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Depositary Receipts in American (ADR) or Global (GDR) form are commonly used in global equity offerings to U.S. and non-U.S. investors. Depositary Receipts facilitate cross-border trading and settlement, minimize transaction costs and may broaden a non-U.S. company's potential investor base, particularly among institutional investors.
What are Depositary Receipts ?
A Depositary Receipt is a negotiable certificate that usually represents a company's publicly traded equity or debt. Depositary Receipts are created when a broker purchases the company's shares on the home stock market and delivers those to the depositary's local custodian bank, which then instructs the depositary bank, such as The Bank of New York, to issue Depositary Receipts. Depositary Receipts may trade freely, just like any other security, either on an exchange or in the over-the-counter market and can be used to raise capital.
ADRs and GDRs
ADRs and GDRs are identical from a legal, operational, technical and administrative standpoint. Simply, the word "Global," rather than "American," is used when it is preferred for marketing reasons.
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Benefits To A Company
The primary reasons why a company would establish a Depositary Receipt program can be divided into two broad considerations: capital and commercial. Among those considerations:
To enlarge the market for its shares through a broadened and a more diversified investor exposure which may increase or stabilize the share price. To enhance the image of the company's products, services or financial instruments in a marketplace outside its home country. To provide a mechanism for raising capital or as a vehicle for an acquisition. To enable employees to invest easily in the parent company.
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Benefits To An Investor
Increasingly, investors aim to diversify their portfolios internationally. Obstacles, however, such as undependable settlements, costly currency conversions, unreliable custody services, poor information flow, unfamiliar market practices, confusing tax conventions and internal investment policy may discourage institutions and private investors from venturing outside their local market.
As negotiable securities, Depositary Receipts are usually quoted in U.S. dollars and pay dividends or interest in U.S. dollars. Depositary Receipts overcome obstacles that mutual funds, pension funds and other institutions may have in purchasing and holding securities outside of their local market. Global custodian safekeeping charges are eliminated, saving Depositary Receipt investors 10 to 40 basis points annually. Dividends and other cash distributions are converted into dollars at competitive foreign exchange rates. Depositary Receipts are as liquid as the underlying securities because the two are interchangeable.
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Types Of Depositary Receipt Facilities
Companies have a choice of four types of Depositary Receipt facilities: unsponsored and three levels of sponsored Depositary Receipts. Unsponsored Depositary Receipts are issued by one or more depositaries in response to market demand, but without a formal agreement with the company. Today, unsponsored Depositary Receipts are considered obsolete and, under most circumstances, are no longer established due to lack of control over the facility and its hidden costs. Sponsored Depositary Receipts are issued by one depositary appointed by the company under a Deposit Agreement or service contract. Sponsored Depositary Receipts offer control over the facility, the flexibility to list on a national exchange in the U.S. and the ability to raise capital.
Sponsored Level I Depositary Receipts
A sponsored Level I Depositary Receipt program is the simplest method for companies to access the U.S. and non-U.S. capital markets. Level I Depositary Receipts are traded in the U.S. over-the-counter ("OTC") market and on some exchanges outside the United States. The company does not have to comply with U.S. Generally Accepted Accounting Principles ("GAAP") or full Securities and Exchange Commission ("SEC") disclosure. Essentially, a Sponsored Level I Depositary Receipt program allows companies to enjoy the benefits of a publicly traded security without changing its current reporting process.
The Sponsored Level I Depositary Receipt market is the fastest growing segment of the Depositary Receipt business. Of the more than 1,600 Depositary Receipt programs currently trading, the vast majority of the sponsored programs are Level I facilities. In addition, because of the benefits investors receive by investing in Depositary Receipts, it is not unusual for a company with a Level I program to obtain 5% to 15% of its shareholder base in Depositary Receipt form. Many well-known multinational companies have established such programs including: Roche Holding, ANZ Bank, South African Brewery, Guinness, Cemex, Jardine Matheson Holding, Dresdner Bank, Mannesmann, RWE, CS Holding, Shiseido, Nestle, Rolls Royce, and Volkswagen to name a few. In addition, numerous companies such as RTZ, Elf Aquitaine, Glaxo Wellcome, Western Mining, Hanson, Medeva, Bank of Ireland, Astra, Telebrás and Ashanti Gold Fields Company Ltd. started with a Level I program and have upgraded to a Level II (Listing) or Level III (Offering) program.
