Bharti-MTN: Structural Problems

The proposed deal between Bharti and MTN to combine their businesses fell through over the weekend. Although the principal reason for the fallout appears to be disagreement over who would control the combined entity, that was aided by problems with structuring the deal from a regulatory perspective. As The Economic Times reports:

“In addition, there are other factors that may have contributed to the collapse of the talks. According to industry sources, a Bharti-MTN merger would have faced major regulatory hurdles on the FDI front. “The merger would have meant that foreign holding in Bharti Airtel would have reached around 85%. While Bharti executives had told MTN that they would be able to get the FDI sectoral cap waived, the feedback that MTN directors were independently receiving was that it would be difficult for the sectoral cap to be relaxed,” said an industry source.”

This clearly indicates the difficulties that Indian companies would face in using their own shares as currency for foreign acquisitions when they are operating in sectors that have a cap on the level of foreign shareholding, with telecom being a prime example. This is particularly so in case of Indian acquirers that already have a large foreign shareholding, thereby limiting the structuring options for overseas acquisitions largely to cash transactions or to the establishment of overseas subsidiaries that carry out such acquisitions.

A Possible IDR Debut in the Indian Markets

A few months ago, we had lamented about the lack of even a single issuance of IDRs by foreign companies in the Indian markets; this, despite the relaxation of rules in 2007 to facilitate IDR listings. We had said:

“Indian Depository Receipts (IDRs) are instruments that enable foreign companies to access the Indian capital markets. It also provides avenues for Indian investors to make investments in foreign companies. In order to facilitate this process, the Companies (Issue of Indian Depository Receipts) Rules, 2004 were promulgated. Even after three years had elapsed, no single foreign company had availed on this route to access the Indian capital markets. Upon finding that the conditions for an IDR offering were too stringent, the Rules were amended in July 2007 to relax some of the conditions. However, status quo continues with no takers yet.”

This situation may possibly change with a report in The Economic Times that Standard Chartered Bank is looking to list its securities on Indian stock exchanges in the form of IDRs. VC Cirle also has a brief analysis. Such a listing would be a path breaker as far as Indian listings of foreign companies are concerned, and would open up avenues for other similar companies too. Being the first deal of its kind, it would certainly necessitate close discussions with regulators such as SEBI (being the securities regulator) and the RBI (being the regulator for banks having Indian operations as well as on the foreign exchange front).

Further, dual listings would also bring about their own sets of issues for companies to deal with. For example, Indian companies listed in the US not only have to comply with Indian corporate governance requirements, but in addition also have to follow the Sarbanes Oxley Act of 2002 as well as the rules of the exchange on which their securities are listed in the US (i.e. either NYSE or NASDAQ). Similarly, in the case of companies issuing IDRs, not only do they have to comply with listing requirements in other jurisdictions (where their securities are listed) but also with the listing agreement with the relevant Indian stock exchange. Of particular relevance is clause 49 of the listing agreement in India which deals with issues involving corporate governance (specifically board and committee structures, audit, disclosure and transparency norms and the like). This would add to compliance requirements on such companies, to the extent the Indian corporate governance requirements vary from those in other jurisdictions where they are listed. An example is cited in the Economic Times report as follows:

“However, StanChart has to think through certain local regulatory needs before pursuing IDRs. For instance, the bank announces its financial results every six months in markets like the UK, as against listed entities in India that must do so every quarter. Also, laws will have to be changed to allow capital gain tax benefits as IDRs have not been included in the definition of ‘securities’. Besides, the bank should have the flexibility to repatriate the money raised through listing.”

Notwithstanding such issues (that require to be addressed), it is hoped that the first IDR deal takes place in the near future as that will clearly pave the way for such future listings by foreign companies on Indian stock exchanges.

Role of Rating Agencies

Credit rating agencies have come under fire on account of their role in the recent global financial crisis arising out of the repackaging of subprime mortgage debts. This has resulted in a call for tighter regulation of rating agencies. But, this revelation in Financial Times is startling:

“Moody’s awarded incorrect triple-A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models, a Financial Times investigation has discovered.

Internal Moody’s documents seen by the FT show that some senior staff within the credit agency knew early in 2007 that products rated the previous year had received top-notch triple A ratings and that, after a computer coding error was corrected, their ratings should have been up to four notches lower.

News of the coding error comes as ratings agencies are under pressure from regulators and governments, who see failings in the rating of complex structured debt as an integral part of the financial crisis. While coding errors do occur there is no record of one being so significant.

Moody’s said it was “conducting a thorough review” of the rating of the constant proportion debt obligations – derivative instruments conceived at the height of the credit bubble that appeared to promise investors very high returns with little risk. Moody’s is also reviewing what disclosure of the error was made.”

Taxation on Sale of Shares in a Foreign Holding Company

Often, divestments by foreign owners of Indian companies are effected through a sale of the stake outside India. More specifically, where foreign companies hold shares in Indian companies through intermediate offshore investment companies, they can effect a divestment by merely selling off shares of the offshore holding companies. This does not in any way result in a transfer of shares of the Indian company giving rise to taxation of capital gains in India. But, the question still remains as to whether such indirect sales that achieve the same end result should also be taxed in India. This issue is discussed in a column by Mukesh Butani in The Business Standard.