European Monetary System The European Monetary System (EMS) was the forerunner of Economic and Monetary Union

(EMU), which led to the establishment of the Euro. It was a way of creating an area of currency stability throughout the European Community by encouraging countries to co-ordinate their monetary policies. It used an Exchange Rate Mechanism (ERM) to create stable exchange rates in order to improve trade between EU member states and thus help the development of the single market. Stable money had been a key part of international economic calculations since World War II. However, by the 1980s, opinion about it was much more divided. As a result, not all countries took part in the EMS straight away, and there were deeper splits in the years to come over the role of the EU in setting monetary policy as the EMS was replaced with the Euro. History The EMS was launched in 1979 to help lead to the ultimate goal of EMU that had been set out in the Werner Report (1970). Since World War II, attempts had been made to maintain currency stability amongst major currencies through a system of fixed exchange rates called the Bretton Woods System. This collapsed in the early 1970s. However, European leaders were keen to maintain the principle of stable exchange rates rather than moving to the policy of floating exchange rates that was gaining popularity in the USA. This led them to create the EMS. It was not an entirely successful move because, firstly, it posed many technical difficulties in setting the correct rate for all member states, and secondly, some members were less committed to it than others. Britain didnt join the ERM until 1990 and was

forced to leave it in 1992 because it could not keep within the exchange rate limits. The project, however, continued: under the Maastricht Treaty (1992), the EMS became part of the wider project for EMU that was developed during the 1990s. When the Euro came into being in 1999, EMS was effectively wound up, although the ERM remained in operation. How did the European Monetary System work? The most important part of EMS was the Exchange Rate Mechanism. This committed all member states governments to keep their currency exchange rates within bands. This meant that no countrys exchange rate could fluctuate more than 2.25% from a central point. This was designed to help create stable commerce without the fear that sudden changes in the values of currencies would dampen trade and encourage the development of trading barriers between member states. It also created a European Currency Unit (ECU) to be used as a unit of account. Although not a real currency, the ECU became the basis for the idea of creating a single currency an idea that was realised with the launch of the Euro in 1999. Facts and Figures rate of 2.95 Deutschmarks to one Pound Sterling. Many feel this rate was too high and caused Britains rapid departure from the system. September 1992 (a day that became known as Black Wednesday), because it was no longer possible to keep the pound within the bands of the ERM. Arguments For

The European Monetary System was important in ensuring currency stability in the European Community at a time when international markets were very volatile. f the single market project would have been more difficult. Against Fixing exchange rates is dangerous because unless the correct rate is set and changed appropriately, a national economy can be forced to pursue policies that are not best suited to domestic conditions simply in order to maintain international stability. monetary policy can suit all member states. The events of 1992 proved that this was not the case. Quotes ERM was a recipe for instability This instability produced a damaging recession Professor Patrick Minford, Cardiff Business School, 2002 Technical Terms Monetary policy: the policies employed by Governments or Central Banks to control money supply and interest rates to achieve economic goals. Exchange rate: the ratio in which one countrys currency is valued against another. Fixed or floating exchange rates: in a fixed rate system all rates are set at commonly agreed levels. In a floating system they are allowed to find their own place through market pressure. Unit of account: an agreed measure for stating the prices of goods and services. Links 10.2.2 Global Depository Receipts (GDRs) GDRs are traded and settled outside the United States. Rule 144A of the

Securities and Exchange Commission (SEC) of U.S.A., however, permits the companies from outside USA to offer their GDRs to Qualified Institutional Buyers (QIB). American Depository Receipts (ADR) are DRs issued in the United States and have to be in accordance with the stringent provisions stipulated by the Securities and Exchange Commission. Global Depository Receipt is in the nature of a depository receipt or certificate created by an overseas depository bank (authorised by the issuing company) outside India and is issued to non-resident investors against the issue of FCCB's or shares of the issuer company. It is a negotiable certificate in US dollars, and traded freely in foreign markets like other securities and can be issued by way of private placement also. Prior permission of Ministry of Finance, Government of India, is required for issue of GDRs. Since the start of the practice of issue of ECBs and GDRs by Indian Companies, substantial foreign investment has come to India and Indian Stocks are now listed on London and Luxembourg Stock Exchanges. 10.2.3 American Depository Receipts (ADR) ADR's are depository receipts issued in United States of America (USA) in accordance with the provisions of Securities and Exchange Commission. Since US market exposes to a higher level of responsibility, disclosures, costs and liability, Indian Companies have resorted to GDR's only. Listing provisions in USA are very stringent. Issue of ADR is costlier. Legal fees, underwriting, road show costs, investor relations and registration fees are also higher. The broader the investor base in USA, the higher is the potential of legal liability for inadequate disclosures.

