International equities or the Euro equities do not represent debt, nor do they represent foreign direct investment. They are comparatively a new financial instruments representing foreign portfolio equity investment. In this case, the investor gets the dividend and not the interest as in case of debt instruments. On the other hand, it does not have the same pattern of voting right that it does have in the case of foreign direct investment. In fact, international equities are a compromise between the debt and the foreign direct investment. They are the instruments that are presently on the preference list of the investors as well as the issuers.
Benefits to Issuer/ Investor
The issuers issue international equities under certain conditions and with certain objectives. First, when the domestic capital market is already flooded with its shares, the issuing company does not like toad further stress to the domestic stock of shares since such additions will cause a fall in the share prices. In order to maintain the share prices, the company issues international equities. Secondly, the presence of restriction on the issue of shares in the domestic market facilitates the issue of Euro equities. Thirdly the co company issues international equities also for the sake of gaining international recognition among the public. Fourthly, international equities bring in foreign exchange which is vital for a firm in a developing country. Fifthly, international capital is available at lower cost though the Euro equities. Sixthly, funds raised through such an instrument do not add to the foreign exchange exposure.
From the viewpoint of the investors, international equities bring in diversification benefits and raise return with a given risk or lower the risk with a given return. If investment is made in international equities along with international bonds, diversification benefits are still greater.
Procedure of Issue
When a company plans to issue international equity, it decides about the size of the issue, the market where the equities are to be issued, the price of the issue, and about many other formalities. It approaches the lead manager normally an investment bank – which has a better knowledge of the international financial market. The lead manager examines the risk factors of the issue as well as its prospect. It suggest about the details of the issue as also whether the shares are to be routed through the American depository or through the Global depository. When the lead manager gives a green signal, the issuing company prepares the prospectus, etc. and takes permission from the regulatory authorities. After getting approval from the regulatory authorities, it deposits the shares to be issued with the custodian bank located in the domestic country. The custodian bank is appointed by the depository in consultation with the share issuing company.
When the shares are deposited with the custodian bank, the latter asks the depository located in a foreign country to issue depository receipts in lieu of the shares held. The ratio between the number of shares and the number of depository receipt is decided well before the actual issue, In fact, the fixing up of the issue price or the ratio between the depository receipts and the shares depends upon a host of economic variables. Generally the issues are priced at discount insofar as the earning per share drops in proportion to the increase in capital. The market price of depository receipt in international market is largely dependent upon earnings potential, industry fundamental, and macro economic fundamentals.
The depository, which is a bank or financial institution situated in a international financial center, functions as a link between the issuing company and the investor. On getting information from the issuing company about the launch, the depository issues the depository receipts. The American depository issues American depository receipts (ADRs), while the depository in the international financial market outside the USA issues Global Depository Receipts (GDRs).
When GDRs are purchased by the investors, the proceeds flow from the depository to the custodian bank and from the custodian bank to the issuing company. The company enters the name of the investor in the register of the shareholders. The investor has the right to surrender GDRs and to take back the investment. For the surrender, the investor deposits the GDRs with the depository who in turn informs the custodian who will issue the share certificates in exchange for the GDRs. The proceeds from the sale of shares are converted into foreign investors. It may be noted here that once the GDR is surrendered in exchange for the shares, such shares cannot be converted back into GDRs.
Again the investors can sell the GDR back in the issuing company’s domestic capital market. In order to discourage this practice, the issuer introduced a clause, known as lock in period, during which this practice is prohibited.
In the process of the issue, the role of underwriting and listing is very important. The lead manager functions normally as an underwriter and charges underwriting fee, the listing agent, who is normally the lead manager, makes an application to the stock exchange for listing. The agent guides the issuing company and helps it file the required documents with the stock exchange. After the formalities are complete, GDRs are traded on the stock exchange. There are also international clearing houses, such as Euro-clear and CEDEL that facilitate the settlement of transactions.
The question of voting rights is also important. Since GDR investors keep changing from time to time, they do not seem very much interested in the voting rights even though these cannot be denies to them. There are different procedures followed in this respect. One is that the issuing company and the overseas depository enter into an agreement which enables a depository to vote either with the majority voters or according to the wishes of the management. In the other procedure, it is understood that the depository votes in the same proportion as the rest of the shareholders do. Again, there is one more alternative where the depository votes in accordance with the instructions of a nominee of the management.
The cost of international equity is normally not large, although commission, management fee, etc, are paid to the lead manager according to the different functions performed by it. The depository incurs some expenses. Theses approximate to 3-4 per cent of the issue amount.
There are many documents used in the process of the issue of international equity. These are:
- The prospectus containing detailed information about the issue and the issuer.
- The depository agreement the agreement between the issuing company and the depository – that contains, among other things, the rules followed for converting the shares into GDRs and back.
- The underwriting agreement concluded between the issuing company and the underwriter, normally the lead manager, accompanies the issue.
- A copy of the agreement concluded between the custodian and the depository is also enclosed.
- A copy of the trust deed is enclosed which provides for the duties and responsibilities of the trustee regarding servicing of the issue.
- A copy of the agreement with the listing stock exchange is annexed so that the investors are well aware of the secondary market for the issue.
Besides a subscription agreement is also enclosed the means of which the lead manager and the syndicate members agree to subscribe to the issue.