ADR Prof. AT

8/4/2019 ADR Prof. AT

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Prof. Amber Tiwari

American Depository Receipt(ADR) Types of ADRs Benefits of ADRs

The ramification of Indian ADRs Global Depository Receipts Benefits and uses of a GDR


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Foreign Equity

If the equity issue is made in a particulardomestic market (in the domestic currencyof that market), it is known as a ForeignEquity Issue. For example, an Indiancompany accessing exclusively the US marketthrough an equity issue would be called aforeign equity issue. The instrumentavailable for the above case is called

American Depository

Receipts(ADR). If a non-European countryraises funds

exclusively from European countries


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Euro Equity

If a company raises funds using equity throughinstruments like Global Depository Receipts(GDRs) or superstock equity in more than oneforeign market except the domestic market ofthe issuing company and denominated in acurrency other than that of the issuers homecountry, it is known as Euro Equity Issue orGlobal Equity Issue.


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Depository Receipt (DR)

A Depository Receipt (DR) is a negotiablecertificate that usually represents a companyspublicly traded equity or debt. Depositoryreceipts are created when a broker purchasesthe company s shares on the home stockmarket and delivers those to the Depositoryslocal custodian bank, which then instructs thedepository bank, to issue Depository Receipts.

Depository receipts are quoted and traded inthe currency of the country in which theytrade, and-are governed by the trading andsettlement procedures of the market. The ease

of trading and settling DRs makes them an


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Glob

al

DRs

meric

an

A


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The most common DRs are the AmericanDepository Receipts (ADRs) and the GlobalDepository Receipts (GDRs). InternationalDepository Receipts (IDRs) and the EuropeanDepository Receipts (EDRs) are rarer forms ofDRs. From a legal and settlement standpoint,there is no difference between various types ofDRs.


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A company may issue DRs for anumber of reasons:To raise capital in foreign markets.

To increase consumer interest in theirproducts by strengthening name recognition

in foreign markets.To potentially increase the liquidity of their

shares by broadening shareholder base (DRsfacilitate cross border trading).

To gain visibility through financial marketpresence which can generate support for andinterest in potential mergers andacquisitions.


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American Depository Receipt(ADR)

An ADR is a dollar denominated negotiablecertificate that represents a non-US companyspublicly traded equity. It falls within theregulatory framework of the USA and requiresregistration of the ADRs and the underlyingshares with the Securities ExchangeCommission (SEC).

In 1990, changes in Rule 144A allowedcompanies to raise capital without having toregister with SEC.) Non-US companies have a

choice of five types of AD R facilities:


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The main hurdle in raising money in the USmarket is that most of the Indian companiesfind it difficult to meet the US GAAP. An ADRwill require complete recasting of the accountsand corporates will have to disclose far moreinformation than they are used to. Also, anADR would mean parting with the voting rightsto individual investors whereas in the case of

GDRs, the voting rights rest with thedepository. Another point that has to be takeninto account is that under the US law, thedirectors of the company are personally liable

to the shareholders. In comparison to G D Rs,


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Types of American DepositoryReceiptsThere are 5 principal types of ADR

rogrammes. The type of ADR programmeemployed depends on the requirements ofthe issuer. It can be broadly classified asunder:


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Level I ADROver-the-Counter (OTC) Traded

Level I GDRUnlisted

Level II ADRU.S. Listed

Level II GDR

Internationally Listed

Level III ADRU.S. Listed

Level III GDR

Internationally Listed

Issuer

Selling New SharesCapital RaisingTransactions

Existing Shares OnlyNon-Capital Raising

Transactions

Existing shares or newshares can be used


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Unsponsored ADR Programme:

initiated by a third party, not the issuingfirm.


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Sponsored ADR Programmes: are furthercategorized by different levels of disclosurereferents:

a. ADR Programme Level is exempt from fullcompliance with the SECs reporting requirementsand cannot be listed on the national exchanges.

b. ADR Programme Level II - should be in fullcompliance with the SECs registration disclosure and

reporting requirements which allow ADRs to be listed


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Rule 144(A) ADRs: restricted ADRs are notrequired to comply with the full SECsregistration and reporting requirements andare used for private placement to qualifiedinstitutional buyers. The trading of thesesecurities is restricted to NASDs PORTAL(Private Offerings, Resale and Trading throughAutomated Linkages) System.


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Unsponsored and SponsoredAdr Facilities

ADR facilities may be established as eitherunsponsored or sponsored. While ADRsissued under these two types of facilities are insome respects similar (for Example, each ADRrepresents a fixed number of securities ondeposit with a depository), there aredistinctions between them relating to therights and obligations of ADR holders and the

practices of market participants.


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Unsponsored Facilities

Unsponsored ADR facilities generally arecreated in response to a combination ofinvestor, broker-dealer and depositoryinterest. Most often, a depository is theprincipal initiator of a facility because itperceives US investor interest in a particularforeign security and recognizes the potentialincome that may be derived from a facility. In

other cases, one or more brokers familiar withUS investor interest and US trading activity in aforeign issuers securities may request that adepository create a facility in order to

facilitate trading.