ADRs are US dollar denominated negotiable instruments issued in the US by a depository bank, representing ownership in non-US securities (underlying ordinary shares). In case of ADR issues, companies have to comply with strict reporting requirements of SEC and US GAAP which requires the total issue cost to be written off in the year of issue. ADRs are subject to two-way fungibility and apprehends large capital inflows. International Financing Decisions a) b) c) d) ADRs can be listed on New York Stock Exchange, American Stock Exchange or NASDAQ. Depository receipts permit investors to trade in foreign securities and at the same time giving the issuing companies an access to major international markets. American Depository Receipts are an offshoot of DR's and are US dollar denominated negotiable instruments issued in the US by a depository bank, representing ownership in non-US securities. ADR's provide non-US companies with access to the US capital markets which has the world's largest domestic investor base. 10.2.4 Foreign Currency Convertible Bonds (FCCBs) Foreign Currency Convertible Bond is an equity linked debt security which can be converted into shares or into DRs. It is a foreign currency debt instrument that an Indian Company issues. The investor in the FCCB has the option to convert it into equity usually in accordance with a predetermined formula and sometimes also at a predetermined exchange rate. This offers capital appreciation on sale. He has also the option to retain it as a bond. Investors have an option to convert the bond if the market price of the stock goes up beyond a percentage of the share price at the time of issue at a predetermined premium. Alternatively,
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some companies retain the right to convert compulsorily. FCCBs are bonds which are convertible into underlying equity, shares of the company, at a predetermined price, at any time at the investor's option, but after 1-2 years after the issue. The maturity of bond can be upto 10-12 years and if the option to convert equity is not exercised, the bond is redeemed. Most FCCB issues are listed at London or Luxembourg stock exchanges. These are bearer securities and generally such issues incorporate put and call options. 10.2.5 Foreign Currency Options Authorised dealers of foreign exchange are permitted to write and trade in cross currency options, to facilitate hedging of foreign exchange risk subject to Reserve Bank of India guidelines, dated 13th September, 1993. 10.2.6 Other International Instruments Instruments such as Yankee Bonds, Samurai Bonds etc. which are found in US and Japanese markets are also being considered now by Indian Companies. Reliance Industries Ltd. issued Yankee bonds in August 1996. The opportunities in the Indian Capital Markets has also attracted foreign investors. With the opening up of Indian market to the world investors, the following instruments have been recognised as essential instruments for trading in the secondary market, These are options, futures and derivatives. Yankee Bonds: Reliance Industries Ltd, had issued Yankee Bonds in US markets with longest ever maturity offering by any sovereign or corporate entity with Baa 3 rating from Moody's in August 1996. The maturity of these bonds is 50 years. The major terms and conditions are Final maturity at 50 years for the first time from an Asian/Indian Issuer. Size: US dollar 100 million. Coupon: 1.0.5 per cent.

No road shows, deals done on phone and screen. Now we examine GDR, ADR and ECB in details. 8 10.3 GLOBAL DEPOSITARY RECEIPTS (GDRs) GDR is a security issud abroad and is listed and traded on a foreign stock exchange. GDR holder can at any time convert it into shares represented by it. Till conversion, GDRs do not carry any voting right. Depository receipts facilitate cross border trading and settlement, minimise transaction cost and broaden the potential investor base. The shares are issued by a company to an intermediary called the depository in whose name, the shares are registered. This depository subsequently issues the GDRs. The physical possession of equity shares is entrusted to another intermediary called the custodian who acts as an agent of depository .The advantage in GDR issue is that company does not assume any exchange risk. The dividend outflow from the company is in Rupees only but depository converts these rupee payments and pays the dividend in US dollar to the ultimate investors after deducting a withholding tax of 10 per cent on deposit. Once a GDR has been issued, it can be freely traded among international investors. GDR plays a crucial role in international corporate finance. GDR's are used to: raise debt or equity capital; diversify shareholder base; increase demand for securities; enhance global image; and create dollar-denominated securities. The depository performs the following functions: Issuing depository receipts upon delivery of the underlying security to its custodian account and releasing the underlying

