American depository receipts. Theory and practice

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Nowadays more and more companies all over the world are looking forward to attract international investors. Going public at a stock exchange is one of the most attractive and cost efficient ways of getting financial inflows. Hence there are companies that prefer local, state stock exchanges, large majority rushes for international stock exchanges, such as NYSE and LSE.


Introduction 3
What is a DR 4
History and Reasons for using ADRs 5
Benefits of ADR’s 7
Benefits to a Company 7
Benefits to an Investor 7
ADRs vs. Stocks 9
ADRs' Special Risks 10
Advantages of ADRs 11
Disadvantages of ADRs 11
Types of DRs 12
Practice: how are DR’s traded 14
Buying and Selling DRs 16
Procedure of issue of ADR 18
Cancellation 19
Trading - (Pricing) 19
Equity Offerings 20
Conclusion 21
Endnotes 22
Bibliography 23

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“American depository receipts. Theory and practice”



                                                                                           Student: Sologub Asia

                                                                                           Group: 5403

                                                                                            Supervisor: Sokolnikova I.V.











Moscow 2012 

table of contents

Introduction 3

What is a DR 4

History and Reasons for using ADRs  5

Benefits of ADR’s 7

Benefits to a Company 7

Benefits to an Investor 7

ADRs vs. Stocks 9

ADRs' Special Risks 10

Advantages of ADRs 11

Disadvantages of ADRs 11

Types of DRs 12

Practice: how are DR’s traded 14

Buying and Selling DRs 16

Procedure of issue of ADR 18

Cancellation 19

Trading - (Pricing) 19

Equity Offerings 20

Conclusion 21

Endnotes 22

Bibliography 23






Nowadays more and more companies all over the world are looking forward to attract international investors. Going public at a stock exchange is one of the most attractive and cost efficient ways of getting financial inflows. Hence there are companies that prefer local, state stock exchanges, large majority rushes for international stock exchanges, such as NYSE and LSE.

A long the costly procedure of preparing for the IPO company’s owner should analyze all the possible consequences of this step, define goals and opportunities, evaluate its assets, choose a stock exchange, where at his opinion, company’s shares will have the best demand.

The American Depositary Receipt (ADR) plays an important part in the process of going public. ADRs represent shares of a foreign stock owned and issued by an underwriter bank. The foreign shares are usually held in custody overseas, but the certificates trade in the U.S. Through this system, a large number of foreign-based companies are actively traded on one of the three major equity markets (the NYSE, AMEX or Nasdaq, LSE or MSE).

To this end ADR is a way of going public at an international level, which allows a significant shift in company’s development.


What is a DR


Globalization is the dissolution of barriers to trade and investments, and the tendency of the world's businesses to integrate customs and values. Globalization is making it increasingly easy to travel, correspond and even invest in other countries.  
Investing money in a home country's stock market is relatively simple. One may call a broker or login to an online account and place a buy or sell order. Investing in a company that is listed on a foreign exchange is much more difficult.  
However, now there is an easy way around this through ADRs. More than 2,000 foreign companies provide this option for investors interested in buying shares.

An American Depository Receipt, or ADR, is a security issued by a U.S. depository bank to domestic buyers as a substitute for direct ownership of stock in foreign companies. An ADR can represent one or more shares, or a fraction of a share, of a non-U.S. company. Individual shares of a foreign corporation represented by an ADR are called American Depositary Shares (ADSs).

An ADR is a convenient way for companies whose stock is listed on a foreign exchange to cross-list their stock in the United States and make their stock available for purchase by U.S. investors, as these receipts can be traded on U.S. exchanges.

Some ADRs are traded on major stock exchanges such as the NDAQ and the NYSE, which require these foreign companies to conform to many of the same reporting and accounting standards as U.S. companies. Other ADRs are traded on over-the-counter exchanges that impose fewer listing requirements.

Stock dividends and similar adjustments to the underlying shares are paid in cash or ADR dividends by the bank.


History and Reasons for using ADRs

American Depositary Receipts have been introduced to the financial markets as early as April 29, 1927, when the investment bank J. P. Morgan launched the first-ever ADR program for the UK’s Selfridges Provincial Stores Limited (now known as Selfridges plc.), a famous British retailer. Its creation was a response to a law passed in Britain, which prohibited British companies from registering shares overseas without a British-based transfer agent, and thus UK shares were not allowed physically to leave the UK.2 The ADR was listed on the New York Curb Exchange (predecessor to the American Stock Exchange.)

The regulation of ADR changed its form in 1955, when the U.S. Securities and Exchange Commission (SEC) established the From S-12, necessary to register all depositary receipt programs. The Form S-12 was replaced by Form F-6 later, but the principles remained the same till today.

Crucial novelties brought the new regulatory framework introduced by the SEC in 1985, which led to emergence of range of DR instruments, as we know it nowadays. Then the three different ADR programs were created, the Level I, II and III ADRs. This change was one of the impulses for revival of activity on the otherwise stagnant ADR market.

In April 1990, a new instrument, referred to as Rule 144A was adopted, which gave rise to private placement depositary receipts, which were available only to qualified institutional buyers (QIBs). This type of DR programs gained its popularity quickly and it is very frequently employed today.

The ADRs were originally constructed solely for the needs of American investors, who wanted to invest easily in non-US companies. After they had become popular in the United States, they extended gradually to other parts of the world (in the form of GDR, EDR or IDR). The greatest development of DRs has been recorded since 1989.

In December 1990, Citibank introduced the first Global Depositary Receipt. Samsung Corporation, a Korean trading company, wanted to raise equity capital in the United States through a private placement, but also had a strong European investor base that it wanted to include in the offering. The GDRs allowed Samsung to raise capital in the US and Europe through one security issued simultaneously into both markets.

In 1993, Swedish LM Ericsson raised capital through a rights offering in which ADDs were offered to both holders of ordinary shares and DR holders. The Ericsson ADDs represented subordinated debentures that are convertible into ordinary shares or DRs. German Daimler Benz AG became the first European Company to establish a Singapore depositary receipts program (SDRs) in May 1994.

 Those shares, or receipts, can then be traded on regular stock markets almost as though they were shares held directly in the foreign company itself, only the arrangement is better for US investors. Since ADRs are traded in US dollars and are securities that originate within the United States, they carry none of the cross-border fees or other hassles that might ensue if an investor from Peoria were to try to buy stock directly in a South Korean steel mill. The worst most investors have to worry about are small fees, often a few pennies per ADR per year, charged by the depository institution to cover their costs of offering the service.

Thus, in a sense, US investors gain access to the world through ADRs without having to leave the comfort of their own living rooms.



Benefits of ADR’s


The increasing demand for Depositary Receipts is driven by the desire of individual and institutional investors to diversify their portfolios, reduce risk and invest internationally in the most efficient manner possible. While most investors recognize the benefits of global diversification, they also understand the challenges presented when investing directly in local trading markets. These obstacles can include inefficient trade settlements, uncertain custody services and costly currency conversions. Depositary Receipts overcome many of the inherent operational and custodial hurdles of international investing. In fact, cost benefits and conveniences may be realized through Depositary Receipt investing, thus allowing those who invest internationally to achieve the benefits of global diversification without the added expense and complexities of investing directly in the local trading markets.

Benefits to a Company

Currently, there are over 2,000 Depositary Receipt programs for companies from over 70 countries. The establishment of a Depositary Receipt program offers numerous advantages to non-U.S. companies. The primary reasons to establish a Depositary Receipt program can be divided into two broad considerations: capital and commercial.

Advantages may include:

  • Expanded market share through broadened and more diversified investor exposure with potentially greater liquidity, which may increase or stabilize the share price.
  • Enhanced visibility and image for the company's products, services and financial instruments in a marketplace outside its home country.
  • Flexible mechanism for raising capital and a vehicle or currency for mergers and acquisitions.
  • Enables employees of U.S. subsidiaries of non-U.S. companies to invest more easily in the parent company.

Benefits to an Investor

Increasingly, investors aim to diversify their portfolios internationally. However, obstacles 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.

Depositary Receipt advantages may include:

  • Quotation in U.S. dollars and payment of dividends or interest in U.S. dollars.
  • Diversification without many of the obstacles that mutual funds, pension funds and other institutions may have in purchasing and holding securities outside of their local market.
  • Elimination of global custodian safekeeping charges, potentially saving Depositary Receipt investors up to 10 to 40 basis points annually.
  • Familiar trade, clearance and settlement procedures.
  • Competitive U.S. dollar/foreign exchange rate conversions for dividends and other cash distributions.
  • Ability to acquire the underlying securities directly upon cancellation.


ADRs vs. Stocks


Like normal stocks, ADRs tend to trade at levels that track the financial health of their underlying companies. Still, there are important differences between an ADR and a directly held stock.

For example, there are different flavors of ADRs, each of which carries a different level of reporting responsibility - in other words transparency in reporting their financial health - to US regulators and investors.

Unsponsored shares: These offer the lowest level of entry into the American market. Unsponsored shares trade only on over-the-counter markets - not on the major US stock exchanges - and bear no responsibility to report to US regulatory agencies. They are rarely issued today.

Level I: These shares can also only be traded on over-the-counter markets, but they are generally issued through only one US agent - their depositary "sponsor." Regulatory reporting requirements are still minimal. Quarterly or annual reports are not required. Even if such reports are issued, they are not required to adhere to US standards of generally accepted accounting principles, or GAAP, and the companies can post their results in a foreign currency.

Level II: Companies that want to sell ADRs to US investors at this level have to register with the Securities and Exchange Commission and file an annual report that complies with GAAP standards. This is the lowest level of shares that can be listed on a US stock exchange.