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Features

A depository may establish an unsponsoredfacility without

participation by (or even necessarily the

acquiescence of) theissuer of the deposited securities, althoughtypically the

depository requests a letter of no objectionfrom such issuer

prior to the establishment of the facility. If theissuer is

neither a reporting issuer under the Exchange


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Once the registration statement becomeseffective, the depository begins to acceptdeposits of securities of the foreign issuer andto issue ADRs against such deposits. Depositedsecurities are usually held by a custodianappointed by the depository (often a bank) inthe country of incorporation of the foreignissuer.


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Holders of unsponsored ADRs generally bear allthe costs of

such facilities. The depository usually charges

fees uponThe deposit and withdrawal of depositedsecurities, the

conversion of dividends into US dollars, thedisposition of

non-cash distributions, and the performance ofother services.


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Sponsored Facilities

A sponsored ADR facility is establishedjointly by an issuer and a depository.Sponsored ADR facilities are createdingenerally the same manner as unsponsoredfacilities, except that the issuer of thedeposited securities enters into a depositagreement with the depository and signs theregistration statement. The deposit agreement

sets out the rights and responsibilities of theissuer, the depository and the ADR holders.Like unsponsored ADR facilities, sponsored ADRfacilities usually involve the use of a foreign

custodian to hold the deposited Securities.


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Features

With sponsored facilities, the issuer of thedeposited securities generally will bear someof the costs relating to. The facility (such asdividend payment, fees of the depository),although ADR holders continue to bear certainother costs (such as deposit and withdrawalfees).

Under the terms of most sponsoredarrangements, depositaries agree to distributenotices of shareholder meetings and voting

instructions, thereby ensuring that ADR holders


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American Depository ReceiptsUnsponsored Programmes

An unsponsored ADR programme is not initiatedor controlled by the issuer but by a bank inresponse to US investor demand. A broker actsas market maker for the issue and works inconjunction with a US bank which, acting asthe depository, will issue the ADRs.

The depository and the issuer together submitan application to the Securities and ExchangeCommission (SEC) seeking exemption from thefull reporting requirements of the Securities

Exchange Act of 1934. Upon receipt of SEC


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As unsponsored ADR programmes are exemptfrom full

compliance with the SECs reporting

requirements,. they canonly he traded on the over-the-counter (OTC)market. The

SECs only requirement is that material publicinformation

published by the issuer in its home country besupplied to the

SE~ and made available to US investors.


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American DepositoryReceipts SponsoredProgrammes


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Programme Level I

A Level I sponsored AD R programme is theeasiest and

least expensive means for a company to

provide for issuanceof its shares in ADR form in the us. A Level Iprogramme is

initiated by the issuer and involves the filing ofregistration

statement. It allows for exemption from fullSEC reporting

requirements.


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Programme Level II

A sponsored Level II ADR must comply with theSECs full registration and reportingrequirements. In addition to filing Form F-6registration statement, the issuer is alsorequired to comply with the SECs otherdisclosure rules, including submission of itsannual report which must be prepared inaccordance with US GMP. Registration allows

the issuer to list its ADRs on one of the threemajor national stock exchanges.

Level II sponsored programmes are initiated by-


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Programme Level III

Level III sponsored ADRs are similar to Level IIADRs in

that the issuer initiates the programme, deals

with onedepository bank, lists on on~ of the major USexchanges, and

files Form F-6 and 20-F registration statementswith the SEC.

The major difference is that a Level IIIprogramme allows

the issuer to raise capital through a public


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Rule 144a AmericanDepository Receipts

Rule 144A, or Restricted AD Rs are depositoryreceipts which are placed and traded inaccordance with Rule 144A, which wasintroduced by the SEC in April 1990 in part tostimulate capital raising in the US by non-USissuers. Some of the former Rule 144restrictions governing resale of privatelyplaced securities (or restricted securities) have

been lifted under Rule 144A, provided the saleis made to Qualified Institutional Buyers (QIBs).


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A QIB is currently defined as an institution,which owns and invests on a discretionary basisat least US$ 100 million (or, in the case ofregistered broker-dealers, US$ 10 million) insecurities of an unaffiliated entity. At present,there are in excess of 4000 QIBs but the SECmay decide to broaden the definition of a QIBto allow a larger number to participate in the

Rule 144A market. Non-US companies now haveeasy access to the US equity privateplacement market and may thus raise capitalthrough the issue of restricted ADRs without

conforming to the full SEC registration and


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Example

Say a gas company in Russia has fulfilled therequirements for DR listing and now wants to list itspublicly-traded shares on the NYSE in the form of anADR.

Before the gas company's shares are traded freely on the

exchange, a U.S. broker, through an international officeor a local brokerage house in Russia, would purchase thedomestic shares from the Russian market and then havethem delivered to the local (Russian) custodian bank ofthe depository bank.

The depository bank is the American institution that

issues the ADRs in America. In this example, thedepository bank is the Bank of New York.

