Capital Market: Components & Functions of Capital Markets, Primary & Secondary Market Operations, Capital Market Instruments - Preference Shares, Equity Shares, Non-voting Shares, Convertible Cumulative Debentures (CCD), Fixed Deposits, Debentures and Bonds, Global Depository receipts, American Depository receipts, Global Debt Instruments, Role of SEBI in Capital Market.

1. Unit 3
3. Capital Market: Components & Functions of Capital
Markets, Primary & Secondary Market Operations, Capital
Market Instruments - Preference Shares, Equity Shares, Non-
voting Shares, Convertible Cumulative Debentures (CCD),
Fixed Deposits, Debentures and Bonds, Global Depository
receipts, American Depository receipts, Global Debt
Instruments, Role of SEBI in Capital Market

2. DEBENTURES
Section 2(30) of the Companies Act, 2013
defines debentures. “Debenture” includes
debenture stock, bonds or any other
instrument of a company evidencing a debt,
whether constituting a charge on the assets of
the company or not;
Debenture is a document evidencing a debt or
acknowledging it and any document which
fulfills either of these conditions is a
debenture.

3. The important features of a debenture are:
1. It is issued by a company as a certificate of indebtedness.
2. It usually indicates the date of redemption and also
provides for the repayment of principal and payment of
interest at specified date or dates.
3. It usually creates a charge on the undertaking or the
assets of the company. In such a case the lenders of money
to the company enjoy better protection as secured
creditors, i.e. if the company does not pay interest or repay
principal amount, the lenders may either directly or
through the debenture trustees bring action against the
company to realise their dues by sale of the
assets/undertaking earmarked as security for the debt.
4. Debentures holders does not have any voting rights.
5. Compulsory payment of interest. The interest on
debenture is payable irrespective of whether there are
profits made or not.

4. TYPES OF DEBENTURES
Naked or unsecured debentures
Debentures of this kind do not carry any charge on
the assets of the company.
Secured debentures
Debentures that are secured by a mortgage of the
whole or part of the assets of the company are
called mortgage debentures or secured
debentures.
Redeemable debentures
Debentures that are redeemable on expiry of certain
period are called redeemable debentures.

5. Perpetual debentures
If the debentures are issued subject to redemption on
the happening of specified events which may not
happen for an indefinite period, e.g. winding up, they
are called perpetual debentures.
Bearer debentures
Such debentures are payable to bearer and are
transferable by mere delivery.
Registered debentures
Such debentures are payable to the registered holders
whose name appears on the debenture certificate/
letter of allotment and is registered on the companies
register of debenture holders maintained as per
Section 88(1)(b) of the Companies Act, 2013.

6. Based on convertibility, debentures can be
classified under three categories:
1. Fully Convertible Debentures (FCDs)
2. Non Convertible Debentures (NCDs)
3. Partly Convertible Debentures
(PCDs)

7. FULLY CONVERTIBLE DEBENTURES
These are converted into equity shares of the
company with or without premium as per the
terms of the issue, on the expiry of specified
period or periods.
If the conversion is to take place at or after eighteen
months from the date of allotment but before 36
months, the conversion is optional on the part of
the debenture holders in terms of SEBI (ICDR)
Regulations.
Interest will be payable on these debentures upto
the date of conversion as per transfer issue.

8. NON CONVERTIBLE DEBENTURES (NCDs)
These debentures do not carry the option of conversion
into equity shares and are therefore redeemed on the
expiry of the specified period or periods.
PARTLY CONVERTIBLE DEBENTURES (PCDs)
These may consist of two kinds namely -convertible and
non-convertible. The convertible portion is to be
converted into equity shares at the expiry of specified
period.
However, the non convertible portion is redeemed at
the expiry of the stipulated period.
If the conversion takes place at or after 18 months, the
conversion is optional at the discretion of the
debenture holder.