security into the home market upon cancellation of DR. Processing DR transfers, maintaining records of registered holders, paying dividends and responding to shareholder enquiries. Holding. consultations with the issuer to promote its DR programme, reporting on the progress, supplying trading and shareholding information and-providing assistance in ensuring regulatory compliance. Cost of GDR issues Cost of issue of GDR comprises of following components: Brokerage. Underwriter commission. Management fee. Legal fee Travel and road shows. Printing and stationery, Listing fee. Stamp duty. Accounting fees. In a size of $ 50 million euro issue, cost would be around 4 to 6 per cent whereas in a issue of equivalent size in domestic market, the cost would be between 14-18 per cent. 9 Raising Funds from International Market (i) (ii) (iii) (iv) (v) (i) (ii) (iii) (i) (ii) (iii) (iv) (v) (vi) (vii) (viii) (ix) International Financing Procedure for GDR issue In a GDR issue, the issuing company issues ordinary shares as per the scheme and delivers the ordinary shares to domestic custodian bank, which will, in terms of the agreement, instruct the overseas depository bank to issue global depository receipt. or certificate to the non-resident investors against the shares held by domestic custodian bank. GDR is normally issued in negotiable form and may be listed on any international stock exchange for trading outside India. Most companies list GDRs in Luxembourg or Dublin Stock Exchanges. The shares

underlying the GDRs will be registered in the name of the overseas depository bank, which will be the holder in the books of the company. The non-resident holder of GDR may transfer those receipts, or may ask the overseas depository bank (ODB) to redeem those receipts. In case of redemption, the ODB shall request domestic custodian bank (DCB) to get the corresponding shares released in favour of the non-resident investors for being sold directly on behalf of the nonresident investors or being transferred in the books of account of the issuing company in the name of the nonresident. In case of redemption of GDRs into underlying shares, a request will be transmitted by the ODB to the DCB with a copy to the company. The cost of acquisition of the shares shall be the cost on the date on which the ODB advises the DCB for redemption. The price of the shares on the stock exchange shall be taken as the cost. Holders of GDRs will have no voting rights or other direct rights of a shareholder with respect to the shares underlying such GDRs. Registered holders of shares withdrawn from the depository arrangement will be entitled to vote and exercise other direct shareholders' rights in accordance with the Indian law. Withdrawn shares cannot be redeposited. Holders of GDRs will be entitled to receive dividends paid on the underlying shares, subject to the tenns of the issue. So long as the GDRs are not withdrawn, the relevant ODB will, in connection with such outstanding shares, convert Rupee dividend into dollars. The outstanding shares of the company under the GDR issue will be listed on Indian Stock Exchanges. Table 10.3 lists the GDR issues by Selected Indian Companies in the recent past. Decisions

10 11 Raising Funds from International Market International Financing 10.4 AMERICAN DEPOSITORY RECEIPTS (ADRs) Introduced to the financial market in 1927, an American Depository Receipt (ADR) is a stock that trades in the Untied States but represents a specified number of shares in a foreign corporation ADRs are bought and sold on American markets just like regular stocks, and are issued / sponsored in the U.S. by a bank or brokerage. ADRs were introduced as a result of the complexities involved in buying shares rn foreign countries. Primarily, the difficulties are associated with trading at different prices and currency values. For this reason, U.S. Banks simply purchase a lot of shares from the company, bundle the shares into groups, and reissue them on the NYSE, AMEX, or NASDAQ. The depository bank sets the ratio of U.S. ADRs per home country share. This ratio can be anything less than or greater than 1. The reason they do this is because they wish to price the ADR high enough so as to show substantial value, yet low enough, so that the individual investors can purchase these shares. The majority of ADRs range between $10 and $100 per share. If, in the home country, the shares were worth considerably less, then each ADR would represent several real shares. There are three different types of ADR issues: Level 1 This is the most basic type of ADR where foreign companies either don't qualify or don't wish to have their ADR listed on an exchange. Levell ADRs are found on the OTC market and are an easy and inexpensive way to gauge interest for its securities in North America. Levell ADRs also have the loosest requirements from the SEC. Level 2: This type of ADR is listed on an exchange or quoted on NASDAQ. These

