The history of cross-listed securities goes back to the 1920s, but there has been a dramatic increase in them, particularly in the US and the UK, since the nineties. Between 1990 and 2000, the number of foreign corporations listed on the NYSE and Nasdaq increased by 450%. Depository receipt programmes increased by more than 500% during the same period. The original programme allowed US investors to register and earn dividends on non-US stock without direct access to the overseas market itself, enabling them to acquire underlying shares in the form of depository receipts. At the moment, cross-border investment programmes are prevalent in foreign capital markets, allowing prospective issuing companies (irrespective of location) a vehicle to generate liquidity that would previously have been unavailable. Such programmes have become attractive to corporations and companies listed on domestic stock exchanges in emerging markets (Brazil, Russia, India and China, for instance). This has led to the issuance of tradable notes in the form of programmes aimed at international investors in such markets.

In the last few years, the advantages and exposure associated with issuing programmes has begun to attract companies from GCC countries, particularly from the United Arab Emirates and Bahrain. Some 34 companies from GCC countries have successfully gained listing on the LSE by virtue of their programmes, with four new entrants alone in 2008. This year, a Kuwaiti investment company successfully issued shares in the form of Global Depository Receipts (GDRs) to foreign investors, thereby becoming the first Kuwaiti company to gain listing on the LSE through the issuance of its GDR programme. This has created a stir among Kuwait capital market watchers and will undoubtedly lead to other Kuwaiti listed companies following suit and issuing their own GDRs.

At present, Kuwait (like other GCC states) has not promulgated specific legislation or guidelines regarding GDRs. There are therefore potential difficulties that may be faced by companies interested in issuing GDR programmes from Kuwait.

GDRs and potential issuers

The Kuwaiti economy is vibrant today, experiencing steady growth, brisk expansion of its GDP, rising per capita income, a widening budget surplus, rising foreign reserves and an active capital and real estate market. Kuwait's economy seems to have come of age, which has led investors to expand into established capital markets. Structured reforms to the capital markets in Kuwait have strengthened inward activity in areas such as banking and real estate development, and listed companies on the Kuwait Stock Exchange (KSE) are now beginning to move outside Kuwait into world capital markets.

The potential desire of listed companies in Kuwait to consider adopting GDR programmes may have received some impetus from market segmentation. GDR programmes and cross-listing in general allow potential issuers to increase capital liquidity and deepen their pool of securities, thus leading to increased share valuation both domestically and internationally. It may be that Kuwaiti companies (which traditionally have not protected minority shareholders very well) are signaling their desire to respect the rights of all their shareholders by listing in jurisdictions with higher scrutiny, tougher regulations and better enforcement (the LSE, for instance). However, the rationale behind GDR programmes and the advantages to potential Kuwaiti issuers, as well as international institutional investors, is multi-faceted. All of these aspects are now being studied.

The GDR programme model in Kuwait is becoming typical of other GDR programmes throughout the world. Depository programmes for Kuwaiti stocks represent underlying shares in issuing companies in Kuwait, structured as GDRs that are quoted and then traded in USD or Euros. Depository banks appointed by issuers through depository agreements hold overseas securities (underlying shares) in custody in Kuwait and convert all dividends and other payments into USD to receipt holders (institutional investors, for instance) irrespective of location. Investors typically bear the currency risk and indirectly pay fees to the depository bank. Each depository receipt denotes shares that represent a specific number of underlying shares in Kuwait (depository receipt ratio, also known as DR ratio). New receipts are then created by the depository bank for investors when the requisite number of shares is deposited in their custodial accounts in Kuwait. Cancellation or redemption of GDRs simply reverses the process.

Kuwaiti companies have come to understand the need to expand outside of Kuwait. By issuing GDR programmes, investors are more likely to show interest. This potential has encouraged institutional investors to shift from a trading approach to long-term ownership. The need to meet this new objective is pressing for Kuwaiti companies that would like to issue GDRs. The potential benefits to Kuwaiti companies are as follows:

• companies can broaden and diversify their investor base by attracting institutional investors from international money markets, thus allowing them to reduce dependency on investors in their traditional spheres of influence (exclusively in Kuwait, for instance);
• companies have the opportunity to enhance their visibility, status and (more importantly) profile as seen through the eyes of international investors;
• companies can potentially increase their liquidity, which in turn can be used to diversify their portfolio of products and services, as well as the opportunity to develop their presence regionally; and
• a potential knock-on effect (as experienced in other emerging markets, for instance India and Russia) is that domestic regulators have been compelled to get in line with international standards, thereby improving investor confidence and stimulating market growth in the GDR sector.