9. Characteristics Partly convertible
debentures
Fully convertible
debentures
Suitability Better suited for companies
with established track
record
Better suited for companies
without established track
record
Capital base Relatively lower equity
capital on conversion of
debentures
Higher equity capital on
conversion of debentures
Flexibility in
financing
Favourable debt equity ratio Highly favourable debt
equity ratio
Classification for
debtC equity ratio
computation
Convertible portion
classified as ‘equity’ and
non-convertible portion as
‘debt’
Classified as equity for debt-
equity computation
Popularity Not so popular with
investors
Highly popular with
investors
Servicing of
equity
Relatively lesser burden of
equity servicing
Higher burden of servicing
of equity

10. Debt markets include:
• Primary markets for bonds, i.e. the markets in
which newly issued instruments are bought,
• Secondary markets , in which existing or
second hand instruments are traded.
Green Bond
• The capital for green bond is raised to fund ‘green’
projects like renewable energy, emission
reductions etc.
• First Green Bond was issued by World Bank in
2007.

11. • The first ever green bond was issued by
multilateral institutions (European Investment
Bank and World Bank) in 2007.
• The first green bond in India was issued by Yes
Bank in
• In 2015, EXIM bank launched India’s first dollar
denominated green bond of $500 million.
• Indian Renewable Energy Development Agency
Ltd has issued bonds to finance renewable energy
without the tag of green bonds.
• India has become the seventh largest green
bond market in the world.

12. • In January 2016, SEBI also released first Green
Bond guidelines relating to listings, norms for
raising money etc.
• According to SEBI, a bond shall be considered
green bond if the funds raised through it will be
used for renewable and sustainable energy
including wind, solar, bio-energy, other sources of
energy which use clean technology.
• Banks have also been permitted to issue green
masala bonds.
• Rural Electrification Corporation’s first
green bond has opened up for trading at the
London Stock Exchange.

13. • It is a Climate Bonds Initiative certified
green bond.
• The proceeds of the bond shall be used to
fund environment friendly projects in India
such as solar, wind
• and biomass assets, as well as sustainable
water and waste management projects.
• Through listing at the LSE, the PSU hopes
to reach out to a new investor base.

14. • Blue Bonds
• The upcoming year will witness the first ‘blue
bond’ issuance in India.
• As per Smart cities initiative, municipal bond
market will be refueled for water supply projects
(a category of Blue Blonds) in cities like Pune and
Hyderabad.
• It is a type of green bond which specifically invests
in climate resilient water management and water
infrastructure.

15. Masala Bonds
• Masala bonds are rupee-denominated bonds issued by
Indian entities in the overseas market to raise funds.
• As of now, it is being traded only at the London Stock
exchange.
• Masala bonds have been named so by the International
Finance Corporation (IFC), an investment arm of the
World Bank which issued these bonds to raise money for
infrastructure projects in India.
• They protect investors from exchange rate fluctuations as
opposed to external commercial borrowing (ECB) that
have to be raised and repaid in dollar.
• The Union Minister of Road Transport & Highways and
Shipping launched the NHAI Masala Bond (NHAI) issue
at the London Stock Exchange.

16. Sovereign Gold Bond Scheme
Sovereign Gold Bonds are government securities
denominated in physical gold.
Gold bonds are tradable on the stock exchange and
can be held in both physical or demat form.
It is issued by the RBI on behalf of the Government
of India
These bonds carry sovereign guarantee both on the
capital invested and the interest.

17. How are Bonds different to Debentures?
• Bonds are more secured compared to debentures.
A guaranteed interest rate is paid on the bonds
that does not change in value irrespective of the
profit earned by the company.
• Bonds are more secure than debentures. The
company provides collateral for the loan.
Moreover, in case of liquidation, bondholders will
be paid off before debenture holders.
• In case of bankruptcy, Debenture holders have no
collateral that a holder can claim from the
company. To compensate for this, companies pay
higher interest rates to debenture holders,
compared to Bond holders.