ADRs have slightly more rigorous requirements from the SEC but they also get higher visibility and trading volume. Level 3: The most prestigious of the three, this is when an issuer floats a public offering of ADRs on a U.S. exchange. Level 3 ADRs are able to raise capital at low cost and gain substantial visibility in the U.S. financial markets. The advantages of ADRs are twofold. For individuals, ADRs are an easy and cost effective way to buy shares in a foreign company. They save considerable money by reducing administration costs and avoiding foreign taxes on each transaction. Foreign entities like ADRs because they get more U.S. exposure and allow them to tap into the wealthy North American equity markets. In return, the foreign company must provide detailed financial information to the sponsoring bank. A significant portion of public offering by non-US companies (and we're most concerned with Indian companies) in the US is in the form of ADRs, or American Depository Receipts (also called American Depository Shares or ADS). ADRs are negotiable receipts issued to investors by an authorised depository, normally a US bank or depository, in lieu of shares of the foreign company which are actually held by the depository. ADRs can be listed and traded in a USbased stock exchange and help the Indian company to be known in the highly liquid US stock exchanges. ADRs also help the US-based and other foreign investors to have the twin benefits of having shareholdingin a high growth Indian company and the convenience of trading in a highly liquid and well-known stock market. Companies go through the depository route

Indian companies are prohibited by law from listing rupee-denominated shares directly in foreign stock markets. Therefore, they issue such shares to a depository Decisions 12 which has an office within India. These shares remain in India with a custodian. Against the underlying shares, the depository issues dollar-denominated receipts to the foreign investors. The foreign investors can then sell these receipts in the foreign stock exchanges or back to the depository and get delivery of the underlying rupee-denominated shares which can then be sold in Indian markets. This is generally done if institutional investors with a presence in both India and the US see an arbitrage opportunity arising out of a difference in prices on the US and Indian exchanges. Difference between ADRs & GDRs ADRs are listed on an American stock exchange. The issue process is governed by American laws and Securities and Exchange Commission (SEC) - the market regulator monitors the issue. GDRs or global depository receipts are listed in a stock exchange other than American stock exchanges, say Luxembourg or London. A listing in America involves adhering to very stringent disclosure and accounting norms. The accounts of the company have to be represented according to US GAAP or generally accepted accounting principles. US GAAP requires representing a combined balance sheet of all group companies, and not just the company which is going for the issue. Typically, a good company can expect its reported profits according to Indian accounting rules to be eroded by 20-30 per cent under US GAAP. Against this, the disclosure requirements for GDR issues are widely thought less stringent.

An ADR listing also allows the famed American retail investors to part-take in the offering and leads to wider interest and better valuations of a company's stock, thus enhancing shareholder value. Also, the Indian company can acquire US companies against issue of shares. The GDR market is mainly an institutional market with lower liquidity. Characteristics of an ADR ADRs are quoted in US dollars and are generally structured so that the number of the foreign company's securities will result in a trading price for each ADR in . the range of $10-$30. The multiple or fraction that an ADR is of the underlying shares is determined with this price range in mind. The depository receives dividends directly from the Indian company in rupees and issues dividend cheques to ADR holders in dollars. When an ADR is sold back to the depository, it is considered as cancelled and the stock of ADRs is not replenished. Procedure of ADR issue The company planning to issue ADRs must get its group accounts consolidated and audited according to US GAAP by an independent agency. It also has to appoint a team of legal and compliance experts as well as Iead managers and investment bankers to the issue. The teams will then have to prepare the draft prospectus or the registration statement which will be submitted to SEC. SEC reverts with its comments and requirements, and this goes on till SEC is satisfied with the information given. Now the draft prospectus is ready to be distributed to prospective investors. Simultaneously, the company will also have to start the application process to list with the particular stock exchange. With the draft prospectus ready, the company can launch its road shows or the selling exercise for getting subscription to the issue. Prospective investors give