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Sponsored Level II And III Depositary Receipts
Companies that wish to either list their securities on an exchange in the U.S. or raise capital use sponsored Level II or III Depositary Receipts respectively. These types of Depositary Receipts can also be listed on some exchanges outside the United States. Each level requires different SEC registration and reporting, plus adherence to U.S. GAAP. The companies must also meet the listing requirements of the national exchange (New York Stock Exchange, American Stock Exchange) or NASDAQ, whichever it chooses.
Each higher level of Depositary Receipt program generally increases the visibility and attractiveness of the Depositary Receipt.
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Private Placement (144A) Depositary Receipt
In addition to the three levels of sponsored Depositary Receipt programs that trade publicly, a company can also access the U.S. and other markets outside the U.S. through a private placement of sponsored Depositary Receipts. Through the private placement of Depositary Receipts, a company can raise capital by placing Depositary Receipts with large institutional investors in the United States, avoiding SEC registration and to non-U.S. investors in reliance on Regulation S. A Level I program can be established alongside a 144A program.
How Depositary Receipts Trade
DESCRIPTION
A Depositary Receipt is a negotiable receipt issued in certificate form which usually represents an existing outstanding class of equity shares in a non-U.S. company. Depositary Receipts facilitate U.S. investor purchases of non-U.S. securities and to allow non-U.S. companies to have their stock trade in the United States by reducing or eliminating the settlement delays, high transaction costs and other inconveniences associated with international securities trading. Depositary Receipts are treated in the same manner as U.S. securities for clearance, settlement, transfer and ownership purposes.
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The Depositary Receipt is issued by a U.S. depositary bank, such as The Bank of New York, when the actual shares are deposited in a local custodian bank, usually by a broker who has purchased the shares in the open market. Once issued, these certificates may be freely traded in the U.S. over-the-counter market or, upon compliance with U.S. Securities and Exchange Commission regulations, on a national stock exchange. When the Depositary Receipt holder sells, the Depositary Receipt can either be sold to another U.S. investor or it can be canceled, in which case the Depositary Receipt certificate would be surrendered and the shares held with the local custodian bank would be released back into the home market and sold to a broker there. Additionally, the Depositary Receipt holder would be able to request delivery of the actual shares at any time. The Depositary Receipt certificate states the responsibilities of the depositary bank with respect to the payment of dividends, voting at shareholder meetings and handling of rights offerings, etc.
Depositary Receipts in American or Global form (ADRs and GDRs, respectively) are used to facilitate cross-border trading and in global equity offerings to U.S. and non-U.S. investors. ADRs and GDRs are identical from a legal, operational, technical, and administrative standpoint. Depositary Receipts can be used to raise equity capital or for acquisitions. They can also be used to represent debt securities or preferred stock.
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DEMAND FOR DEPOSITARY RECEIPTS
The demand by investors for Depositary Receipts is growing between 30 to 40 percent annually and is driven by the increasing desire of retail and institutional investors to diversify their portfolios globally. Many of these investors typically do not, or cannot for various reasons, invest outside of the U.S. and, as a result, utilize Depositary Receipts as a means to diversify their portfolios. Investors who do have the capabilities to invest outside the U.S. prefer to utilize Depositary Receipts because of the convenience, enhanced liquidity and cost effectiveness Depositary Receipts offer as compared to purchasing and safekeeping ordinary shares in the home country. In most cases, a Depositary Receipt can save an investor over 50 basis points annually as compared to all of the costs associated with trading and holding the ordinary shares outside the U.S.