19. Indian Companies can raise foreign currency
funds from abroad in the following ways:
(a) by the issue of ADRs/ GDRS
(b) by the issue of ECBs
(c) by the issue of FCCBs
An ADR means an American Depository
Receipt, whereas a GDR means a Global
Depository Receipt.
ADRs (also known as American Depository
Shares or ADS) are listed on an American
stock exchange.

20. The entire issue process is in accordance with the
rules and regulations laid down by the Securities
and Exchange Commission or SEC (the capital
markets regulator in the USA).
Compared to ADRs, GDRs are listed on a stock
exchange outside the USA, normally on the
Luxembourg or London stock exchange. However,
nowadays several companies are even listing on
newer exchanges such as Singapore, etc.
ADRs/ GDRs allow companies to tap foreign
investors and thereby have a wider shareholding
leading to better valuations and stakeholder value
creation.

21. American Depository Receipts (ADR)
Devised in the late 1920s to help Americans invest
in overseas securities. The main reason for
introducing ADRs were the complexities involved
in buying shares in foreign countries and the
difficulties associated with trading at different
prices and currency values.
American Depository Receipts (ADRs) are a way of
trading non-U.S. stocks on the U.S. exchange.
Through ADRs, Indian companies who are willing
to raise funds from the U.S. can do so by issuing
shares on American Stock exchange.

22. American Depository Receipts (ADR)
However, the issuance of ADR is governed by the rules
and regulations as laid down by the regulator SEC
(Securities and Exchange Commission).
The Indian Companies will have to maintain accounts
as per the American Standards.
The Indian companies cannot directly list their equity
shares on the international stock exchange. So in
order to overcome this problem; the companies give
shares to an American bank.
These American banks in return for those shares
provide receipts to the Indian companies. The
companies raise funds by providing those ADR
receipts in American share market.

23. How are ADRs created?
Indian companies cannot directly list their equity
shares on the international stock exchange.
So, in order to overcome this problem, the
companies give shares to an American bank.
These banks will take hold of the stock, and issue
receipts to Indian companies in return.
The companies raise funds by providing those ADR
receipts in American share market. These ADRs
are listed on the major stock exchanges of the US,
like NASDAQ. They can also be sold Over-The-
Counter (OTC).

24. Trading Mechanism of ADRs
One ADR comprises of a certain number of shares
in an Indian company and these ADRs are quoted
in US dollars.
The investors of a foreign country can buy and sell
shares directly and the investor is free to convert
the ADR to receive the equivalent number of
shares.
For example, an American citizen willing to invest in
Infosys limited in U.S. can do so by purchasing
ADR from the listed entity.
As an investor, they will receive all the dividends
and capital gains in US dollars, no matter where
the original company is from.

25. Two-way Fungibility
The two-way fungibility in ADRs/ GDRs has spruced up
the ADR/ GDR market. Twoway fungibility was
introduced by the RBI in 2001.
Earlier, the ADRs/ GDRs could be converted into
ordinary Indian shares by the foreign investors
however, the converse was not possible. Now a
registered broker can purchase shares of an Indian
company which has issued ADRs/ GDRs, on behalf of
a non-resident, for converting the shares purchased
into ADRs/ GDRs.
The shares have to be purchased on a stock exchange
only. Thus, if there is an Indian company which is
only listed abroad, then it cannot avail of this facility,
e.g., Satyam Infoway, Rediff, etc. The regulatory
framework for the same is explained in para 11.7.2.

26. What are the Types of ADRs available to Investors?
All ADRs are categorized into two broad categories –
1. Sponsored ADRs
A sponsored ADR is created through an agreement
between a non-American company and an American
bank.
Here, the company handles all the costs related to the
issuing of the receipts in the American markets.
In return, the American bank handles all transactions
between the company and the American investors
through the depository receipts.
These ADRs, like normal company shares, offer voting
rights to their holders.

