[This guest post is by Pratik Datta and Mehtab Hans, who are Consultants at the National Institute of Public Finance and Policy (NIPFP), New Delhi. They can be reached at firstname.lastname@example.org and email@example.com respectively.]
Last week, the SEBI (Issue of Capital and Disclosure Requirements) (Fourth Amendment) Regulations, 2015 were issued to facilitate listing of start-ups on institutional trading platforms (ITPs) in India. The regulator is optimistic that start-ups which list on ITPs will eventually grow and move on to list on the main market. This is certainly a move in the right direction. But if the regulator is genuinely interested to give a boost to Indian start-ups, it should supplement this measure by facilitating Indian start-ups' access to international capital markets through depository receipts.
However, the SEBI Chief's recent comments seem to suggest otherwise. Regarding the implications of this new start-up listing regulations, Mr. U.K. Sinha reportedly remarked: “I am hopeful that many of these companies, which were being approached by Singapore and New York exchanges earlier, would come and list here.” This seems to suggest that these new listing norms are more in response to some start-ups' eagerness to list abroad. The regulator seems to be under the impression that foreign listing of Indian start-ups is undesirable from a policy perspective.
We argue that this line of reasoning is fallacious. Listing on an Indian ITP is not necessarily a substitute for admission to trading or listing on a foreign trading platform or exchange. Unlisted Indian start-ups may want to access foreign capital markets like New York or Singapore for various inherent commercial advantages which Mumbai cannot offer.
Let us start by assuming for a moment that foreign listings can be substituted by domestic listings. That would mean that no company incorporated in Singapore or US would ever want to list abroad – say in London – because they can raise all the capital they want domestically in Singapore or US respectively. However, this is not what happens in reality.
For example, Constellation Healthcare is a company incorporated in Delaware, US. Although unlisted in US, it is admitted to trading on AIM (London Stock Exchange’s international market for smaller growing companies). The securities of Constellation Healthcare that are traded on AIM are not domestic US shares but Depositary Interests (DIs). DIs are simply mirror images of the domestic shares, akin to depositary receipts. DIs are issued by a depositary against underlying shares and have the same International Security Identification Number (ISIN) as the domestic shares.
Another example is Yujin International. This company is incorporated in Singapore but is admitted to trading on AIM through the DI route. Yujin International's prospectus explains the reasons for its admission on the AIM platform. They are to:
1. Enhance the company’s reputation with customers and suppliers. The Directors believe that as an AIM company, Yujin will be in a stronger position to negotiate contracts and will be seen as a more attractive partner;
2. Strengthen commitment from existing employees and to attract further high quality employees through participation in employee share ownership schemes. The Directors believe that the prestige of working for a company whose shares are trading on AIM, together with the possibility of participating in the Company’s success and growth through employee share ownership is extremely attractive.
Clearly, these companies are listing their securities in London not merely because of availability of capital but something more. A related interesting phenomenon observed by Howson and Khanna is reverse cross-listing – where listed companies from developed economies (with matured capital markets) cross-list in developing economies (with less matured capital markets). To understand why these happen, we need to go back to the basics.
Why do firms list abroad?
Substantial literature already exists on this subject. The Sahoo Committee Report on depository receipts also addressed it. Some of the potential reasons relevant for the present purpose are explained below:
1. Cost of capital: Cost of capital is more important than mere access to capital. If AIM in London offers better cost of capital than NYSE in New York, it makes sense even for a US company to list on AIM. The same logic applies to start-ups in India. If a Bangalore based start-up is getting better cost of capital in New York or Singapore as compared to Mumbai, it should be free to choose the former. Forcing it to stick to Mumbai over New York or Singapore is not in the best interest of the start-up; however, Indian stock exchanges will clearly gain out of such a policy since it would shield them from competition with the international capital markets.
2. Better valuation: Certain jurisdictions have advantages in particular sectors with sophisticated sectoral analysts offering better valuation. Let us assume a company operates as an unlisted Indian start-up producing niche chocolate products. There are five options to list: Mumbai, New York, London, Singapore and Switzerland. Such a company may legitimately prefer to list on the Swiss Stock Exchange (SIX) which dominates the European food products industry (Nestle SA is listed there) and is likely to give the company a better valuation. Plus, that may also benefit its brand of chocolates by associating it with Switzerland. Asking it to list in Mumbai may not make much commercial sense.
3. Brand visibility and business operations: A start-up may be exporting products to a foreign market where it intends to expand its business. In that case, the start-up may want to list in that foreign market to enhance its brand visibility – Howson and Khanna refer to this as consumer-commercial markets bonding. Although listed in India, Infosys was driven by similar considerations when it undertook a US listing in the late 1990s, as Khanna and Palepu have analysed. Also, raising capital in the currency of that foreign jurisdiction, for business operations there, would help it hedge currency risks. An example of this phenomenon are Japanese companies with business interests in mainland China listing in Hong Kong.
As is evident from the above examples, there are myriad commercial reasons that may motivate unlisted start-ups to prefer listing abroad rather than listing domestically. Cost of capital, although important, is just one factor. Left to itself, an Indian start-up may for genuine business interests (beyond capital raising) prefer a New York or Singapore listing over Mumbai.
Foreign listings do not harm the Indian economy
The fundamental assumption of capitalism is that markets work. If there is any potential of market failure, regulations must specifically address them. If there is no potential market failure, no state intervention in the form of regulation is necessary. The market should be allowed to function freely.
So what is the potential market failure for foreign listings? The only possible market failure is lack of investor protection. That is exactly what securities law tries to do in the first place by imposing disclosure obligations on the issuer of securities. In case of Indian start-ups listing abroad, investor protection is a concern for the foreign jurisdiction where the Indian start-up is listing its securities. It is not a concern for the Indian regulator. There is no other potential market failure in India. Therefore, allowing unlisted Indian start-ups to list abroad does not in any way harm the Indian economy.
The socialist Indian state has been used to the command and control form of dirigiste regulations. Post-liberalisation this tendency seems to have continued by way of inertia. However, in a capitalist market economy (that we now claim to be), regulations must not seek to substitute business judgement of commercial firms. Instead it must only address market failures. As we have explained, there is no market failure in foreign listings for the Indian regulators to be worried about. Therefore, the most optimal policy solution would be to create a level playing field between domestic and foreign listings; and leave it to the start-ups to choose where they want to list. This approach would be more aligned with the current Government's aspirations of `start up India' and its broader economic philosophy.
- Pratik Datta & Mehtab Hans