American depository receipts. Theory and practice

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 international offices or through a local broker in the company's home market, purchase the underlying 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 evidencing the shares to the investor. Broker can also obtain Depositary Receipts by purchasing existing Depositary Receipts, which is not a new issuance.

Transfer - (Intra-Market Trading)

Once Depositary Receipts are issued, they are tradable in the United States and like other U.S. securities, they can be freely sold to other investors. Depositary Receipts may be sold to subsequent U.S. investors by simply transferring them from the existing Depositary Receipt holder (seller) to another Depositary Receipt holder (buyer); this 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 The Depository Trust Company (DTC). Intra-market trading accounts for approximately 95 percent 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.

 

Buying and Selling DRs

 

If an investor wishes to purchase shares in a foreign company, he can either buy the foreign shares in the local market through a broker in that country or, providing the foreign company in question has a DR program, the investor can request his broker to buy DRs. The broker may either purchase existing DRs or, if none are available, he may arrange for a depositary bank (e.g. Deutsche Bank) to issue new ones. The process for issuing new DRs is very simple. The investor's broker contacts a broker in the issuing company's home market and acquires shares in that company. These shares are then deposited with the depositary bank's local custodian. Upon confirmation that the custodian has received the shares, the depositary issues the requisite number of DRs to the investor via the broker.

 

In some exceptional cases there may be restrictions on the issuance of new DRs under existing programs (e.g. Indian GDR programs) because of local regulations. DRs can be sold in DR form, in which case they trade and settle like other US or Euro securities. They can also, however, be cancelled. In this case the broker acting on behalf of the owner of the DRs will request the depositary bank to cancel the DRs and release the underlying shares to a domestic broker in the issuing company's home market. The domestic broker will then sell the shares locally and the proceeds will be remitted to the investor who cancelled those DRs.

 

• DRs certify that a stated number of underlying shares have been deposited with the depositary's custodian in the foreign country.

 

• DR holders are entitled to all the dividends payable on the underlying foreign shares and, furthermore, to have these paid in the currency in which the DRs are denominated – usually US dollars.

 

• The DRs may be bought or sold through investors' own brokers, and they clear and settle through the Depository Trust Company (DTC) for ADRs, through Euro clear and Clear stream for EDRs and through all three (and possibly other clearing systems) in the case of GDRs, depending on which markets they access.

 

• Shareholder information such as annual reports, notices of general meetings and corporate actions, and official news releases are provided by the issuer to the depositary and to the receipt holders, either direct or through the local custodian.

 

• The investor is thus spared the costs and difficulties often encountered when direct investment is made in local markets, where currency, settlement, and linguistic problems may be compounded by an excessive number of intermediaries.

 

Procedure of issue of ADR

 

To find the Depository bank 
 
Depository bank has only right to issue the GDRs. So, it is necessary to find depository bank in USA and other European countries. 
 
Issue the Shares to Depository bank 
 
Shares cannot be issued to foreign investors. But shares are issued to depository bank and depository bank will accept the shares of Indian companies as the custodian of foreign investors.  
 
Deposit the fees  
 
For issuing GDRs, either investors or Company has to deposit the fees for issuing the certificate named global depository receipt.  
 
Issue of GDRs and Record 
 
Depository bank has right to issue one GDR certificate for 2 to 10 shares. The issue of GDRs is for those investors who will pay the amount of shares of companies. After this, it will be assumed that USA or other foreign countries' investors have acquired the shares of companies. Indian company gets money of shares through depository banks. On the other side, foreign investors' name registered and they will get dividend through this bank in USA Dollar. Companies are using same procedure for getting fund through GDRs. This year, an investment company successfully issued shares in the form of Global Depository Receipts (GDRs) to foreign investors. After issuing GDRs, these shares can deal in any foreign stock exchange and GDRs will be one of the security type in stock exchange list of stocks.

 

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 cross-border transaction. In cross-border transactions, brokers, either through their international offices or through a local broker in the company's home market, will sell the shares back into the home market. 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 three percent to six percent 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 upon 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 that are outstanding in the market. The broker may also be holding an inventory of ordinary shares, in which 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 percent 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.

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 will then 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.

 

Conclusion

 

Investing in foreign stocks or in a foreign stock market can be a complex and challenging undertaking. However, an American Depositary Receipt (ADR) makes the process much easier for an individual investor. An American Depositary Receipt is a foreign stock issued on an U.S. exchange by an investment bank denominated in U.S. currency. 
 
The main advantage of buying an American Depositary Receipt rather than the foreign stock itself is the ease of the transaction. Many people are more familiar and comfortable investing on the U.S. exchanges. ADRs are a great way to invest abroad without having to convert U.S. dollars to many different currencies. Also, it can be difficult to learn how to purchase shares on a foreign stock exchange as an individual investor. Another advantage offered by an ADR is that if the foreign stock does pay dividends, the investment bank will convert the dividends to U.S. dollars and remit the payment. In addition, if the dividend is subject to foreign tax, the investment bank will withhold the tax. 
 
In conclusion, American Depositary Receipts are a great way to invest in foreign companies. Since the ADRs are issued on U.S. exchanges they are very easy to buy and sell without having to convert currencies. However, even though investing on a U.S. exchange, the foreign company’s profits are usually earned in a different currency. Therefore, if exchange rates may vary, it would hurt the value of ADR. If investing in foreign stocks, ADRs should be part of investment decision.

 

Endnotes

1. Federal Law of the Russian Federation No. 282-FZ "On Amendments to the Federal Law "On the Securities Market" dated December 30, 2006, amending   Federal Law of the Russian Federation No. 39-FZ "On the Securities Market" dated April 22, 1996, as amended.              

2. According to the FSFM official website (URL: http://www.fsfm.gov.ru/document.asp?ob_no=8668).

3. Federal Law of the Russian Federation No. 173-FZ "On Currency Regulation and Currency Control" dated December 10, 2003, as amended.

4. Russiallaws.com

 

Bibliography

 

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