Investors who bet on the maiden Indian Depository Receipt (IDR) issue from Standard Chartered Plc, despite the regulatory uncertainty involved with this instrument, suffered a setback on Monday after a SEBI directive.

The market regulator issued a circular last Friday stating that redemptions in IDR are allowed only if the instruments were infrequently traded — if the trading turnover is less than 5 per cent of the outstanding IDRs.

The monthly trading volume of the IDR over the last six months was 56 per cent (annualised) of the outstanding IDRs.

The move may mean that the Standard Chartered IDRs cannot be converted into shares as expected. This not only does away with the arbitrage opportunity but could also impact future price discovery for the Indian security.

As the one year lock-in for conversion of IDR into shares concludes this week (June 11), investors were probably hoping to take advantage of the premium that the Standard Chartered Plc's London listed shares were trading (adjusted for currency) over the Indian IDR.

Standard Chartered Plc stock was trading at an average premium of 9 per cent over IDR over the last one year, before the Monday's price decline. This premium may allow arbitrage profits even after accounting for the transaction costs. This premium was shrinking over the last few days as the expected conversion date was nearing.

Less volatile stock

Regulatory issues notwithstanding, the StanChart IDR has proved to be a defensive bet for investors in India with a 14.8 per cent return, ahead of Monday's fall. Much of the returns of the IDR was due to the pound appreciation as Standard Chartered PLC's shares are trading at a similar price as a year ago.

Investors who held on to this instrument had actually enjoyed similar returns as that of BSE Bankex but at a far lower volatility until Monday.

As the Indian banking sector underperforms, Standard Chartered was expected to be a good diversifier to investors' banking portfolio. The correlation between the index and Standard Chartered stock was low at 0.01 year-to-date.

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