Undercutting the Underwriters: An Indian Perspective to Direct Listing on the Wall Street

– Aastha Saily & Pranav Bafna

Status Quo

“Simplicity is hard to build, easy to use, and hard to charge for. Complexity is easy to build, hard to use, and easy to charge for.” – Chris Sacca, Lowercase Capital

The aforementioned quote would be an apt description of capital markets in the 21^st century. Initial Public Offerings (IPO’s) have been a cash cow for underwriting bankers. The complexities involved in the book building – price discovery – process have been leveraged by underwriters to amass substantial wealth. Firstly, by charging large sums for their underwriting services and secondly, from the day one “IPO Pop” premium which allows the underwriter bank to sell the underwritten shares at a tidy profit to its buy-side customers. The fundraising process becomes even more complicated and expensive if funds were to be raised from overseas markets through issuance of Depository Receipts or Foreign Currency denominated Bonds. In this regard, it has been touted that the feasibility and directness of fund raising through “Overseas Direct Listing” (‘ODL’) will disrupt the status quo, and would create a brand new niche in the capital raising space.

Case in Point

The success of an ODL was first demonstrated in 2018 when Spotify Technology S.A. (‘Spotify’), a Swedish company, decided to list its shares directly on the New York Stock Exchange (‘NYSE’). Unlike a conventional IPO – where new shares are issued to investors – the Direct Listing allowed all of Spotify’s existing shareholders to directly sell their shares via the NYSE trading platform. Not only did the listing gains go entirely to Spotify’s shareholders, but it also allowed Spotify to avoid the underwriting fees which could range anywhere from 5-7% of gross IPO proceeds. After Spotify, the successful listing of Slack Technologies in 2019 has fortified the position of “Direct Listings” as a novel and relatively cheaper option for ‘going public’.

Obsolescence of Depository Receipt Schemes

In the past few years, the Indian corporations’ appetite for Depository Receipt issuances seems to have ebbed. The concerns around abuse of Foreign Depository Receipts for money laundering and round tripping purposes have tarnished its image. So much so, that no new American Depository Receipts or Global Depository Receipts were issued by Indian companies in 2016-17 and 2017-18. Though a sum of 1.8 billion dollars was raised in 2018-19, it is a far cry from the figures prior to the 2008 Global Financial Crisis.

Foreign Direct Listing from an Indian perspective

Allowing Indian companies to directly list overseas allows them to tap a global investor base and secure an internationally competitive valuation. Thus, with several unicorn startups expected to go public in the near future, permitting these companies to benefit from an ODL couldn’t come at a better time. In furtherance to the same, permission to directly list on overseas bourses and allowing foreign companies to list on Indian bourses was proposed vide Companies (Amendment) Bill, 2020. With the Indian regulators yet to provide clear directions on the legalities and modus operandi of an inbound/ outbound Direct Listing mechanism, the listing formalities in the overseas market are worthy of note.

Direct Listing opportunities in the USA

The United States of America (‘U.S.’) abodes the most liquid capital markets in the world – the NYSE and the National Association of Securities Dealers Automated Quotations (‘NASDAQ’). With the successful listing of several new-age companies, American investors have proven their appetite for the unknown. Undoubtedly, the NYSE and the NASDAQ are expected to be key markets for Indian companies seeking dual listing or transfer to the U.S. based stock exchanges. Listing securities in the US markets would entail compliance with an entirely different set of laws and regulations, both before as well as after the issue. Ergo, if Wall Street is the ‘holy grail’ of equity markets, securing the SEC mandate is its very own ‘baptism by fire’. Accordingly, some of these compliance measures have been elucidated hereinafter.

Pre-Listing Compliances

Pursuant to NASDAQ’s proposal to adopt a new set of Direct Listing Standards, the standards prescribed by NYSE and NASDAQ for direct listing have become substantially similar. Additionally, the said proposal also mandates Direct Listings to be subject to the same initial listing requirements as are applicable in case of an IPO. In this regard, it must be noted that the direct listing requirements are also subject to the same set of exemptions as set forth by the corporate governance requirements in Rule 5600 Series.

While the listing process initiated by the submission of a registration statement (u/s 12 of the Securities Exchange Act, 1934) stays the same, the valuation threshold guidelines ought to be of key interest to Foreign Issuers.

