The two-way fungibility of Indian global depository receipts (GDRs) and American depository receipts (ADRs) kicked off by India Cements last week and followed in quick succession by Reliance and Ranbaxy will benefit not only India Inc but also increase the visibility of Indian markets abroad. India has now added a sophisticated product to the basket of equity products, making it a relatively attractive destination for foreign investors.
The announcement permitting dual fungibility was made in the Union budget in February 2001; the guidelines were issued by the Reserve Bank of India (RBI) in February 2002. Until the guidelines were put in place, only conversions of ADRs and GDRs into domestic shares was allowed.
Two-way fungibility implies that an investor can convert ADRs (listed on the New York stock exchange and Nasdaq) and GDRs (listed in London and Luxembourg) into local shares and re-convert local shares into ADRs/GDRs up to a limit of the original ADR/GDR issue. No specific permission is required from RBI for the re-conversion of shares into ADRs/GDRs.
The GDRs of large capitalised and reputed companies like ITC, Bajaj Auto and Reliance Industries may come back to life since there are good arbitrage opportunities in converting local shares into GDRs that are quoted at a premium to local shares, subject to head-room availability (head room refers to the extent to which depository receipts can be issued under two-way fungibility). However, the benefit will be negligible for companies for which there has been no conversion or negligible conversion from ADR/GDR to domestic shares. Infosys Technologies is one such example.
Marketmen expect two-way fungibility to create arbitrage opportunities in such scrips, creating additional volumes in local shares as well as GDRs/ADRs. Mutual funds and financial institutions with a good inventory of blue-chips that also have GDRs listed will benefit the most. It is also likely that they may emerge as major arbitrageurs between the local and ADR/GDR markets.
However, at a later stage, the two-way fungibility process may limit the staggering difference that often prevails between share prices and the depository receipts listed abroad. Yet, the differential will continue, just as it does on the Bombay Stock Exchange and the National Stock Exchange.
The move will also open a new window to overseas investors who do not want to deal directly in local shares but intend to take exposure to Indian equities. Two-way fungibility may also revive activity in GDRs that had almost vanished due to conversion of GDRs into local shares that were sold in the domestic market.
The re-conversion of shares into ADRs/GDRs will be distinct from portfolio investments by foreign institutional investors (FIIs). The RBI has permitted the re-issue of ADRs/GDRs to the extent of the original instruments that have been converted into local underlying shares which may have been sold in the domestic market.
The role of domestic custodians and overseas depositories will now assume greater importance. Says Deepak Bagla, vice-president, ADRs/GDRs, Citibank:
