BES’s INSTITUTE OF MANAGEMENT STUDIES &

RESEARCH

BATCH (2009-11)

REPORT ON ADVANCED FINANCIAL MANAGEMENT

VALUE BASED MANAGEMENT

ADR/GDR AND SEBI GUIDELINES IN THIS RESPECT

LOAN SYNDICATION

SUBMITTED TO

Prof. Ganachari
 

SUBMITTED BY:

NIKHIL JIRANGE (16)

SUNIL KAMBLE (18)

SAGAR KORDAY (23)

 VALUE-BASED MANAGEMENT

Management processes

Adopting a value-based mindset and finding the value drivers gets you only halfway home.
Managers must also establish processes that bring this mindset to life in the daily activities of the
company. Line managers must embrace value-based thinking as an improved way of making
decisions. And for VBM to stick, it must eventually involve every decision maker in the
company.

There are four essential management processes that collectively govern the adoption of VBM.
First, a company or business unit develops a strategy to maximize value. Second, it translates this
strategy into short- and long-term performance targets defined in terms of the key value drivers.
Third, it develops action plans and budgets to define the steps that will be taken over the next
year or so to achieve these targets. Finally, it puts performance measurement and incentive
systems in place to monitor performance against targets and to encourage employees to meet
their goals.

These four processes are linked across the company at the corporate, business-unit, and
functional levels. Clearly, strategies and performance targets must be consistent right through the
organization if it is to achieve its value creation goals.

Strategy development:
Though the strategy development process must always be based on maximizing value,
implementation will vary by organizational level.At the corporate level, strategy is primarily
about deciding what businesses to be in, how to exploit potential synergies across business units,
and how to allocate resources across businesses. In a VBM context, senior management devises a
corporate strategy that explicitly maximizes the overall value of the company, including buying
and selling business units as appropriate. That strategy should be built on a thorough
understanding of business-unit strategies. At the business-unit level, strategy development
generally entails identifying alternative

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strategies, valuing them, and choosing the one with the highest value. The chosen strategy should
spell out how the business unit will achieve a competitive advantage that will permit it to create
value. This explanation should be grounded in a thorough analysis of the market, the
competitors, and the unit’s assets and skills. The VBM elements of the strategy then come into
play. They include:
 Assessing the results of the valuation and the key assumptions driving the value of the
strategy. These assumptions can then be analyzed and challenged in discussions with
senior management.
 Weighing the value of the alternative strategies that were discarded, along with the
reasons for rejecting them.
 Stating resource requirements. VBM often focuses business-unit managers on the balance
sheet for the first time. Human resource requirements should also be specified.
 Summarizing the strategic plan projections, focusing on the key value drivers. These
should be supplemented by an analysis of the return on invested capital over time and
relative to competitors.
 Analyzing alternative scenarios to assess the effect of competitive threats or
opportunities.

Developing business-unit strategy does not have to become a bureaucratic time sink; indeed, the
time and costs associated with planning can even be reduced if VBM is introduced
simultaneously with a reengineering of the planning process.

Target setting:
Once strategies for maximizing value are agreed, they must be translated into specific targets.
Target setting is highly subjective, yet its importance cannot be overstated.Targets are the way
management communicates what it expects to achieve. Without targets, organizations do not
know where to go. Set targets too low, and they may be met, but performance will be mediocre.
Set them at unattainable levels, and they will fail to provide any motivation. In applying VBM to
target setting, several general principles are helpful:

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Base your targets on key value drivers, and include both financial and nonfinancial targets.
The latter serve to prevent “gaming” of short-term financial targets. An R&D-intensive
company, for example, might be able to improve its short-term financial performance by
deferring R&D expenditures, but this would detract from its ability to remain competitive in the
long run.
One solution is to set a nonfinancial goal, such as progress toward specific R&D objectives, that
supplements the financial targets.

Tailor the targets to the different levels within an organization. Senior business-unit
managers should have targets for overall financial performance and unit-wide nonfinancial
objectives. Functional managers need functional targets, such as cost per unit and quality.

Link short-term targets to long-term ones. An approach we particularly like is to set linked
performance targets for ten years, three years, and one year. The ten-year targets express a
company’s aspirations; the three-year targets define
how much progress it has to make within that time in order to meet its ten-year aspirations; and
the one-year target is a working budget for managers. Ideally, you should always set targets in
terms of value, but since value is always based on long-term future cash flows and depends on an
assessment of the future, short-term targets need a more immediate measure derived from actual
performance over a single year.

Economic profit is a short-term financial performance measure that is tightly linked to value
creation. It is defined as:

Economic profit =
Invested capital x (Return on invested capital – Weighted average cost of capital)

Economic profit measures the gap between what a company earns during a period and the
minimum it must earn to satisfy its investors. Maximizing economic profit over time will also
maximize company value.

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Action plans and budgets:
Action plans translate strategy into the specific steps an organization will take to achieve its
targets, particularly in the short term. The plans must identify the actions that the organization
will take so that it can pursue its goals in a methodical manner.

Performance measurement:
Performance measurement and incentive systems track progress in achieving targets and
encourage managers and other employees to achieve them. Rarely do front-line supervisors and
employees have clear performance measures that are linked to their company’s long-term
strategy; indeed, many have none at all.

VBM may force a company to modify its traditional approach to these systems. In particular, it
shifts performance measurement from being accounting driven to being management driven. All
the same, developing a performance measurement system is relatively straightforward for a
company that understands its key value drivers and has set its short- and long-term targets. Key
principles include:

1.Tailor performance measurement to the business unit.

Each business unit should have its own performance measures – measures it can influence.
Many multibusiness companies try to use generic measures. They end up with purely financial
measures that may not tell senior management what is really going on or allow for valid
comparisons across business units. One unit might be capital intensive and have high margins,
while another consumes little capital but has low margins.
Comparing the two on the basis of margins alone does not tell the full story.

2. Link performance measurement to a unit’s short- and long-term targets.

This may seem obvious, but performance measurement systems are often based almost
exclusively on accounting results.

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3. Combine financial and operating performance in the measurement.
Too often, financial performance is reported separately from operating performance, whereas an
integrated report would better serve managers’ needs.

4. Identify performance measures that serve as early warning indicators.

Financial indicators can only measure what has already happened, when it may be too late to
take corrective action. Early warning indicators might be simple items such as market share or
sales trends, or more sophisticated pointers such as the results of focus group interviews. Once
performance measurements are an established part of corporate culture and managers are familiar
with them, it is time to revise the compensation system. Changes in compensation should follow,
not lead, the implementation of a value-based management system.

Implementing VBM successfully:

Although putting a VBM system in place is a long and complex process, successful efforts
share a number of common features. Most of these points have already been discussed, and
others are self-explanatory, but the first feature is worth elaborating. As with any major program
of organizational change, it is vital for top management to understand and support the
implementation of VBM. At one company, the CEO and CFO made a video for their employees
in which they pledged their support for the initiative, declared that the basis of compensation
would shift at the end of the year from earnings to economic profit, and gave examples of what
VBM meant. All business units, for instance, would be expected to earn their cost of capital. “If
our cost of capital is 12 percent,” the CEO said, “a 12 percent rate of return on the capital that we
have invested is not good enough. An 11 percent return destroys value, and a 13 percent return
creates value. But a 14 percent rate of return creates twice as much value as a 13 percent return.”
Most managers had not thought about their business in these terms. The video caught their
attention and showed them that top management supported the change that was under way.
Though active top management support is a necessary condition for the successful
implementation of VBM, it is not sufficient in itself. Value-based management, as we have
suggested, must permeate the entire organization. Not until line managers embrace VBM and use

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it on a daily basis for making better decisions can it achieve its full impact as an aid to the long-
term maximization of value.

Keys to successful implementation

1. Establish explicit, visible top management support.
2. Focus on better decision making among operating (not just financial) personnel.
3. Achieve critical mass by building skills in a wide cross-section of the company.
4. Tightly integrate the VBM approach with all elements of planning.
5. Underemphasize methodological issues and focus on practical applications.
6. Use strategic issue analyses that are tailored to each business unit rather than a generic
approach.
7. Ensure the availability of crucial data (e.g. business-unit balance sheets).
8. Provide standardized, easy-to-use valuation templates and report formats to facilitate the
submission of management reports.
9. Tie incentives to value creation.
10. Require that capital and human resource requests be value based.

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 ADR/GDR AND SEBI GUIDELINES IN THIS RESPECT

What Are Depositary Receipts?

A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on
a local stock exchange but represents a security, usually in the form of equity, that is issued by a
foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold
shares in equity of other countries. One of the most common types of DRs is the American
depositary receipt (ADR), which has been offering companies, investors and traders global
investment opportunities since the 1920s

Since then, DRs have spread to other parts of the globe in the form of global depositary receipts
(GDRs) (the other most common type of DR), European DRs and international DRs. ADRs are
typically traded on a U.S. national stock exchange, such as the New York Stock Exchange
(NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock
exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated
in U.S. dollars, but can also be denominated in euros.

How Does the DR Work?

The DR is created when a foreign company wishes to list its already publicly traded shares or
debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange,
the company in question will first have to meet certain requirements put forth by the exchange.
Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-
counter. Let us look at an example of how an ADR is created and traded:

Example
Say a gas company in Russia has fulfilled the requirements for DR listing and now wants to list
its publicly traded shares on the NYSE in the form of an ADR. Before the gas company's shares
are traded freely on the exchange, a U.S. broker, through an international office or a local

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 brokerage house in Russia, would purchase the domestic shares from the Russian market and
then have them delivered to the local (Russian) custodian bank of the depository bank. The
depository bank is the American institution that issues the ADRs in America. In this example,
the depository bank is the Bank of New York. Once the Bank of New York's local custodian
bank in Russia receives the shares, this custodian bank verifies the delivery of the shares by
informing the Bank of New York that the shares can now be issued in the United States. The
Bank of New York then delivers the ADRs to the broker who initially purchased them.

Based on a determined ADR ratio, each ADR may be issued as representing one or more of the
Russian local shares, and the price of each ADR would be issued in U.S. dollars converted from
the equivalent Russian price of the shares being held by the depository bank. The ADRs now
represent the local Russian shares held by the depository, and can now be freely traded equity on
the NYSE.

After the process whereby the new ADR of the Russian gas company is issued, the ADR can be
traded freely among investors and transferred from the buyer to the seller on the NYSE, through
a procedure known as intra-market trading. All ADR transactions of the Russian gas company
will now take place in U.S. dollars and are settled like any other U.S. transaction on the NYSE.
The ADR investor holds privileges like those granted to shareholders of ordinary shares, such as
voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate.

Pricing and Cross-Trading

When any DR is traded, the broker will aim to find the best price of the share in question. He or
she will therefore compare the U.S. dollar price of the ADR with the U.S. dollar equivalent price
of the local share on the domestic market. If the ADR of the Russian gas company is trading at
US$12 per share and the share trading on the Russian market is trading at $11 per share
(converted from Russian rubles to dollars), a broker would aim to buy more local shares from
Russia and issue ADRs on the U.S. market. This action then causes the local Russian price and
the price of the ADR to reach parity. The continual buying and selling in both markets, however,
usually keeps the prices of the ADR and the security on the home market in close range of one

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another. Because of this minimal price differential, most ADRs are traded by means of
intramarket trading.
A U.S. broker may also sell ADRs back into the local Russian market. This is known as cross-
border trading. When this happens, an amount of ADRs is canceled by the depository and the
local shares are released from the custodian bank and delivered back to the Russian broker who
bought them. The Russian broker pays for them in roubles, which are converted into dollars by
the U.S. broker.

The Benefits of Depositary Receipts

The DR functions as a means to increase global trade, which in turn can help increase not only
volumes on local and foreign markets but also the exchange of information, technology,
regulatory procedures as well as market transparency. Thus, instead of being faced with
impediments to foreign investment, as is often the case in many emerging markets, the DR
investor and company can both benefit from investment abroad. Let's take a closer a look at the
benefits:

For the Company

A company may opt to issue a DR to obtain greater exposure and raise capital in the world
market. Issuing DRs has the added benefit of increasing the share's liquidity while boosting the
company's prestige on its local market ("the company is traded internationally"). Depositary
receipts encourage an international shareholder base, and provide expatriates living abroad with
an easier opportunity to invest in their home countries. Moreover, in many countries, especially
those with emerging markets, obstacles often prevent foreign investors from entering the local
market. By issuing a DR, a company can still encourage investment from abroad without having
to worry about barriers to entry that a foreign investor might face.

For the Investor

Buying into a DR immediately turns an investors' portfolio into a global one. Investors gain the

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benefits of diversification while trading in their own market under familiar settlement and
clearance conditions. More importantly, DR investors will be able to reap the benefits of these
usually higher risk, higher return equities, without having to endure the added risks of going
directly into foreign markets, which may pose lack of transparency or instability resulting from
changing regulatory procedures. It is important to remember that an investor will still bear some
foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the
other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to
most foreign currencies.

Conclusion
Giving you the opportunity to add the benefits of foreign investment while bypassing the
unnecessary risks of investing outside your own borders, you may want to consider adding these
securities to your portfolio. As with any security, however, investing in ADRs requires an
understanding of why they are used, and how they are issued and traded.

Types of Depository Recepits

  American Depositary Receipts (ADR)  

Companies have a choice of four types of Depositary Receipt facilities: unsponsored
and three levels of sponsored Depositary Receipts. Unsponsored Depositary Receipts
are issued by one or more depositaries in response to market demand, but without a
formal agreement with the company. Today, unsponsored Depositary Receipts are
considered obsolete and, under most circumstances, are no longer established due to
lack of control over the facility and its hidden costs. Sponsored Depositary Receipts are
issued by one depositary appointed by the company under a Deposit Agreement or
service contract. Sponsored Depositary Receipts offer control over the facility, the
flexibility to list on a national exchange in the U.S. and the ability to raise capital.

Sponsored Level I Depositary Receipts

A sponsored Level I Depositary Receipt program is the simplest method for companies

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to access the U.S. and non-U.S. capital markets. Level I Depositary Receipts are traded
in the U.S. over-the-counter ("OTC") market and on some exchanges outside the
United States. The company does not have to comply with U.S. Generally Accepted
Accounting Principles ("GAAP") or full Securities and Exchange Commission ("SEC")
disclosure. Essentially, a Sponsored Level I Depositary Receipt program allows
companies to enjoy the benefits of a publicly traded security without changing its
current reporting process

. The Sponsored Level I Depositary Receipt market is the fastest growing segment of
the Depositary Receipt business. Of the more than 1,600 Depositary Receipt programs
currently trading, the vast majority of the sponsored programs are Level I facilities. In
addition, because of the benefits investors receive by investing in Depositary Receipts,
it is not unusual for a company with a Level I program to obtain 5% to 15% of its
shareholder base in Depositary Receipt form. Many well-known multinational
companies have established such programs including: Roche Holding, ANZ Bank,
South African Brewery, Guinness, Cemex, Jardine Matheson Holding, Dresdner Bank,
Mannesmann, RWE, CS Holding, Shiseido, Nestle, Rolls Royce, and Volkswagen to
name a few. In addition, numerous companies such as RTZ, Elf Aquitaine, Glaxo
Wellcome, Western Mining, Hanson, Medeva, Bank of Ireland, Astra, Telebrás and
Ashanti Gold Fields Company Ltd. started with a Level I program and have upgraded
to a Level II (Listing) or Level III (Offering) program.

Sponsored Level II And III Depositary Receipts

Companies that wish to either list their securities on an exchange in the U.S. or raise
capital use sponsored Level II or III Depositary Receipts respectively. These types of
Depositary Receipts can also be listed on some exchanges outside the United States.
Each level requires different SEC registration and reporting, plus adherence to U.S.
GAAP. The companies must also meet the listing requirements of the national
exchange (New York Stock Exchange, American Stock Exchange) or NASDAQ,
whichever it chooses.

Each higher level of Depositary Receipt program generally increases the visibility and

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attractiveness of the Depositary Receipt.

Private Placement (144A) Depositary Receipt

In addition to the three levels of sponsored Depositary Receipt programs that trade
publicly, a company can also access the U.S. and other markets outside the U.S.
through a private placement of sponsored Depositary Receipts. Through the private
placement of Depositary Receipts, a company can raise capital by placing Depositary
Receipts with large institutional investors in the United States, avoiding SEC
registration and to non-U.S. investors in reliance on Regulation S. A Level I program
can be established alongside a 144A program.

Global Depositary Receipts (GDR)

GDRs are securities available in one or more markets outside the company’s home
country. (ADR is actually a type of GDR issued in the US, but because ADRs were
developed much earlier than GDRs, they kept their denotation.) The basic advantage of
the GDRs, compared to the ADRs, is that they allow the issuer to raise capital on two
or more markets simultaneously, which increases his shareholder base. They gained
popularity also due to the flexibility of their structure.

GDR represents one or more (or fewer) shares in a company. The shares are held by
the custody of the depositary bank in the home country. A GDR investor holds the
same rights as the shareholders of ordinary shares, but typically without voting rights.
Sometimes voting rights can be the executed by the depositary bank on behalf of the
GDR holders.

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 How are DRs Traded?

  Description
A Depositary Receipt is a negotiable security which represents the underlying securities
(generally equity shares) of a non-U.S. company. Depositary Receipts facilitate U.S.
investor purchases of non-U.S. securities and allow non-U.S. companies to have their stock
trade in the United States by reducing or eliminating settlement delays, high transaction
costs, and other potential inconveniences associated with international securities trading.
Depositary Receipts are treated in the same manner as other U.S. securities for clearance,
settlement, transfer, and ownership purposes. Depositary Receipts can also represent debt
securities or preferred stock.

The Depositary Receipt is issued by a U.S. depositary bank, such as The Bank of New
York, when the underlying shares are deposited in a local custodian bank, usually by a
broker who has purchased the shares in the open market. Once issued, these certificates may
be freely traded in the U.S. over-the-counter market or, upon compliance with U.S. SEC
regulations, on a national stock exchange. When the Depositary Receipt holder sells, the
Depositary Receipt can either be sold to another U.S. investor or it can be canceled and the
underlying shares can be sold to a non-U.S. investor. In the latter case, the Depositary
Receipt certificate would be surrendered and the shares held with the local custodian bank
would be released back into the home market and sold to a broker there. Additionally, the
Depositary Receipt holder would be able to request delivery of the actual shares at any time.
The Depositary Receipt certificate states the responsibilities of the depositary bank with
respect to actions such as payment of dividends, voting at shareholder meetings, and
handling of rights offerings.

Depositary Receipts (DRs) in American or Global form (ADRs and GDRs, respectively) are
used to facilitate cross-border trading and to raise capital in global equity offerings or for

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mergers and acquisitions to U.S. and non-U.S. investors.

Demand For Depositary Receipts

The demand by investors for Depositary Receipts has been growing between 30 to 40
percent annually, driven in large part by the increasing desire of retail and institutional
investors to diversify their portfolios globally. Many of these investors typically do not, or
cannot for various reasons, invest directly outside of the U.S. and, as a result, utilize
Depositary Receipts as a means to diversify their portfolios. Many investors who do have
the capabilities to invest outside the U.S. may prefer to utilize Depositary Receipts because
of the convenience, enhanced liquidity and cost effectiveness Depositary Receipts offer as
compared to purchasing and safekeeping ordinary shares in the home country. In many
cases, a Depositary Receipt investment can save an investor up to 10-40 basis points
annually as compared to all of the costs associated with trading and holding ordinary shares
outside the United States.

Issuance
Depositary Receipts are issued or created when investors decide to invest in a non-U.S.
company and contact their brokers to make a purchase. These brokers, through their
international offices or through a local broker in the company's home market, purchase the
underlying ordinary shares and request that the shares be delivered to the depositary bank's
custodian in that country. The broker who initiated the transaction will convert the U.S.
dollars received from the investor into the corresponding foreign currency and pay the local
broker for the shares purchased. On the same day that the shares are delivered to the
custodian bank, the custodian notifies the depositary bank. Upon such notification,
Depositary Receipts are issued and delivered to the initiating broker, who then delivers the
Depositary Receipts evidencing the shares to the investor. Your broker can also obtain
Depositary Receipts by purchasing existing Depositary Receipts, which is not a new
issuance.

Transfer - (Intra-Market Trading)

Once Depositary Receipts are issued, they are tradable in the United States and like other

15
 U.S. securities, they can be freely sold to other investors. Depositary Receipts may be sold
to subsequent U.S. investors by simply transferring them from the existing Depositary
Receipt holder (seller) to another Depositary Receipt holder (buyer); this is known as an
intra-market transaction. An intra-market transaction is settled in the same manner as any
other U.S. security purchase: in U.S. dollars on the third business day after the trade date
and typically through The Depository Trust Company (DTC). Intra-market trading accounts
for approximately 95 percent of all Depositary Receipt trading in the market today.
Accordingly, the most important role of a depositary bank is that of Stock Transfer Agent
and Registrar. It is therefore critical that the depositary bank maintain sophisticated stock
transfer systems and operating capabilities.

Comparison between ADRs & GDRs

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 ADR GDR

Centre The NYSE is the largest stock The LSE is not as large as the NYSE overall,
exchange in the world by both but is the Global center for international
value and turnover, foreign equities, which dominate in turnover.
equities play a minor role.

Instrument No large or technical difference Unlike the NYSE, the LSE makes no demands
between an ADR and a GDR. requiring companies to give holders the right to
The US has three levels of ADR vote. The NYSE insists on this point.
programme: Level III is suited to
fundraising.

Disclosure Comprehensive disclosure Detailed information required on the company,

required for F-1, the US but less onerous for GDR listing then full
prospective which must equity.
accompany a public offering.

GAAP Foreign companies listing in the LSE satisfied with a statement of the difference
US must reconcile their accounts between the UK and Indian accounting
to US GAAP. standards.

Cost US listing could be expensive. GDR listing on the LSE is comparatively

Total initial costs likely to be in inexpensive. Initial costs likely to be in the
the rang of US $ 10,00,000 to US rang US $ 2,00,000 to US $ 4,00,000.
$ 20,00,000.

retail A public offering in the US Over 5,000 US QIBs accessed , but ordinary
allows an issuer to access the US investors cannot participate. US demand
retail market. This provides extra therefore not maximized.
sources of demand.

Liability Legal liability of both a company Legal liability of a company and its director is
and its individual directors less than in the case of an ADR.
increased by a full US listing.

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18
Guidelines for ADR/GDR issues by the Indian Companies -
Disinvestment of shares by the Indian companies in the Overseas market through issue of
ADRs/GDRs

(i) Divestment by shareholders of their holdings of Indian companies, in the overseas markets
would be allowed through the mechanism of Sponsored ADR/GDR issue in respect of:-
(a) Divestment by shareholders of their holdings of Indian companies listed in India;
(b) Divestment by shareholders of their holdings of Indian companies not listed in India but
which are listed overseas.
(ii) The process of divestment would be initiated by such Indian companies whose shares are
being offered for divestment in the overseas market by sponsoring ADR/GDR issues against the
block of existing shares offered by the shareholders under the provisions of these guidelines.
(iii) Such a facility would be available pari-passu to all categories of shareholders, of the
company whose shares are being sold in the ADR/GDR markets overseas. This would ensure
that no class of shareholders gets a special dispensation.
(iv) The sponsoring company, whose shareholders propose to divest existing shares in the
overseas market through issue of ADRs/GDRs will give an option to all its shareholders
indicating the number of shares to be divested and the mechanism how the price will be
determined under the ADR/GDR norms. If the shares offered for divestment are more than the
pre-specified number to be divested, shares would be accepted for divestment in proportion to
existing holdings.
(v) The proposal for divestment of the existing shares in the ADR/GDR market would have to be
approved by a special resolution of the company whose shares are being divested.
(vi) The proceeds of the ADR/GDR issue raised abroad shall be repatriated into India within a
period of one month of the closure of the issue.
(vii) Such ADR/GDR issues against existing shares arising out of the divestment would also
come within the purview of the existing SEBI Takeover Code if the ADRs/GDRs are cancelled
and the underlying shares are to be registered with the company as shareholders.
(viii) Divestment of existing shares of Indian companies in the overseas markets for issue of
ADRs/GDRs would be reckoned as FDI. Such proposals would require FIPB approval as also
other approvals, if any, under the FDI policy.

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(ix) Such divestment inducting foreign equity would also need to conform to the FDI sectoral
policy and the prescribed sectoral cap as applicable. Accordingly the facility would not be
available where the company whose shares are to be divested is engaged in an activity where
FDI is not permitted.
(x) Each case would require the approval of FIPB for foreign equity induction through offer of
existing shares under the ADR/GDR route.
(xi) Other mandatory approvals such as those under the Companies Act, etc. as applicable would
have to be obtained by the company prior to the ADR/GDR issue.
(xii) The issue related expenses (covering both fixed expenses like underwriting commissions,
lead managers charges, legal expenses and reimbursable expenses) for public issue shall be
subject to a ceiling of 4% in the case of GDRs and 7% in the case of ADRs and 2% in case of
private placements of ADRs/GDRs. Issue expenses beyond the ceiling would need the approval
of RBI. The issue expenses shall be passed onto the shareholders participating in the sponsored
issue on a prorate basis.
(xiii) The shares earmarked for the sponsored ADR/GDR issue may be kept in an escrow
account created for this purpose and in any case, the retention of shares in such escrow account
shall not exceed 3 months.
(xiv) If the issues of ADR/GDR are made in more than one tranche, each tranche would have to
be treated as a separate transaction.
(xv) After completing the transactions, the companies would need to furnish full particulars
thereof including amount raised through ADRs/GDRs, number of ADRs/GDRs issued and the
underlying shares offered, percentage of foreign equity level in the Indian company on account
of issue of ADRs/GDRs, details of issue parameters, details of repatriation, and other details to
the Exchange Control Department of the Reserve Bank of India, Central Office, Mumbai within
30 days of completion of such transactions.
(xvi) The tax provision under Section 115 AC of the Income Tax Act 1961, which is applicable
to non-resident investors for ADR/GDR offering against issue of fresh underlying shares would
extend to non-resident investors investing in foreign exchange in ADRs/GDRs issued against
disinvested existing shares, in terms of the relevant provisions of the Income Tax Act, 1961

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(xvii) Resident shareholders divesting their holdings will be subject to Capital Gain tax
provisions applicable under the Income Tax Act 1961 i.e. Section 115 AC applicable for non-
residents would not extend to them.

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 LOAN SYNDICATION

Introduction on Loan Syndication:

There has been a sharp rise in loan off-take recently, with the credit growth being 25% higher
than the previous year. As India Inc. goes on a capital expenditure and expansion spree, the
financial system is witnessing a subtle change in the way credit is mopped up. More and more
corporate are looking at loan syndications - a common phenomenon in the West.

 "Syndication is an arrangement where a group of banks, which may not have any other business
relationship with the borrower, participate for a single loan."

 "A syndicated facility is a lending facility, defined by a single loan arrangement, in which
several or many banks participate."

The standard theory for why banks join forces in a syndicate is risk diversification. The banks in
the syndicate share the risk of large, indivisible investment projects. Syndicates may also arise
because additional syndicate members provide informative opinions of investment projects or
additional expertise after the funding has been extended.

In other words - if a company wants a huge amount as a loan for expansion or any other purpose,
say when Reliance or ITC wants money, loans are got from the banks. But generally, its got from
a single bank and that single bank alone shares the risk. Take the case of funding a rocket launch
- if the launch is a failure, then the bank which funds for it may become bankrupt. But in
syndication, many banks come together and fund a single project, hence sharing the risks. This
also assists in getting competitive interest rates for the banks. Generally, when a group of banks
get together, they select a lead bank which handles all the dealings with the company, such as
negotiating the interest rates, and hence a deal is signed between the company and the banks.
Loan syndication is basically done to share the total loss or liability.

 Typically, syndicated loans are structured as term loans or operating revolvers. However, they
may also include tranche or segmented structures, letters of credit, acquisition facilities,
construction financing, asset-based structures, project financing and trade finance.

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When Does a Corporate Go for Syndication?

Corporate opt for syndication when: -

 The borrower wants to raise large amount of money quickly and conveniently.
  The amount exceeds the exposure limits or appetite of any one lender.
  The borrower does not want to deal with a large number of lenders.

 Traditionally, loan syndication was practiced in Europe. Euro syndicated loan is usually a
floating rate loan with fixed maturity, a fixed draw down period and a specified repayment
schedule. One, two or even three banks may act as lead managers and distribute the loan among
themselves and other participating banks. One of the lead banks acts as the agent bank and
administers the loan after execution, disbursing funds to the borrower, collecting and distributing
interest payments and principal repayments among lead banks, etc. A typical Euro credit would
have maturity between 5 to 10 years, amortization in semi-annual installments, and interest rate
reset every three or six months with reference to LIBOR.

 Syndicated loans can be structured to incorporate various options, e.g., a drop lock feature
converts the floating rate loan into a fixed rate loan if the benchmark index hits a specified floor.
A multi-currency option allows the borrower to switch the currency of denomination on a roll-
over date. Security in the form of government guarantee or mortgage on assets is required for
borrowers in developing countries like India.

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Types of Syndications

Globally, there are three types of underwriting for syndications: an underwritten deal, best-
efforts syndication, and a club deal. The European leveraged syndicated loan market almost
exclusively consists of underwritten deals, whereas the U.S. market contains mostly best-efforts.

1. Underwritten deal

An underwritten deal is one for which the arrangers guarantee the entire commitment, then
syndicate the loan. If the arrangers cannot fully subscribe the loan, they are forced to absorb the
difference, which they may later try to sell to investors. This is easy, of course, if market
conditions, or the credit’s fundamentals, improve. If not, the arranger may be forced to sell at a
discount and, potentially, even take a loss on the paper. Or the arranger may just be left above its
desired hold level of the credit.

Arrangers underwrite loans for several reasons. First, offering an underwritten loan can be a
competitive tool to win mandates. Second, underwritten loans usually require more lucrative fees
because the agent is on the hook if potential lenders balk. Of course, with flex-language now
common, underwriting a deal does not carry the same risk it once did when the pricing was set in
stone prior to syndication.

2. Best-efforts syndication

A best-efforts syndication is one for which the arranger group commits to underwrite less than
the entire amount of the loan, leaving the credit to the vicissitudes of the market. If the loan is
undersubscribed, the credit may not close—or may need major surgery to clear the market.
Traditionally, best-efforts syndications were used for risky borrowers or for complex
transactions. Since the late 1990s, however, the rapid acceptance of market-flex language has
made best-efforts loans the rule even for investment-grade transactions.

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 3. Club deal

A club deal is a smaller loan—usually $25–100 million, but as high as $150 million—that is pre-
marketed to a group of relationship lenders. The arranger is generally a first among equals, and
each lender gets a full cut, or nearly a full cut, of the fees.

The Syndication Process:

Leveraged transactions fund a number of purposes. They provide support for general corporate
purposes, including capital expenditures, working capital, and expansion. They refinance the
existing capital structure or support a full recapitalization including, not infrequently, the
payment of a dividend to the equity holders. They provide funding to corporations undergoing
restructurings, including bankruptcy, in the form of super senior loans also known as debtor in
possession (DIP) loans. Their primary purpose, however, is to fund M&A activity, specifically
leveraged buyouts, where the buyer uses the debt markets to acquire the acquisition target’s
equity.

In the U.S., the core of leveraged lending comes from buyouts resulting from corporate activity,
while, in Europe, private equity funds drive buyouts. In the U.S., all private equity related
activities, including refinancing and recapitalizations are called sponsored transactions; in
Europe, they are referred to as LBOs.

A buyout transaction originates well before lenders see the transaction’s terms. In a buyout, the
company is first put up for auction. With sponsored transactions, a company that is for the first
time up for sale to private equity sponsors is a primary LBO; a secondary LBO is one that is
going from one sponsor to another sponsor, and a tertiary is one that is going for the second time
from sponsor to sponsor. A public-to-private transaction (P2P) occurs when a company is going
from the public domain to a private equity sponsor.

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As prospective acquirers are evaluating target companies, they are also lining up debt financing.
A staple financing package may be on offer as part of the sale process. By the time the auction
winner is announced, that acquirer usually has funds linked up via a financing package funded by
its designated arranger, or, in Europe, mandated lead arranger (MLA).

Before awarding a mandate, an issuer might solicit bids from arrangers. The banks will outline
their syndication strategy and qualifications, as well as their view on the way the loan will price
in market. Once the mandate is awarded, the syndication process starts.

In Europe, where mezzanine capital funding is a market standard, issuers may choose to pursue a
dual track approach to syndication whereby the MLAs handle the senior debt and a specialist
mezzanine fund oversees placement of the subordinated mezzanine position.

The arranger will prepare an information memo (IM) describing the terms of the transactions.
The IM typically will include an executive summary, investment considerations, a list of terms
and conditions, an industry overview, and a financial model. Because loans are unregistered
securities, this will be a confidential offering made only to qualified banks and accredited
investors. If the issuer is speculative grade and seeking capital from nonbank investors, the
arranger will often prepare a “public” version of the IM. This version will be stripped of all
confidential material such as management financial projections so that it can be viewed by
accounts that operate on the public side of the wall or that want to preserve their ability to buy
bonds or stock or other public securities of the particular issuer (see the Public Versus Private
section below). Naturally, investors that view materially nonpublic information of a company are
disqualified from buying the company’s public securities for some period of time. As the IM (or
“bank book,” in traditional market lingo) is being prepared, the syndicate desk will solicit
informal feedback from potential investors on what their appetite for the deal will be and at what
price they are willing to invest. Once this intelligence has been gathered, the agent will formally
market the deal to potential investors.

The executive summary will include a description of the issuer, an overview of the transaction
and rationale, sources and uses, and key statistics on the financials. Investment considerations
will be, basically, management’s sales “pitch” for the deal.

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The list of terms and conditions will be a preliminary term sheet describing the pricing, structure,
collateral, covenants, and other terms of the credit (covenants are usually negotiated in detail
after the arranger receives investor feedback).

The industry overview will be a description of the company’s industry and competitive position
relative to its industry peers.

The financial model will be a detailed model of the issuer’s historical, pro forma, and projected
financials including management’s high, low, and base case for the issuer.

Most new acquisition-related loans are kicked off at a bank meeting at which potential lenders
hear management and the sponsor group (if there is one) describe what the terms of the loan are
and what transaction it backs. Management will provide its vision for the transaction and, most
importantly, tell why and how the lenders will be repaid on or ahead of schedule. In addition,
investors will be briefed regarding the multiple exit strategies, including second ways out via
asset sales. (If it is a small deal or a refinancing instead of a formal meeting, there may be a
series of calls or one-on-one meetings with potential investors.)

In Europe, the syndication process has multiple steps reflecting the complexities of selling down
through regional banks and investors. The roles of each of the players in each of the phases are
based on their relationships in the market and access to paper. On the arrangers’ side, the players
are determined by how well they can access capital in the market and bring in lenders. On the
lenders’ side, it is about getting access to as many deals as possible.

There are three primary phases of syndication in Europe. During the underwriting phase, the
sponsor or corporate borrowers designate the MLA (or the group of MLAs) and the deal is
initially underwritten. During the sub-underwriting phases, other arrangers are brought into the
deal. In general syndication, the transaction is opened up to the institutional investor market,
along with other banks that are interested in participating.

In the U.S. and in Europe, once the loan is closed, the final terms are then documented in
detailed credit and security agreements. Subsequently, liens are perfected and collateral is
attached.

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Loans, by their nature, are flexible documents that can be revised and amended from time to time
after they have closed. These amendments require different levels of approval. Amendments can
range from something as simple as a covenant waiver to something as complex as a change in
the collateral package or allowing the issuer to stretch out its payments or make an acquisition.

Loan Market Participants

There are three primary-investor constituencies: banks, finance companies, and institutional
investors; in Europe, only the banks and institutional investors are active.

In Europe, the banking segment is almost exclusively made up of commercial banks, while in the
U.S. it is much more diverse and can involve a commercial bank, a savings and loan institution,
or a securities firm that usually provides investment-grade loans. These are typically large
revolving credits that back commercial paper or are used for general corporate purposes or, in
some cases, acquisitions.

For leveraged loans, U.S. banks typically provide unfunded revolving credits, letters of credit
(LOCs), and—although they are becoming increasingly less common—amortizing term loans,
under a syndicated loan agreement. European banks fund and hold all tranches within the credit
structure.

Finance companies have consistently represented less than 10% of the leveraged loan market,
and tend to play in smaller deals—$25–200 million. These investors often seek asset-based loans
that carry wide spreads and that often feature time-intensive collateral monitoring.

Institutional investors in the loan market are principally structured vehicles known as
collateralized loan obligations (CLO) and loan participation mutual funds (known as “prime
funds” because they were originally pitched to investors as a money-market-like fund that would
approximate the prime rate) also play a large role. Although U.S. prime funds do make
allocations to the European loan market, there is no European version of prime funds because

28
European regulatory bodies, such as the Financial Services Authority (FSA) in the U.K., have
not approved loans for retail investors.

In addition, hedge funds, high-yield bond funds, pension funds, insurance companies, and other
proprietary investors do participate opportunistically in loans. Typically, however, they invest
principally in wide-margin loans (referred to by some players as “high-octane” loans), with
spreads of 500 bps or higher over the base rate.

CLOs are special-purpose vehicles set up to hold and manage pools of leveraged loans. The
special-purpose vehicle is financed with several tranches of debt (typically a ‘AAA’ rated
tranche, a ‘AA’ tranche, a ‘BBB’ tranche, and a mezzanine tranche) that have rights to the
collateral and payment stream in descending order. In addition, there is an equity tranche, but the
equity tranche is usually not rated. CLOs are created as arbitrage vehicles that generate equity
returns through leverage, by issuing debt 10 to 11 times their equity contribution. There are also
market-value CLOs that are less leveraged—typically three to five times—and allow managers
more flexibility than more tightly structured arbitrage deals. CLOs are usually rated by two of
the three major ratings agencies and impose a series of covenant tests on collateral managers,
including minimum rating, industry diversification, and maximum default basket.

In the U.S., CLOs had become the dominant form of institutional investment in the leveraged
loan market by 2007, taking a commanding 60% of primary activity by institutional investors.
But when the structured finance market cratered in late 2007, CLO issuance tumbled and by mid-
2008, the CLO share had fallen to 40%.

In Europe, over the past few years, other vehicles such as credit funds have begun to appear on
the market. Credit funds are open-ended pools of debt investments. Unlike CLOs, however, they
are not subject to ratings oversight or restrictions regarding industry or ratings diversification.
They are generally lightly levered (two or three times), allow managers significant freedom in
picking and choosing investments, and are subject to being marked to market.

In addition, in Europe, mezzanine funds play a significant role in the loan market. Mezzanine
funds are also investment pools, which traditionally focused on the mezzanine market only.
However, when second lien entered the market, it eroded the mezzanine market; consequently,

29
mezzanine funds expanded their investment universe and began to commit to second lien as well
as payment-in-kind (PIK) portions of transaction. As with credit funds, these pools are not
subject to ratings oversight or diversification requirements, and allow managers significant
freedom in picking and choosing investments. Mezzanine funds are, however, riskier than credit
funds in that they carry both debt and equity characteristics.