27. 2. Unsponsored ADRs
These ADRs are created by American banks without
the involvement or the permission of a non-
American company.
Because of this, different banks can issue
unsponsored ADRs for the same company as well.
However, since they don’t involve the company’s
participation, they are usually traded over-the-
counter or OTC.
They also don’t offer voting rights to their
shareholders.

28. These ADRs are further categorized into three more
types –
Type I ADR: These are only to establish a
presence in the American market. They don’t
permit the raising of funds.
Type II ADR: These cannot be used to raise funds,
but they are permitted to have a higher visibility
and trading volume than Type I ADRs.
Type III ADR: These are a prestigious category of
ADRs. The companies issuing these are allowed to
raise funds and float an IPO on the American
stock markets as well.

29. Global Depository Receipts (GDR)
GDR equity shares are denominated in dollar and
tradable on a stock exchange in Europe or USA.
For example, a GDR of $100 may comprise of 2
equity shares of $50 each amounting to whatever
the prevailing exchange rate is.
Main features of GDR:
GDR represents certain number of equity shares
denominated in dollar terms
The issuer collects the proceeds in foreign currency
GDRs are traded on stock exchanges of Europe and
USA

30. Main features of GDR:
And funds are raised from foreign capital market of
the USA and Europe
All shares to be issued are deposited with an
intermediary called ‘depository’ located in the
listing country
The Depository issues a receipt against these shares
Each receipt has a fixed number of shares usually 2
or 4
The shares issued to the depository may be in
physical possession of another
Intermediary called ‘custodian’ who acts as
depositor’s agent.

31. The equity shares registered in the name of
depository are then issued in form of GDR to the
investors of that foreign country
The GDR does not appear in the books of the
issuing company
ADR or GDR holders do not have voting rights and
therefore not bound by strict definition of foreign
ownership
Two-way fungibility is permitted in GDRs
whereby they are freely convertible into Shares
and back into GDRs without restriction to the
extent of the original issue size.

32. The issue of GDR is governed by international laws
Since GDR is also denominated in rupees, hence,
GDR does not carry any exchange risk as its face
value is protected against the exchange risk
GDRs are listed at Luxembourg and traded at two
other stock exchanges namely,
The OTC market in London and in the USA by
private placement
NRIs and foreign residents can buy GDR by using
their regular share trading account

33. How are GDRs created?
The process of creating a GDR is quite similar to an
ADR.
Companies can approach depository banks of
various countries and make an agreement with
them.
In exchange for the companies handling the costs
associated with trading in different markets, the
banks will handle all transactions between the
investors and the GDRs of the company.

34. Trading Mechanism of GDRs
GDRs act as negotiable certificates. Therefore,
they are usually traded just like shares of a
company in any international market.
A single GDR can represent different amounts of
shares, as per the company’s needs and
objectives.
GDRs can also be used to raise capital from
countries in the form of US Dollars or Euros.
When GDRs are traded in Euros, they are known
as European Depository Receipts or EDRs.

35. What are the Types of GDRs available to Investors?
There are two broad categories of GDRs –
1. Rule 144A GDRs
These GDRs are those which operate through the rule 144A
of the Securities Exchange Commission (SEC) of the US.
This rule allows non-American companies to trade and
raise capital in the American Markets.
It also makes these GDRs a cheaper alternative to raise
capital from American markets than Level III ADRs.
2. Regulation S GDRs
These GDRs are those which help non-American companies
raise funds and establish a trading presence in the
European markets only.
These GDRs usually trade on the London or Luxembourg
Stock Exchange only, and are popularly known as Reg S
GDRs. Only non-American investors can trade in Reg S
GDRs.
A company can issue both Reg S and Rule 144A GDRs, but
they will be subject to different laws.