Potential legal hurdles

Under the Kuwaiti Commercial Companies Law (CCL) Article 111, shareholders in Kuwaiti stock companies (KSC) have a pre-emptive right to subscribe to any issuance of new shares. However, Article 111 also provides that the Articles of Association (AOA) of a KSC may include a provision eliminating such right. If the AOA does not provide for the right to waive pre-emptive rights, either approval of all the shareholders would be required or the company would be required to hold an extraordinary general meeting to provide for the right of the shareholders to make such a waiver and to approve the capital increase of the company. The reason why a waiver of pre-emption is important stems from the fact that the fresh issuance of shares which are then offered to foreign investors in the form of GDR programmes would need to be offered without encumbrances as a pre-condition to listing on the LSE and NYSE. Though GDRs are not against statute in Kuwait (unlike Russia or India), Kuwait has yet to enact specific legislation governing GDRs or their procedural requirements. It is anticipated that a ministerial resolution will soon be issued to give direction regarding minimum shareholding for non-Kuwaitis in GDR issuances in light of the fact that the potential for Kuwaiti companies to exercise the issuing of GDR programmes is great.

At present, Kuwaiti companies that wish to issue their own GDR programmes must cross the pre-emption rights hurdle, which is dependent upon shareholder participation and consent.

Minority shareholders do have some protection under the CCL, which provides that shareholders owning at least 15% of shares in a KSC have recourse to courts in Kuwait to challenge the validity of a company board resolution in excess of the board's authority (to waive pre-emption rights as well as to amend the AOA to increase capital and waive rights, for instance). Due to lack of legislation, there is no other forum for dispute resolution open to shareholders in the event that internal meetings reach a stalemate: the only option for a minority shareholder would be to seek court intervention. This is not without limitations, not just in terms of legal costs, procedural delays and so on, but the courts fundamentally lack legislative guidance and would have no test cases to aid them if such a dispute arose where minority shareholders were resisting amendments to a company's AOA because of a company's intent to issue a GDR programme. In the event of court intervention, Kuwaiti courts would likely only offer a remedy in the form of adjourning the enforcement of any such resolution, thereby allowing majority shareholders to purchase minority shareholders' shares. This not only provides minority shareholders with leverage but also presumes that the majority shareholders would have the financial resources to purchase the shares of minority shareholders.

Tax

Income tax in Kuwait is governed by Decree 3 of 1955 (Income Tax Decree), as amended by Law 2 of 2008 Amending Certain Provisions of Kuwait Income Tax Decree 3 of 1955 published in Al-Kuwait Al-Youm (the Official Gazette of the State of Kuwait) on February 3 2008, together with the Income Tax Decree (Income Tax Laws). Regulations setting out the implementation of the amendment were issued in the second half of July 2008.

Under the Income Tax Laws, there is no income tax payable in Kuwait on capital gains realised from trading of shares of companies listed on the KSE. Income tax (if any) that is payable upon the distribution of any cash dividends, bonus shares, other in-kind distribution or on undistributed profits of Kuwaiti companies listed on the KSE that are held by foreign corporate entities will be imposed at a rate of 15%.

It is the long-standing practice of the Department of Income Tax (DIT) to levy income tax only on foreign corporate entities deemed by the DIT to be carrying on business or trade in Kuwait as defined in Article 2(1) of the Income Tax Laws. Kuwaiti companies whose capital is wholly-owned by Kuwaiti or GCC nationals (including companies incorporated in Kuwait or the GCC and whose capital is wholly owned by Kuwaiti or other GCC nationals) and individuals (regardless of their nationality, domicile or place of residence) are not subject to any income tax in Kuwait.

The senior officials at the DIT have expressed the view that dividends should be taxed under the Income Tax Laws and that such tax would be calculated on the amount of dividends distributed to the foreign corporate entity and not on the basis of such entity's pro rata share in the company's undistributed net profits. The view that foreign shareholders will not be subject to their respective interests in undistributed profits of a Kuwaiti company is reasonable because:

• there is no express provision in the amendment, Income Tax Decree or any other existing law, rule or regulation in Kuwait which imposes income tax on shareholders on the undistributed profits of KSE-listed companies;
• there is no past practice by the DIT under the Income Tax Decree of imposing income tax on shareholders of any KSE-listed company for any undistributed profits; and
• before the amendment, the DIT is believed to have taken the view that it had the right to tax foreign corporate entities for the portion of undistributed profits of a KSE-listed company but did not seek to enforce this right and the DIT has indicated that it does not intend to impose a tax on undistributed profits of KSE-listed companies following enactment of the amendment.