Once the Bank of New York's local custodian bank inRussia receives the shares, this custodian bank verifiesthe delivery of the shares by informing the Bank of NewYork that the shares can now be issued in the United

States.


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Example (contd.)The Bank of New York then delivers the ADRs to the

broker who initially purchased them.

Based on a determined ADR ratio, each ADR may beissued as representing one or more of the Russian localshares, and the price of each ADR would be issued inU.S. dollars converted from the equivalent Russian priceof the shares being held by the depository bank.

The ADRs now represent the local Russian shares held bythe depository, and can now be freely traded equity onthe NYSE.

After the process whereby the new ADR of the Russiangas company is issued, the ADR can be traded freelyamong investors and transferred from the buyer to theseller on the NYSE, through a procedure known as intra-market trading.

All ADR transactions of the Russian gas company will nowtake place in U.S. dollars and are settled like any otherU.S. transaction on the NYSE.

The ADR investor holds privileges like those granted to

shareholders of ordinary shares, such as voting rightsand cash dividends. The ri hts of the ADR holder are


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Pricing and Cross-Trading

When any DR is traded, the broker will aimto find the best price of the share inquestion.

He or she will therefore compare the U.S.dollar price of the ADR with the U.S. dollarequivalent price of the local share on thedomestic market.

If the ADR of the Russian gas company is

trading at US$12 per share and the sharetrading on the Russian market is trading at$11 per share (converted from roubles todollars), a broker would aim to buy morelocal shares from Russia and issue ADRs on

the U.S. market.


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The Benefits of DepositaryReceipts

The DR functions as a means to increaseglobal trade, which in turn can helpincrease not only volumes on local andforeign markets but also the exchange of

information, technology, regulatoryprocedures as well as market transparency.

Thus, instead of being faced withimpediments to foreign investment, as is

often the case in many emerging markets,the DR investor and company can bothbenefit from investment abroad.


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For the Company

A company may opt to issue a DR to obtaingreater exposure and raise capital in theworld market.

Issuing DRs has the added benefit ofincreasing the share's liquidity whileboosting the company's prestige on itslocal market ("the company is tradedinternationally").

Depositary receipts encourage aninternational shareholder base, andprovide expatriates living abroad with aneasier opportunity to invest in their homecountries.

Moreover in man countries es eciall


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Benefits for the Investor

Buying into a DR immediately turns aninvestors' portfolio into a global one.

Investors gain the benefits of

diversification, while trading in their ownmarket under familiar settlement andclearance conditions.

DR investors will be able to reap thebenefits of these usually higher-risk,higher-return equities, without having toendure the added risks of going directly

into foreign markets, which may pose lack


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Definition of Important Terms

Domestic Custodian Bank

means a banking company which acts as a custodian for the ordinaryshares or foreign currency convertible bonds of an Indian Companywhich are issued by it against global depositary receipts or certificates;

Foreign Currency Convertible Bonds

means bonds issued in accordance with this scheme and subscribed bya non- resident in foreign currency and convertible into ordinary sharesof the issuing company in any manner, either in whole, or in part, onthe basis of any equity related warrants attached to debt instruments;

Global Depositary Receipts

means any instrument in the form of a depositary receipt or certificate

(by whatever name it is called) created by the Overseas DepositaryBank outside India and issued to non- resident investors against theissue of ordinary shares or Foreign Currency Convertible Bonds ofissuing company;

Issuing Company

means an Indian company permitted to issue Foreign CurrencyConvertible Bonds or ordinary shares of that company against GlobalDepositary Receipts;


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ADR Risks

There are several factors that determinethe value of the ADR beyond theperformance of the company. Analyzingthese foreign companies involves further

scrutiny than merely looking at thefundamentals. Here are some other risksthat investors should consider:

Political Risk - Ask yourself if you think thegovernment in the home country of theADR is stable? For example, you might bewary of Russian Vodka Inc. because of thecharacteristic instability of the Russian

government.


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The Process

The process of issuing an ADR usually startsby seeking a financial advisor, aninternational investment bank, or may beinitiated by a foreign investment bank that

recognizes the attraction to a company forits money management clients (and ofcourse the fees generated for its ownbottomline).

The advisor would then contactcommercial banks that can act as adepository in the foreign market and as acustodian in the domestic market and formthe depository trust against shares held in

the domestic market.


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The Process (contd.)

To set the price of the ADR, the advisor goes through a price discoveryprocess as dictated by the markets, participants, and the supply-demandconsiderations.

The advisor might invite other investment banks to join it to form asyndicate.

The syndicate should have more financial muscle and bigger client base to

place the issue in the market. A foreign investor may find it beneficial to invest in an ADR as opposed to

a domestic share, for a variety of reasons

lack of custody or safekeeping agent in the foreign market,

difficult settlement procedures for share purchase and transactioncosts associated with foreign currencies.

The ADRs, from the perspective of a foreign buyer, may be moreliquid as they trade among large institutional investors and can besold in bulk.

The liquidity makes for quicker execution and less transaction costs.

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ADR Prof. AT

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