Wednesday, July 8, 2009

Depository Receipts and the Takeover Regulations

SEBI yesterday published its informal guidance in the matter pertaining to Bharti Airtel Limited. The question was whether the acquisition of 36% global depository receipts (GDRs) in Bharti Airtel Limited by MTN and its shareholders as part of the combination transaction would trigger various obligations under the SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997.

There are principally two obligations on the part of an acquirer under the Takeover Regulations, (i) to make an open offer to the other shareholders where the acquisition exceeds 15% shares; and (ii) to make requisite disclosures where the acquisition crosses certain thresholds, e.g. 5%, 10%, 14%, etc. Apart from the Takeover Regulations there are disclosure obligations under the SEBI (Prohibition of Insider Trading) Regulations, 1992.

The Bharti-MTN combination presents a specific issue since MTN and its shareholders will not be acquiring shares in Bharti, but would be acquiring GDRs instead. In its informal guidance, SEBI ruled that the GDR holders would be required to make an open offer to the other shareholders of Bharti only when they convert their GDRs into shares whereby their shareholding exceeds 15%. It, however, ruled that the disclosure requirements under the Takeover Regulations as well as the Insider Trading Regulations would apply at the time of acquisition of GDRs itself.

This position is fairly clear from the text of the Regulations themselves. Reg. 3(2) of the Takeover Regulations provides: “Nothing contained in Chapter III of the regulations shall apply to the acquisition of Global Depository Receipts or American Depository Receipts so long as they are not converted into shares carrying voting rights”. It is Chapter III that prescribes open offer requirements on acquirers exceeding 15% shares in the company. GDRs do not fall within the ambit of these requirements.

On the other hand, as far as disclosures are concerned, they are prescribed in Chapter II of the Regulations to which the above exemption does not apply. Moreover, the definition of “shares” under Reg. 2(k) of the Takeover Regulations includes “any security which would entitle the holder to receive shares with voting rights”. Since GDRs can potentially be converted into equity shares, they would fall within the scope of this definition. Hence, all disclosure requirements applicable to shares would apply to GDRs as well, at the time of their acquisition and even before they are converted. As regards the Insider Trading Regulations, they do not carry a definition of “shares” so as to include convertible instruments such as GDRs. Although it is arguable that in those circumstances “shares” do not include “GDRs” thereby staying outside the purview of the disclosure requirement, SEBI has nevertheless adopted a more conservative stance of requiring disclosure (although the informal guidance opinion is devoid of any reasoning on this count). From a practical standpoint, this debate is of minimal relevance because if disclosure of acquisition of GDRs is required anyway, it matters less as to which precise regulation the disclosure needs to be made under.

It is not clear as to what the rationale behind this somewhat complex scheme of things in the Takeover Regulations was, but it does certainly encourage Indian companies to use depository receipts (ADRs and GDRs) as currency for effecting overseas acquisitions of companies. This is also well-supported by the various guidelines under the Foreign Exchange Management Act pertaining to the issue of depository receipts in lieu of overseas acquisitions (see relevant Master Circular issued by the Reserve Bank of India).

(Update – August 26, 2009: It has been reported that a shareholder appeal has been filed before the Securities Appellate Tribunal, that is currently pending.)

3 comments:

Anonymous said...

But if DRs carry no voting rights, is it not the exemption alright?

Umakanth Varottil said...

Yes. That would be right. One of the motivating factors behind the exemption appears to be the fact that DRs do not generally carry voting rights. In case the DRs are to carry voting rights in any specific case due to the nature of the contractual arrangements (i.e. depository agreement), then the current analysis many not necessarily hold good.

Anonymous said...

ok - so everyone seems to have missed the point.

The issue is as follows - GDRs per se are exempt - the question is whether 'structured' GDRs are exempt. So if an Acquirer is allotted 30 % GDRs with another 20 veto rights and all the rights one gets to see in a shareholders agreement and simply have a clause that the GDRs do not have a voting right until converted does it take the GDR issue outside the open offer requirements under the Takeover Code. Thats how the issue has to be understood and appreciated. The exemption under Reg 3 for GDRs was meant for 'public issue' GDRs - clearly the regulators missed the concept of a privately placed GDR. Absent voting rights, there are many ways one can get corporate rights aand thats what this ruling seems to have missed.

More importantly - the application of Chapter 2 is very important - SEBI has gone against its own Informal Guidance in the case of Goldman Sachs that convertibles such as FCCBs and GDRs are not reportable under Chapter 2 until they are converted. The market does not report CCDs/CCPs/GDRs/FCCBs - this would mean these have to be reported. I agree the issues surrounding the definition of 'shares' - but that does not take away the impracticalities and contradictions SEBI is fostering.