While India has recently widened channels allowing foreign investors to invest directly into equities through the qualified foreign investor (QFI) scheme, BNY Mellon says it is missing out on billions of dollars of investor demand via the over-the-counter market.

Fund managers, chiefly in the US, are hoping to get exposure to India-listed companies through OTC American depositary receipts (ADRs), notes Neil Atkinson, vice-president of depositary receipts in Hong Kong at BNY Mellon.

The US firm, which has a substantial DR business, has been lobbying the Securities and Exchange Board of India (Sebi), the country’s Ministry of Finance and the Reserve Bank of India to allow OTC ADRs. Referencing India’s ADR development, BNY Mellon says in a client letter: “The elephant can already dance; it's time to learn some new steps.”

There are various reasons that foreign investors prefer buying OTC ADRs to listed ordinary shares via the QFI or foreign institutional investor (FII) route, says Atkinson.

Last year, the Indian government started allowing foreign investors to invest directly into onshore equities and bonds through QFI, which does away with the requirement to register with the Securities and Exchange Board of India (Sebi). Thus far, QFI has facilitated direct equity investment amounting to Rp6.8 billion ($126 million).

But QFI is mired with operational hurdles, says BNY Mellon, such as requirements to set up a permanent account number (a tax ID number for non-residents) and to pre-fund trades. 

Another way of investing in Indian stocks is via P-notes (a form of derivative), but this involves taking on counterparty credit risk, whereas buying ADRs does not, says Atkinson.

Many separately managed accounts in the US managed by institutional investors have ADR-only mandates, he adds, and investors in these vehicles are frustrated by the lack of access to Indian equities in ADR form.

Of the 72 Indian companies in the MSCI emerging market index, only eight are available in DR form that can be openly accessed by investors (i.e. they are not restricted by private placement programmes).

The bank argues that for fund houses with AUM lower than $20 billion – which covers many Asian firms, such as China’s GF Fund Management and China Southern Fund Management – the challenges of investing directly into India are more acute. Yet it remains to be seen whether an additional OTC instrument would entice these managers to increase their India exposure.

DRs are not new to India; the regulator has, since 1992, approved 330 Indian corporates to list DRs globally, with 13 in the form of ADRs on the New York Stock Exchange and Nasdaq. The bulk of the rest are listed in London, Luxembourg, and Singapore.

The benefit of OTC ADRs for issuers is that foreign companies do not have to comply with US GAAP reporting requirements, or provide full US Securities and Exchange Commission disclosure.

BNY Mellon says it acts as depositary for more than 2,700 American and global DR programmes with companies across 68 countries. For the fourth quarter of 2012 the business (under ‘issuer services’) accounted for 13.6% of the group’s total $1.56 billion in investment services fees.