Post Listing Reporting and Disclosure Requirements

The U.S. Securities Law provides certain dispensations and flexibilities to Foreign Issuers. Flexibility in preparation of Financial Statements is permitted by allowing the adoption of local Generally Accepted Accounting Principles (‘GAAP’). Filing of annual returns and reports is also delayed. For instance, Foreign Issuers are expected to file annual returns within 4 months of the end of their respective fiscal year. Whereas, the deadline for domestic issuers ranges from sixty to ninety days after the end of the fiscal year, depending on the market capitalization of the company. Exemption from compliance with Proxy Rules is also granted to Foreign Issuers. For instance, Section 14(a) of the Securities Exchange Act, 1934 makes it unlawful for any person to ‘solicit’ any proxy with respect to any security registered under the Act, however, Foreign Issuers are exempt from this rule. 

Apart from the concessions granted, both the NYSE and the NASDAQ prescribe certain disclosures to be made to the exchange and to the public. The disclosure requirements are akin to those prescribed by the Securities and Exchange Board Of India (‘SEBI’) under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. Therefore, since the Indian compliance standards are at par with those followed abroad, the concerned companies should not feel excessively overwhelmed by the compliance burden of an overseas listing.

Adherence to the Corporate Governance Standards

Indian companies desiring to list on the NYSE or NASDAQ will also benefit from the corporate governance rules which allow the Foreign Issuers to follow their home-country practices in lieu of the general standards followed by U.S. companies. Relaxations are given in relation to certain matters dealing with Director Independence and Nominations; Compensation to the Board; Remuneration to stockholders; Shareholders’ approval prior to issuance of certain securities; Review of Related Party Transactions, Code of Business Ethics applicable to Directors, Officers and Employees.

The Foreign Issuers following home-country standards are also required to describe the home-country standards and list the significant differences between its home country practice and the applicable standards as per U.S. Securities Law in all their public filings.

Corporate Governance vis-a-vis the Sarbanes-Oxley Act, 2002

Foreign Issuers are required to satisfy extensive due diligence and disclosure standards to meet the auditing guidelines mandated by the Sarbanes-Oxley (‘SOX’) Act passed in the aftermath of the Enron scandal. One of the guidelines requires the company to constitute an independent audit committee within the company. Unlike the requirements mandated under Section 177 of the Indian Companies Act, 2013 – wherein the audit committee consists of the Board of Directors – SOX requires the said committee to be separate from the top-level management of the company. Further, SOX requires a far more elaborate internal control framework which would require foreign issuers to have highly functioning automated control systems in place.

Analysis

With several Indian ‘Unicorns’ on the precipice of a public listing, it’s more a question of ‘when’ rather than ‘if’ before one of them decides to test these unchartered waters. Complying with listing requirements of an overseas market would entail a significant increase in the annual operating and administrative costs. Further, it can be reasonably presumed that the company would be accountable to two different sets of legal jurisdictions which would double its compliance burden.

A major reason for going public is securing the most attractive valuation in the capital markets. Historically, the job of pre-empting the market’s expectations, vis-à-vis what a company is worth, has been done by underwriting institutions. Not only that, underwriting Banks act as purchasers of last resort in case the market doesn’t absorb the listed shares in its entirety. In case of Direct Listings – with no underwriters involved – companies lose out on a guaranteed purchaser of their stock and the valuation expertise that comes with it. This becomes a riskier proposition for issuers with a limited understanding of the overseas Capital Markets.

However, for certain companies, the aforementioned concerns can be taken care of. From a compliance perspective, Direct Listing would be advisable for companies which have a demonstrated experience in foreign capital markets. Further, from a valuation standpoint, Direct Listing is recommended for those companies whose goodwill can be leveraged internationally. In all other instances, the Direct Listing route would be inadvisable.

Conclusion

With India Inc. desirous of creating internationally competitive companies, its involvement with overseas capital markets is essential. Indeed, undercutting the underwriters is a resourceful and promising alternative, however, its benefits can be leveraged only by a select few. Conclusively, Foreign Direct Listing is a niche category which belongs solely to the creme de la creme.

This article is authored by Aastha Saily and Pranav Bafna. Both of them are students of law at ILS Law School, Pune.