the bank and the bank issues receipts or certificates or instruments known as Depository Receipts (DRs).

These receipts are then listed as shares by the bank in its domestic stock exchange from where the investors can buy and trade. This means they trade like domestic shares in that country (even though they belong to a foreign company) and investors can purchase them in an international marketplace.

So, the bank is essentially a financial intermediary which acts as the custodian of shares issued by the Indian company. GDRs thus provide a simplified mechanism for buying and trading shares of foreign companies.

Types of DRs

There are three of importance -

1. Global Depository Receipts (GDRs)
2. American Depository Receipts (ADRs)
3. Indian Depository Receipts (IDRs)

ADRs are used by Indian companies to raise funds in the US and they are denominated in US Dollars. GDRs are used for the same purpose in all foreign countries apart from the US. IDRs, however, run reverse to either of the above. They are used by foreign companies to raise capital in India.

Usually, most companies from India follow the GDR route due to the more stringent accounting norms, disclosures and other regulatory requirements involved in the US law-compliant ADRs.

But, GDRs are unsecured securities. They are not backed by any asset except for the value of shares held in the receipts. They also come with risks like forex rate volatility. The shares and dividend prices are denominated in foreign currencies so any fluctuation can impact the value of returns.

And most often, they don’t entail voting rights for the foreign shareholders. Those rights are retained by the intermediary (i.e. Bank) which has directly bought the shares.

In some instances, the company uses its GDR proceeds as collateral to borrow from the same bank. So, the amount raised via GDRs gets offset entirely or in part to repay the debts of the company. Going forward, if the proceeds aren’t substantial and the company defaults on its loans, the bank could seize the existing proceeds which in turn could impact the liquidity of investors.

Why Invest In DRs

For companies: They provide simplified access to investments in foreign countries. Companies can expand their capital and shareholder bases in foreign markets with great ease.

Plus, the global market visibility. If a company offers investment in another jurisdiction then it gains more attention and coverage in those markets.

For investors: These receipts, due to their interconvertibility with equity shares, are as good as equity shares. They bring more liquidity (plus diversification) to an investor’s portfolio. They are also usually denominated in Dollars or Euros — both very strong currencies to hold investments in.

There are a couple of other ways in which Indian companies can fundraise from offshore locations. One is through FPOs (Follow on Public Offers) aka secondary offerings. This is, however, possible when the company itself is registered overseas and listed on their exchange.

Then there is the option of issuing Foreign Currency Convertible Bonds or FCCBs. But this requires converting bonds into equity only after the stock hits the conversion rate which again limits liquidity of the investor.

GDRs, on the other hand, are very simple. They are not subject to lock-in periods and are easily interchangeable with securities. When an investor wishes to exit his position, the depository bank will simply convert the GDR of the investor into shares and sell them on the floor of the exchange.

How GDRs Are Manipulated

GDRs are instruments raised in a foreign country. So they are regulated under foreign law. This makes it very easy for some people to evade domestic scrutiny when they tamper with GDRs because they used to be exempted from SEBI’s jurisdiction.

FYI: In 2013, the Supreme Court changed this by ruling that GDRs would fall within the definition of securities under Indian law. After that, SEBI launched a full-scale crackdown on the violators.

The most spectacular GDR fraud uncovered so far was by Pan Asia and its associates between 2009 and 2010. It was triggered when SEBI noticed some unusually large orders and off-market transactions in stocks.

This is what happened:

• The number of GDRs issued were almost always higher than the existing paid-up capital of these companies, sometimes even seven to eight times higher.
• After a very short period of issuing these GDRs, they would be cancelled and converted into Indian shares and sold in the domestic market.
• There were a series of synchronised trades, almost always involving the same group of brokers based in India. They were all linked to Arun Panchariya and his family.

Panchariya and his company set up a whole chain — they issued GDRs, arranged investors abroad to buy them and propped up a group of brokers to give these investors easy exits.

Once they exited their positions, those shares were dumped in the Indian markets where clueless investors were enticed to purchase them, judging by their sudden surge in trading volumes and activity. Plus, these investors thought they were decent bets given their large GDR issuances and FII investments.

Pan Asia wasn’t the only one doing it. Some of the other companies involved were — Cals Refineries, Bhoruka Aluminium, Vintage FZE, etc.

And now, there is the Sujana Group.

The ET report says that Sujana Universal, the group’s flagship company, raised around $43m via GDRs between 2005 and 2007. In all of these issues, Pan Asia acted as the lead manager and had the same set of initial investors as it had in the other GDR scams.

This is how it worked. A shell company was created by the Sujana Group in the British Virgin Islands. This company acted as the sole subscriber of the GDRs that were raised by a Portuguese depository bank. So Sujana essentially funded its entire GDR issue by itself. The market was given a false impression which pushed the company’s stock prices up.

SEBI has slapped fines worth crores on many errant companies engaged in GDR manipulation so far. Could the Sujana Group be next?

In any case, rules are getting more liberalised with the recent announcement to allow GDR listing at the IFSC in Gujarat. It would definitely promote fundraising for companies. But with cases of fraud and manipulation looming, it is perhaps time to bring stringency in GDR regulation in the country.

(Originally published July 3rd 2021 in transfin.in)