Level III: This is the gold standard of ADR ratings. It allows foreign companies to issue shares directly into the US, rather than simply allowing the indirect purchase of already created shares. In exchange, the company is required to file annual reports that comply with GAAP standards, typically something known as a form 20-F (compared to the regular 10-K filing by companies in the United States). And it is required to share any news that it distributes within its home country to US investors as well.


ADRs' Special Risks


Of course, even though they trade in US dollars and can, at least on the surface, closely look and feel of American stocks, ADRs come with their own set of special considerations to keep in mind.

Currency risk: If the value of the US dollar rises against the value of the company's home currency, a good deal of the company's intrinsic profits might be wiped out in translation. Conversely, if the US dollar weakens against the company's home currency, any profits it makes will be enhanced for a US owner. For more information on how this could damage or inflate results, read the danger of investing in international bonds.

Political risk: ADR status does not insulate a company's stock from the inherent risk of its home country's political stability. Revolution, nationalization, currency collapse or other potential disasters may be greater risk factors in other parts of the world than in the US, and those risks will be clearly translated through any ADR that originates in an affected nation.

Inflation risk: Countries around the globe may be more, or less, prone to inflation than the US economy is at any given time. Those with higher inflation rates may find it more difficult to post profits to an US owner, regardless of the company's underlying health.

In other words, ADRs are just what they seem: a representation of a foreign stock, rather than an actual holding in the company. Because of all of the considerations listed above, an ADR of a foreign company in the US. May be traded a little ahead or a little behind the price the company commands in its own currency in its own home base. But it's safe to say that buying an ADR is the closest an American investor can come to participating directly in the rest of the world's economy.


Advantages of ADRs

  • Flexibility to list on national exchange in the US
  • Ability to rise capital
  • Increasing of awareness of a company
  • Diversify portfolio
  • Reducing financial costs on taxes and international transactions
  • Trade is clear and settle in US Dollar

Disadvantages of ADRs

ADRs have some important limitations and drawbacks.

  • Limited selection: Not all foreign companies are available as ADRs. For example, Japan's Toyota Motor has an ADR, but Germany's BMW does not.
  • Liquidity: Plenty of companies have ADR programs available, but some may be very thinly traded.
  • Exchange rate risk: While ADRs are priced in dollars, for sake of convenience, investment is still exposed to fluctuations in the value of foreign currencies.
  • Because ADRs are like stocks, it is necessary to buy enough of them to ensure adequate diversification. So if investment capital is not enough to spread around, say 25 to 30 ADRs (or more), it is hard to create a truly diversified portfolio.


Types of DRs


American Depositary Receipts (ADR)

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.


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.

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.

Global Depositary Receipts (GDR)

GDRs are securities available in one or more markets outside the company’s home country. (ADR is actually a type of GDR issued in the US, but because ADRs were developed much earlier than GDRs, they kept their denotation.) The basic advantage of the GDRs, compared to the ADRs, is that they allow the issuer to raise capital on two or more markets simultaneously, which increases his shareholder base. They gained popularity also due to the flexibility of their structure.

GDR represents one or more (or fewer) shares in a company. The shares are held by the custody of the depositary bank in the home country. A GDR investor holds the same rights as the shareholders of ordinary shares, but typically without voting rights. Sometimes voting rights can be the executed by the depositary bank on behalf of the GDR holders.


Practice: how are DR’s traded



A Depositary Receipt is a negotiable security which represents the underlying securities (generally equity shares) of a non-U.S. company. Depositary Receipts facilitate U.S. investor purchases of non-U.S. securities and allow non-U.S. companies to have their stock trade in the United States by reducing or eliminating settlement delays, high transaction costs, and other potential inconveniences associated with international securities trading. Depositary Receipts are treated in the same manner as other U.S. securities for clearance, settlement, transfer, and ownership purposes. Depositary Receipts can also represent debt securities or preferred stock.

The Depositary Receipt is issued by a U.S. depositary bank, such as The Bank of New York, when the underlying 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. SEC 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 and the underlying shares can be sold to a non-U.S. investor. In the latter 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 actions such as payment of dividends, voting at shareholder meetings, and handling of rights offerings.

Depositary Receipts (DRs) in American or Global form (ADRs and GDRs, respectively) are used to facilitate cross-border trading and to raise capital in global equity offerings or for mergers and acquisitions to U.S. and non-U.S. investors.

Demand for Depositary Receipts

The demand by investors for Depositary Receipts has been growing between 30 to 40 percent annually, driven in large part 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 directly outside of the U.S. and, as a result, utilize Depositary Receipts as a means to diversify their portfolios. Many investors who do have the capabilities to invest outside the U.S. may 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 many cases, a Depositary Receipt investment can save an investor up to 10-40 basis points annually as compared to all of the costs associated with trading and holding ordinary shares outside the United States.

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