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Debentures are the debt instruments which may be issued by a listed or non- listed firm to raise funds in a security market. They are of many types, viz., Redeemable, Non-redeemable, Partially Convertible and Fully Convertible. In case of ‘fully convertible debentures’ an ‘option’ (that is why the name OFCDs, i.e., Optionally Fully Covertible Debentures) is given to the debenture-holders who may wish to convert their OFCDs into shares (after expiry of the period fixed by the debenture issuing firm—known as ‘lock-in’ period). But the ‘rate’, will be decided by the company (e.g., how many shares against how many debentures). For debenture-holders the ‘option’ to convert debenture into shares is profitable and/or safer once either of the following situations are correct:
(i) The firm is likely to make high profit (so the shareholder can earn higher dividend), or
(ii) Firm’s share-price is likely to rise in the share market (profit can be made by selling shares).
But suppose the firm has weak balance sheet (going bankrupt), then it is better to keep hold on the debenture rather than converting them into shares, because when a company is liquidated (i.e., its assets sold off), the debenture holders get primacy over shareholders in payment. It means OFCD is a bit tricky thing and is the only suitable route to invest in the security market for the investors who have some knowledge and understanding of share prices, company performance, etc.
Recently, the OFCDs issued by Sahara (an NBFC under regulatory control of the RBI) were in news due to some irregularities – it was a simple case of certain loopholes in the regulation of OFCDs and some violations by Sahara:
(i) Actually, an OFCD issue process has to be completed within 10 working days (Sahara continued for over two years).
(ii) If the OFCD is being issued through the ‘Private Placement’ route only
50 individuals/ institutions can subscribe to it (Sahara issued it to over 23 million people and raised over Rs. 24,000 crores). Such a tricky instruments being issued to novice public was a clear case of financial irregularities.
(iii) Unlisted companies do not come under the regulatory control of SEBI. In place they are regulated by the Ministry of Corporate Affairs (both the Sahara firms which issued OFCDs are unlisted). But SEBI contended that it can regulate even an unlisted firm if it issues OFCD, as the SEBI Act, 1992 contains the term OFCDs. There was really some regulatory confusion. This is why the government added a ‘clause’ in the recently passed Companies Act, 2012 which gives SEBI undisputed jurisdiction over any investment scheme involving more than 50 investors whether the company is listed or unlisted. Menawhile, Sahara has been ordered to return the total capital it raised through OFCDs with an interest of 15 per cent per annum.
Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index or reference rate), in a contractual manner.
The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the ‘underlying’.
In the Indian context the Securities Contracts (Regulation) Act, 1956
[SC(R)A] defines derivative to include :
(i) A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security.
(ii) A contract, which derives its value from the prices, or index of prices, of underlying securities.
Derivatives are securities under the SC(R)A and hence the trading of
derivatives is governed by the regulatory framework under the SC(R)A and are allowed to be traded on the floors of the stock exchanges.
Indian Depository Receipts (IDRs)
As per the definition given in the Companies (Issue of Indian Depository Receipts) Rules, 2004, IDR is an instrument in the form of a depository receipt created by the Indian depository in India against the underlying equity shares of the issuing company. In an IDR, foreign companies would issue shares, to an Indian depository [say the National Security Depository Limited (NSDL)], which would in turn issue depository receipts to investors in India. The actual shares underlying IDRs would be held by an Overseas Custodian, which shall authorise the Indian depository to issue of IDRs.
Just try to understand in a simple way. An IDR is a mechanism that allows investors in India to invest in listed foreign companies, including multinational companies, in Indian rupees. IDRs give the holder the opportunity to hold an interest in equity shares in an overseas company. IDRs are denominated in Indian Rupees and issued by a Domestic Depository in India. They can be listed on any Indian stock exchange. Anybody who can invest in an IPO (Initial Public Offer) is/are eligible to invest in IDRs. In other words, what ADRs/GDRs are for investors abroad with respect to Indian companies, IDRs are for Indian investors with respect to foreign companies.
But one question comes in mind. How does investing in IDRs differ from investing in shares of foreign company listed on foreign exchanges? Indian individuals can invest in shares of foreign companies listed on foreign exchanges only upto US$ 200,000 and the process is costly and cumbersome as the investor has to open a bank account and demat account outside of India and comply with Know Your Customer (KYC) norms of respective companies. It also involves foreign currency risks. IDR subscription and holding is just like any equity share trading on Indian exchanges and does not involve such hassels.
Stan Chart is the first and the only issuer of IDRs in Indian markets which came out with its IDR issue in May 2010 through which it had raised Rs. 2,500 crore on high demand from institutional investors and was listed on the
Bombay Stock Exchange and National Stock Exchange. Ten StanChart IDRs represent one underlying equity of the UK-listed bank. StanChart IDRs were due to come up for redemption on 11 June, 2011.
SEBI came out with the new guidelines in June 2011which ruled that after the completion of one year from date of issuance of IDRs, redemption of the IDRs will be permitted only if the IDRs are infrequently traded on the stock exchange in India. SEBI rules make it clear that if the annual trading turnover in IDRs in the preceding six calendar months before redemption is less than
5 per cent, then only the company could go into for redemption of IDRs. The regulator had said that the company issuing IDRs would have to test the frequency of trading the instrument on the bourses on a half-yearly basis ending June and December every year.
Shares ‘at Par’ and ‘at Premium’
An ordinary share in India, in general, is said to have a par value (face value) of Rs. 10, though some shares issued earlier still carry a par value of Rs. 100. Par value implies the value at which a share is originally recorded in the balance sheet as ‘equity capital’ (this is the same as ‘ordinary share capital’). SEBI guidelines for public issues by new companies established by individual promoters and entrepreneurs, require all new companies to offer their shares to the public at par, i.e., at Rs. 10. However, a new company set up by existing companies (and of course existing companies themselves) with a track record of at least five years of consistent profitability are allowed to issue shares at a premium.
When a company issues shares at a premium, it is able to raise the required amount of capital from the public by issuing a fewer number of shares. For example, while a new company promoted by first time entrepreneurs intending to raise say, Rs. 1 crore, has to offer 10 lakh ordinary shares at Rs. 10 each (at par), an existing company may raise the same amount by offering only 2 lakh shares at Rs. 50 each (close to the market value of its shares). The latter is said to have issued its share at a ‘subscription price’ of Rs. 50 (Rs. 10 in the case of the former company), at a premium of Rs. 40 (being the excess of subscription price over par value). In such a situation in India, the company’s books of accounts will show Rs. 10 towards share capital account
and Rs. 40 towards share premium account. It means that the higher the premium, the fewer will be the number of shares a company will have to service. For this very reason, following the policy of free pricing of issues in 1993, many companies came out with issues at prices so high that in many cases they were higher than their market prices, leading to under-subscription of such issues. The companies are, however, learning fast about the pitfalls of high pricing of shares and it is only a matter of time before the issue prices become more realistic.
In India, no company is allowed to issue shares at a discount, i.e., at a price below par. Again, in India, once a company has issued the shares, it cannot easily reduce its capital base, (i.e., buy back or redeem) its own shares.
This means that ordinary share capital is a more or less permanent source of capital, which normally a company is never under an obligation to return to the investors, because a shareholder who wishes to disinvest (i.e., get back the invested capital) can always do so by selling the shares to other buyers in the secondary market. Also, in India, a company receives no tax benefits for the dividends distributed. In other words, dividends are paid by the companies out of the earnings left after taxes and they get taxed once again at the hands of the investors.