Module - 33 International Equity Market and Cross Listing of Shares

Transcription

1 Module - 33 International Equity Market and Cross Listing of Shares Developed by: Dr. Prabina Rajib Associate Professor (Finance & Accounts) Vinod Gupta School of Management IIT Kharagpur, [email protected]

2 Lesson - 33 International Equity Market and Cross Listing of Shares Highlights & Motivation: International fund raising used to be the domain of multinational companies. MNCs not only source raw material across the world or sell products at many geographical regions, they also scouting for capital all over the world and raise capital where it is cheaper. However with globalization and increased cross-border capital flows, smaller companies are enjoying the benefits of raising capital in the international market. Cross listing of shares through issuance of depository receipts have become a common occurrence. Investors appetite for foreign company shares have also increased manifold and internationalization of equity market across globe is happening at a faster speed. Though internationalization of equity markets has a broader connotation covering entire gamut of FDI, portfolio investment by big ticket players like pension funds, hedge funds and private equity funds and their ilk, this module focuses on equity capital to have been raised by Indian companies from the international market. Learning Objectives: Hence in this chapter, issues related to cross-listing of shares specifically from Indian companies perspective have been discussed. The topics covered are: Brief discussion on different types of instruments (both debt and equity Options) to have been issued by Indian companies in the international market. Cross listing of shares through depository receipts Benefits/Costs of Depository Receipt to Issuers and Investors o NASDAQ listing fee details o Types of Depository Receipts Sponsored/Unsponsored o Level I, Level II, Level III and Private Placement

3 33.1 Introduction: International fund raising used to be the domain of multinational companies. MNCs not only source raw material across the world or sell products at many geographical regions, they also scout for capital all over the world and raise capital whereever it is cheaper. However with globalization and increased cross-border capital flows, smaller companies are also raising capital in the international market. Greater interaction among financial markets has enabled companies to access global capital market. Big and small companies are raising both debt and equity capital from the global market. Cross listing of shares through issuance of depository receipts have become common occurrence. Investors appetite for foreign company shares have also increased manifold and internationalization of equity markets across globe is happening at a faster speed. Though internationalization of equity markets has a broader connotation covering entire gamut of FDI, portfolio investment by big ticket players like pension funds, hedge funds and private equity funds and their ilk, this module focuses on equity capital to have been raised by Indian companies from the international market. Even relatively smaller companies are sourcing capital from foreign countries and do not want to remain restricted to commercial banks and other lenders of home countries as well as do not want to depend on the domestic equity market. With the globalization of trade flows, liberalization of restrictive business polices, cross border sourcing of capital has become hallmark of the day. Just to buttress on this aspect, many Indian companies, big as well as small ones have tapped international market to raise funds. The following figure, Figure 33.1 highlights different instruments used by Indian companies to raise fund International Fund Raising Options Debt Capital Yankee Bonds Eurobonds Floating Rate Notes External Commercial Borrowings India Millennium Deposit India Resurgent Bond India Development Bond Equity Capital Global Depository Receipts American Depository Receipts Indian Depository Receipts Figure 33.1: Different Types of Debt and Equity Capital Raised by Indian Companies