their price and amount to the lead managers to the issue. Based on investor response, the lead managers fix the price of the issue, which is intimated to the SEC and the concerned stock exchange. 13 Raising Funds from International Market International Financing With their concurrence, the issues is listed Table 10, 4 lists some ADR Issues made by Indian Companies Guidelines for ADR/GDR issues by the Indian Companies. A Scheme for issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipts Mechanism) was notified by the Government of India in November, 1993. Revisions/modifications in the operative guidelines for Euro-issues are announced from time to time. 2. With a view to further liberalising the operational guidelines and in particular track record scrutiny of the ADRIGDR proposals and approval mechanism various options were considered by the Government of India. Given the fact that investments through ADRIGDR being risk capital, it has been decided that the track record scrutiny process for ADRIGDR issues and the two stage approval by the Ministry of Finance, Department of Economic Affairs could be dispensed with. 3. The following guidelines for ADRIGDR issues, in continuation of the Notification of November, 1993 (amended in November, 1999) shall come into effect from the date of issue of these guidelines. These guidelines will also extend to proposals which have already been filed with the Ministry of Finance as also in cases where an `in principle' approval has been issued by the Ministry of Finance, Department of Economic Affairs. These modified guidelines will, however, not extend to Foreign Currency Covertible Bond (FCCB) issues which

will continue to be governed by existing guidelines. Further, the issue of ADRs/ GDRs under the liberalised guidelines would be only against expansion of the existing capital base through issuance of fresh equity shares as underlying shares for ADRs/GDRs. 4. Approvals 4.1 Indian companies raising money through ADRs/GDRs through registered exchanges would hence for be free to access the ADRIGDR markets through an automatic route without the prior approval of the Ministry of Decisions 14 Finance, Department of Economic Affairs. Private placement of ADRs/ GDRs would also be eligible for the automatic approval provided the issue is lead managed by an investment banker. (For the purpose of this scheme, an Investment Banker would be defined as an Investment Banker registered with the Securities and Exchange Commission in the USA, or under Financial Services Act in U.K., or the appropriate regulatory authority in Europe, Singapore or in Japan.) The track record condition will not be operative for ADR/GDR issues. 5. Mandatory Approval Requirements: 5.1 In all cases of automatic approval mentioned above, the mandatory approval requirement under FDI policy, approvals such as under the Companies Act, approvals for overseas investments/business acquisition (where ADR/GDR proceeds are utilised for overseas investments), etc. would need to be obtained by the company prior to the ADR1GDR issues. 5.2 The issuer company would need to obtain RBI approval under the provisions FERA/FEMA prior to the overseas issue. 6. End uses

While no detailed end uses are specified, the existing bar on investments in stock markets and real estate would continue to be operative. 7. Issue related expenses: The issue related expenses (covering both fixed expenses like underwriting commissions, lead managers charges, legal expenses and other reimbursible expenses) shall be subject to a ceiling of 4% in the case of GDRs and7% in the case of listing on US Exchange. Issue expenses beyond the ceiling would need the approval of RBI. Tax Impllication of ADR/GDR Taxation of income arising out of ADRs, the underlying shares and of ESOPs linked to ADRs is governed by the provisions of the Income Tax Act, 1961 (1-T Act), read with the provisions of the guidelines contained in the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Mechanism) Scheme, 1993 and Fresh Guidelines for Euro Issues, 1994 .as amended from time to time. Accordingly, there is no tax in India on transfer of ADRs between two nonresidents outside India. Redemption of ADRs into underlying shares is exempt in India, dividend income received by ADR holder or the holder of underlying shares is not taxed in their hands. Sections 1 15AC and 115CA of the I-T Act, specifically provide for taxation of long term capital gains on sale of underlying shares. However, as explained later, this aspect is fraught with ambiguity. 10.5 EXTERNAL COMMERCIAL BORROWINGS (ECBs) External Commercial Borrowings (ECBs) include: Commercial bank loans; Buyer's credit; Supplier's credit;
Securitized instruments (floating rates notes and fixed rate bonds);