Issue of GDRs and Market Manipulation

Last week, SEBI issued an order relating to a specific transaction structure that involved the use of global depository receipts (GDRs) to allegedly manipulate the stock price of several companies.
The modus operandi was as follows. The companies issued GDRs, which were acquired by various foreign institutional investors (FIIs) or their sub-accounts. The GDRs were all soon thereafter converted into underlying equity shares of the issuing company, which were then sold in large (synchronized) deals to several buyers, such as stock brokers. The stock brokers would in turn sell the shares to other investors. After investigation, SEBI found that the companies, the lead manager to the GDRs, the FIIs/sub-accounts and the stock-brokers were all acting in common as a group. They were able to maintain the stock price of the company through these transactions without symmetry of information to outside investors who may have paid a high price given the issuance of GDRs by the companies and large holdings maintained in them by FIIs. SEBI found this to be an instance of market manipulation and passed an order restraining the relevant companies and investors from participating in the capital markets.
Mobis Phillipose has a detailed analysis in the Mint. He argues that the light regulation of GDR issuances by Indian companies may have contributed to this instance as it allowed parties to take advantage of that route. He notes:
The outcome of all this from the GDR issuing company’s perspective is that they can completely avoid the regulatory process and due diligence that is required while raising funds in the Indian market. Issuing GDRs are a much simpler process, especially when they are listed in exchanges such as London Stock Exchange’s Alternative Investment Market. Indian regulators have allowed this since it pertains to securities that are listed in markets outside their jurisdiction and are bought by investors who are not regulated by them.
But as the recent investigations show, some market participants are using this as a loophole. And ironically, it’s Indian investors who end up with the short end of the stick, when these GDRs are quickly converted into Indian shares. In sum, while it’s made to look like an issue of GDRs, in essence it’s an issuance of Indian stock, given the fact that most GDRs are cancelled and converted into shares.
The last point above is noteworthy as loose regulation of GDRs may lead listed companies to undertake large securities issuances without following either the norms for qualified institutional placements or follow-on public offerings. One solution may lie in tightening the GDR regulations, as Mobis suggests:
Needless to say, Sebi and the central bank will need to look at plugging these loopholes. As a Mint report in July pointed out, regulators are looking at imposing stringent conditions on Indian companies issuing GDRs. But while doing so, policymakers should be careful that genuine users of overseas equity and equity-linked instruments aren’t turned away. Some of the above-mentioned loopholes can be fixed with just better reporting standards, rather than having to get involved in extensive screening.

In any event, the regulations governing market manipulation are quite wide to deal with abuse of otherwise genuine financial instruments such as GDRs, which SEBI has readily invoked in this case.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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