Retail investors can access the loan market through prime funds. Prime funds were first
introduced in the late 1980s. Most of the original prime funds were continuously offered funds
with quarterly tender periods. Managers then rolled true closed-end, exchange-traded funds in
the early 1990s. It was not until the early 2000s that fund complexes introduced open-ended
funds that were redeemable each day. While quarterly redemption funds and closed-end funds
remained the standard because the secondary loan market does not offer the rich liquidity that is
supportive of open-end funds, the open-end funds had sufficiently raised their profile that by
mid-2008 they accounted for 15-20% of the loan assets held by mutual funds.

As the ranks of institutional investors have grown over the years, the loan markets have changed
to support their growth. Institutional term loans have become commonplace in a credit structure.
Secondary trading is a routine activity and mark-to-market pricing as well as leveraged loan
indexes have become portfolio management standards.

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Credit Facilities

Syndicated loans facilities (Credit Facilities) are basically financial assistance programs that are
designed to help financial institutions and other institutional investors to draw notional amount
as per the requirement.

There are four main types of syndicated loan facilities: a revolving credit; a term loan; an
amortizing term loan; an institutional term loan:

A revolving credit line allows borrowers to draw down, repay and re-borrow as often as
necessary. The facility acts much like a corporate credit card, except that borrowers are charged
an annual commitment fee on unused amounts, which drives up the overall cost of borrowing
(the facility fee). In the U.S., many revolvers to speculative-grade issuers are asset-based and
thus tied to borrowing-base lending formulas that limit borrowers to a certain percentage of
collateral, most often receivables and inventory. In Europe, revolvers are primarily designated to
fund working capital or capital expenditures (capex).

A term loan is simply an installment loan, such as a loan one would use to buy a car. The
borrower may draw on the loan during a short commitment period and repay it based on either a
scheduled series of repayments or a one-time lump-sum payment at maturity (bullet payment).
There are two principal types of term loans: an amortizing term loan and an institutional term
loan.

An amortizing term loan (A-term loan or TLA) is a term loan with a progressive repayment
schedule that typically runs six years or less. These loans are normally syndicated to banks along
with revolving credits as part of a larger syndication. In the U.S., A-term loans have become
increasingly rare over the years as issuers bypassed the bank market and tapped institutional
investors for all or most of their funded loans.

An institutional term loan (B-term, C-term or D-term loan) is a term-loan facility with a
portion carved out for nonbank, institutional investors. These loans became more common as the
institutional loan investor base grew in the U.S. and Europe. These loans are priced higher than

31
amortizing term loans because they have longer maturities and bullet repayment schedules. This
institutional category also includes second-lien loans and covenant-lite loans.

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Indian Banks Entering Loan Syndication Market:

Union Bank of India, Bank of India, Allahabad Bank, Corporation Bank, UCO, United Bank of
India are among the banks entering this space. Traditional players will now have to chase
customers given the increase in competition. State-owned banks such as Union Bank of India,
Bank of India, Allahabad Bank, Corporation Bank, UCO, United Bank of India are gradually
making inroads into this domain and giving the traditional leaders in the loan syndication market
such as SBI Capital Markets, Axis Bank, IDBI Bank, a run for their fee income. The prospect of
earning an attractive fee income by leveraging their corporate relationships is luring banks to set
up loan syndication desks.

In the case of plain vanilla loan syndication, a bank earns a fee ranging between 25 and 50 basis
points (of the loan amount), depending on the size of the loan. If a bank chooses to underwrite
the syndication then it can earn anywhere between 50 basis points and 100 basis points. Unlike
the leaders, who routinely syndicate loans in excess of Rs 1,000 crore for large corporates, the
aspiration of the new entrants is modest. They are looking to arrange sub-Rs 1,000 crore loans
for mid-size corporates. Given that newer players are entering their turf, past achievements alone
will no longer assure business for the traditional leaders in the loan syndication market. They
cannot hope for walk-in business and will have to chase customers instead.

When the loan requirement of a corporate is large, then its lead bank undertakes to syndicate the
loan. The lead bank on its part takes a large credit exposure to the corporate even as it maintains
a prudent and manageable credit exposure by roping in other banks which take a portion of the
loan on their books. In a bid to diversify its revenue stream, Allahabad Bank set up its
syndication desk about two months ago. So far the bank has completed two transactions and
another five to six are in the pipeline. “Loan syndication is a good source of fee income for
banks. Our bank is focusing on mid-segment customers. The average size of these transactions is
in the Rs 100-400 crore range,” said Mr. K.R. Kamath, Chairman and Managing Director,
Allahabad Bank.

Corporate customers are more comfortable when the entire loan syndication deal is handled by a
single bank rather than approaching several banks themselves. “We can give value in terms of

33
convenience and quick delivery of service to corporate customers going in for syndication,” Mr.
Kamath explained. Corporation Bank recently set up a syndication cell in a bid to grow its fee
income. “We have just made a beginning. We have a couple of credit and marketing officers in
the syndication cell actively scouting for business,” said a senior bank official.

Bank of India is in the process of setting up a dedicated loan syndication desk. A bank official
said “instead of knocking on the doors of various banks for funds, it will be advantageous for a
corporate to assign the mandate in this regard to a single bank. It is easier for a bank, which has
already done due diligence on a corporate, to talk to other banks and tie up resources.” Union
Bank of India has already set up a large syndication desk comprising about 15 credit officers
specialising in different sectors of the economy. Most of the credit officers either have
engineering-MBA (finance) background or are Chartered Accountants. A senior official said the
bank has made a beginning by undertaking loan syndication of small ticket size, around Rs 500
crore.

Once it gains requisite experience in the market, the bank plans to arrange big ticket loans for
India Inc. The buoyancy in the loans syndication business can be gauged from the fact that SBI
Capital Markets, the investment banking subsidiary of State Bank of India, has helped 24
companies, most of them in the core sector, tie up funds aggregating Rs 72,500 crore from banks
in the first three months of the current financial year. This is against around Rs 95,000 crore for
54 companies it arranged in the whole of the last financial year.

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