ISSUANCE
Depositary Receipts are issued or created when investors decide to invest in a non-U.S. company and contact their brokers to make a purchase. These brokers, through their own international offices or through a local broker in the company's home market, purchase the actual ordinary shares and request that the shares be delivered to the depositary bank's custodian in that country. The broker who initiated the transaction will convert the U.S. dollars received from the investor into the corresponding foreign currency and pay the local broker for the shares purchased. On the same day that the shares are delivered to the custodian bank, the custodian notifies the depositary bank. Upon such notification, Depositary Receipts are issued and delivered to the initiating broker, who then delivers the Depositary Receipts to the investor.
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TRANSFER - (INTRA-MARKET TRADING)
Once Depositary Receipts are issued, they are tradable in the United States and, just as with any other U.S. security, they can be freely sold to other investors. When a Depositary Receipt is sold to another U.S. investor and the existing Depositary Receipt is simply transferred from one Depositary Receipt holder (seller) to another Depositary Receipt holder (buyer), it is known as an intra-market transaction.
An intra-market transaction is settled in the same manner as any other U.S. security purchase: in U.S. dollars on the third business day after the trade date and typically through Depository Trust Company (DTC). Intra-market trading accounts for approximately 95% of all Depositary Receipt trading in the market today. Accordingly, the most important role of a depositary bank is that of Stock Transfer Agent and Registrar. It is therefore critical that the depositary bank maintain sophisticated stock transfer systems and operating capabilities.
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CANCELLATION
When investors want to sell their Depositary Receipts, they notify their broker. The broker can either sell the Depositary Receipts in the U.S. market through an intra-market transaction or sell the shares outside of the U.S., typically into the home market, through a procedure known as a cross-border transaction. In cross-border transactions, brokers, either through their own international offices or through a local broker in the company's home market, will sell the shares back into the home market. In order to settle the trade, the U.S. broker will surrender the Depositary Receipt to the depositary bank with instructions to deliver the shares to the buyer in the home market. The depositary bank will cancel the Depositary Receipt and instruct the custodian to release the underlying shares and deliver them to the local broker who purchased the shares. The broker will arrange for the foreign currency to be converted into U.S. dollars for payment to the Depositary Receipt holder.
TRADING - (PRICING)
Once Depositary Receipts are issued and there are an adequate number of Depositary Receipts outstanding in the U.S. market, usually 3% to 6% of the company's shares in Depositary Receipt form, a true intra-market trading market emerges. Until this market develops, the majority of Depositary Receipt purchases result in Depositary Receipt issuances versus the deposit of shares. When executing a Depositary Receipt trade, brokers seek to obtain the best price by comparing the Depositary Receipt price in U.S. dollars to the dollar equivalent price of the actual shares in the home market. Brokers will buy or sell in the market that offers them the best price and they can do so in three ways: by issuing a new Depositary Receipt, transferring an existing Depositary Receipt or canceling a Depositary Receipt. For example, if the price of the actual shares in the home market is $12.28 per share after allowing for foreign currency translation, and the Depositary Receipt is selling for $12.30, the broker will buy shares and issue Depositary Receipts until the price of the ordinary shares increases to $12.30, at which time the broker will simply buy and sell the existing Depositary Receipts which are outstanding in the market. The broker may also be holding an inventory of ordinary shares. In this case the local trading price is irrelevant.
The continuous buying and selling of Depositary Receipts in either market tends to keep the price differential between the local and U.S. markets to a minimum. As a result, about 95% of Depositary Receipt trading is done in the form of intra-market trading and does not involve the issuance or cancellation of a Depositary Receipt.
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EQUITY OFFERINGS
When a non-U.S. company completes an offering of new shares, part of which will be sold as Depositary Receipts in the U.S. or international market, the company will deliver the shares to the depositary bank's local custodian at the time of the closing. The depositary bank then will issue the corresponding Depositary Receipts and deliver them to the members of the underwriting syndicate. With this pool of Depositary Receipts, a regular trading market commences where Depositary Receipts can then be issued, transferred or canceled.
With thanks to The Bank of New York Company, Inc.
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