36. Procedural Requirements for a GDR/ADR
Legal and accounting due diligence on Issuer in lines of
the GAAP accounting principals accepted in the US
Authorization by the shareholders
Application for listing the additional shares on the Indian
Stock Exchange
Filing
Facilitate and arrange Legal and Accounting Due
Diligence on the Issuer
Approval of the Foreign Investment Promotion Board
(‘FIPB’)
Like ADR and GDR there are “Other depository
receipts” depending on the country where it’s issued.
Euro equity issued in European countries is called as
European Depository Receipts (EDRs)
In Singapore is called as Singapore Depository
Receipts

38. Differences between ADR and GDR
American Depository Receipt (ADR) is a depository
receipt which is issued by a US depository bank
against a certain number of shares of non-US
company stock. Whereas Global Depository
Receipt (GDR) is a depository receipt which is
issued by the international depository bank,
representing foreign company’s stock.
Foreign companies can trade in US stock market,
through various bank branches with the help of
ADR. Whereas GDR helps foreign companies to
trade in any country’s stock market other than the
US stock market.

39. Differences between ADR and GDR
ADR is issued in America while GDR can be issued
in both America and Europe.
ADR is listed in American Stock Exchange i.e. New
York Stock Exchange (NYSE) whereas GDR is
listed in non-US stock exchanges like London
Stock Exchange or Luxembourg Stock Exchange.
ADR can be traded in America only while GDR can
be traded in all around the world.
ADR Market is more liquid as compared to GDR
market

40. Regulatory framework
Regular Issue
An issue of ADRs/ GDRs is governed by the FEMA
Regulations as well as the Issue of Foreign
Currency Convertible Bonds and Ordinary Shares
(Through Depository Receipt Mechanism)
Scheme, 1993 (“Scheme”) issued by the Central
Government. This Scheme is the main legislation
which governs the issue of ADRs/ GDRs

41. The important steps and conditions involved
are as follows:
(a) If the company is eligible under the Scheme to
float an issue then it does not require the prior
permission of the Finance Ministry.
(b) The company is not ineligible to issue shares to
foreign investors under the FDI policy since ADR/
GDR are treated as part of FDI.
(c) Now companies do not require the prior
approval of the Finance Ministry as it has been
put on an automatic route. Private placement of
ADRs/ GDRs are also put on this route. RBI has
also allowed such issues on an automatic route

42. (d) An Indian company which is restrained from accessing
the securities market by the SEBI is not eligible to float an
ADR / GDR issue.
(e) Issue pricing norms, which till September, 2005 were
free, have now been laid down. The minimum price in
case of a listed company must be the higher of the
following two averages:
Average weekly high and low of the closing prices of the
share quoted on the stock exchange during the 6 months
preceding the relevant date;
Average weekly high and low of the closing prices of the
share quoted on the stock exchange during the 2 weeks
preceding the relevant date;
The relevant date for this purpose means a date 30 days
prior to the date on which a shareholders’ meeting is
called for passing a Special Resolution u/s. 81(1A) of the
Companies Act, 1956. Thus, now the pricing of ADRs/
GDRs has been put on par with the preferential issue
pricing norms

43. (f) In case an unlisted company wishes to float
an ADR/ GDR issue, then it must also take
steps for prior or simultaneous listing in India.
(g) Existing Indian unlisted companies which
have already issued ADRs/ GDRs must get
listed in India on the earlier of their making a
profit from the financial year beginning 2005-
06 or within 3 years from the date of issue of
the ADRs/ GDRs. This provision would impact
unlisted companies such as Rediff, Satyam
Infoway, etc.

44. Existing Indian unlisted companies which have taken
verifiable effective steps prior to 31st August, 2005 for
getting listed are exempt from the pricing
requirements (specified in (e) above) and the
simultaneous listing condition (specified in (f) above).
The term “effective steps” is defined to mean the
following:
(i) The company has completed the due diligence and
filed the offering circular in the overseas exchange; or
(ii) The approval of the overseas exchange has been
obtained; or
(iii) The approval of the RBI (if applicable) has been
obtained for meeting issue related expenses.