Furthermore, there are no express provisions in the amendment, the Income Tax Decree or any other existing laws, rules or regulations which impose a tax on distributions of bonus shares or other non-cash or in-kind distributions by companies in Kuwait. There is also no precedent of the DIT imposing taxes on such distributions. Senior officials at the DIT confirmed that at the moment there is no tax on bonus shares but that this position may be reviewed should the DIT determine that distributions of bonus shares are being used as a way of avoiding taxation of income.

If income tax is payable on the dividend, the liability to pay the same will be on the foreign shareholder under Kuwaiti law. However, the foreign shareholder may decide to pass the liability on to the individual GDR holders.

Foreign shareholders' rights

Potential Kuwaiti issuers of GDR programmes would presumably enter into highly regulated markets where shareholders' rights and obligations with regard to voting and disclosure are clearly set out in the relevant rules and regulations. However, these fundamental rights and obligations are not clearly defined under Kuwaiti rules and regulations.

Regarding shareholder disclosure obligations, Law 2 of 1999 and KSE Decision 5 of 1999 require that shareholders holding interests in Kuwaiti listed companies which equal or exceed 5% are required to disclose them to the KSE. This obligation is also imposed on companies in which shareholders hold those underlying shares (second tier ownership, for instance, is also likely to apply to GDR holders). Therefore, the GDR holder and/or foreign depository may be compelled to make such disclosures if it or its shareholders acquire shares of 5% or more of the share capital of a company listed on the KSE. It is unclear whether the foreign depository bank would have the obligation in addition to the GDR holder or even in lieu of the GDR holder. In other words, it is not clear who would be regarded as the shareholder for the purposes of the disclosure law with respect to GDRs. We note that if any violation of the aforementioned laws is discovered, the result will be disqualification of the violating shareholders from exercising voting rights for two consecutive meetings of the shareholders and disqualification of its representatives from acting on the board of directors.

Regarding the voting rights of GDR holders, Kuwaiti legislation does not specifically set out voting rights of foreign shareholders and/or the depository bank for GDRs.

According to Kuwaiti law, a shareholder has to use all of its shares to vote in a particular manner, and cannot vote a portion of its shareholding in favour of a resolution and the other portion of its shares against the same resolution. Since the shareholder is the sole registered owner of the shares against which GDRs have been issued and holds them for the benefit of many individual GDR holders, one way for the shareholder to vote is to do so as instructed by the majority of the GDR holders.

An alternative voting arrangement is to treat the shareholder as a portfolio manager. Under Kuwaiti law, a Kuwaiti investment company holding shares in an investment portfolio is allowed to vote such shares in accordance with the wishes of the portfolio owner. In such a case, a Kuwaiti investment company can vote shares it holds in an investment portfolio both in favour of a particular resolution and against a particular resolution, depending on the voting instructions received from the various portfolio owners. Since the shareholder will be using the shares to vote on behalf of the individual beneficial owners (as is the case for a portfolio manager), it may be better to allow the shareholder to vote in accordance with instructions from the GDR holders for a particular resolution so as to better reflect the voting preferences of the individual beneficial owners of the company. However, the Kuwaiti regulatory authorities have not provided any views on treating the shareholder, holding shares against which GDRs have been issued, as a portfolio manager.

Listed companies in Kuwait are coming to understand the benefits associated with GDR programmes. The objectives of foreign investors have changed: by issuing GDRs, Kuwaiti companies are set to tap into this pool of potential investors in the Kuwaiti capital markets. However, in the short term at least, the above issues remain and it remains to be seen how they will be resolved.

Author biographies

Rob Little Rob Little is a member of Al Sarraf & Al Ruwayeh. He was born in 1963 and received his education at the University of Saskatchewan, Canada. He was admitted to both the Law Society of Upper Canada (Ontario) and the Law Society of Saskatchewan in 1993. Before joining Al Sarraf & Al Ruwayeh, Rob practiced law in Canada. While in Canada, he lectured on the Bar Admission Course and published papers on various aspects of commercial law. Rob specialises in general corporate commercial law, capital markets, project work and financial transactions and regularly advises banks and other financial institutions. Rob has recently been selected by Best Lawyers publication as being among the best lawyers in Kuwait in various specialties. Mike Durgavich Mike Durgavich is an associate in Al Sarraf & Al Ruwayeh and is based at the Bahrain office. Mike received his BA in Economics from the University of Virginia in 1986. He attended the California Western School of Law in San Diego and received his Juris Doctorate in 1993. He is admitted to practice in California and in the Federal Courts of the United States. Mike practices in the areas of corporate law, securities, banking and finance and mergers and acquisitions on behalf of local and international clients.