4 In a similar token, investors risk appetite is also changing, they are not scared put money into companies which are not home grown. To diversify their risk, investors are increasingly getting interested in investing in companies of their choice, irrespective of their nationality. Emergence of venture capital and private equity investments are providing added boost to the growth of international equity investment. All over the world, the policy regulations restricting international flow of capital are also easing, thus paving the path for integration of capital markets which were hitherto operating insularly. This process is getting hastened up with increased global M&A activities. Companies are funded through both debt and equity. International debt market is thriving over the last 3-4 decades, but slowly international equity market is gaining momentum. In this session, how Indian companies are sourcing equity capital in the international market and what are the issues associated with these are discussed Brief Introduction to ADRs and GDRs: International equity market has developed through cross listing of shares in different stock exchanges. Cross listing indicates that a company lists its shares in foreign stock exchanges besides listing its shares in domestic exchanges. For example, investors from US can invest in Infosys equity shares as Infosys shares are listed in NASDAQ. Cross listing of shares normally happens through depository receipts (DRs) or registered shares. Depository receipts can be ADRs (American Depository Receipts) or GDRs (Global Depository Receipts) or for that matter any country specific depository receipts can be issued. GDRs are primarily issued and traded in London or Luxembourg stock exchanges. ADRs by default issued in USD. All most all GDRs are also denominated in USD. But GDRs can be issued in EURO. Similarly like ADRs/GDRs, If a foreign company lists its shares in Chinese Stock exchange, then these will be known CDRs (Chinese Depository Receipts). A foreign company can list its IDRs (Indian Depository Receipts) in any Indian stock exchanges. These depository receipts are negotiable receipts of securities issued by foreign companies but listed and traded in domestic stock exchanges denominated in the home currency of the domestic country. Each depository receipt has specific number of company s shares as underlying. For example, HDFC Bank ADR has three shares representing one ADR. This ratio is known as DR/Underlying share ratio. There is no hard and fast rule regarding the number of underlying shares representing one depository receipt. In a DR, the company declares the dividend in its home currency. This dividend

5 is converted to the home currency of the DR investor. In other words, the DR investors, receive the dividend in their home currency. For all practical purpose, these depository receipts behave like domestic securities. According to JPMorgan website, which has a comprehensive list of depository receipts issued all over the world, all together 3248 companies have issued ADRs/GDRs. A snapshot of the data is given in the table, Table Table 33.1: Sample list of ADRs and GDRs Source: Company Name Country Sector Name Type Underlying Exchange Underlying Currency Issue Date AGENIX LTD Australia Biotechnology ADR ASX AUD 5/29/2002 AGFA- GEVAERT NV Belgium Photography/ Imaging ADR EN BRUSSELS EUR 10/15/2008 AGILE PROPERTY HOLDINGS LTD Hong Kong Real Estate ADR HONG KONG HKD 11/4/2008 AGL ENERGY LTD Australia Power Producers ADR ASX AUD 6/23/2008 AGORA SA Poland Broadcasting (TV,Radio,Cable) GDR WARSAW PLN 3/4/1999 AGRICULTURA L BANK OF GREECE Greece Banks (Major Regional) ADR ATHENS EUR 10/20/2008 AIDA ENGINEERING LTD Japan Machinery ADR TOKYO JPY 1/1/1983 AIFUL CORP AIOI INSURANCE CO LTD Japan Japan Consumer Finance ADR TOKYO JPY 3/25/2004 Insurance (Life/Health) ADR TOKYO JPY 10/17/2008 HONG KONG CNY 6/30/2006 AIR CHINA LTD China Airlines ADR AIR FRANCE- KLM France Airlines ADR PARIS EUR 5/5/2004 AIR LIQUIDE France Chemicals ADR PARIS EUR 1/1/1983 AIR NEW ZEALAND LTD New Zealand Airlines ADR NZX NZD 10/28/2008 Table 33.1 indicates name of the issuer company, which country it belongs to, sector name, whether issued ADR/GDR, home country exchange name, currency denomination of underlying shares, and ADR/GDR issue date. At this point, it is important to understand why foreign company equity shares listed in a domestic stock exchange is known as depository receipts. When a foreign company lists

6 its shares in a domestic stock exchange, it cannot directly list its equity shares. The reasons for so are as follows: As the equity shares are denominated in home currency of the foreign company, the domestic investor may not be interested to trade in the issuer s home currency. For example, an investor from UK will not be interested to invest in ICICI Bank shares denominated in Indian Rupees, even if it is possible to trade ICICI Bank shares at London Stock Exchange. By doing so, the investor would take foreign currency risk. Secondly, investors will not be get his/her own grievances redressed by the regulatory body of its country as the regulatory body may not have the jurisdiction to govern a foreign company which is registered in a foreign country. If the investors from the UK agrees to invest in ICICI bank shares listed in Indian stock exchange ( willing taking foreign exchange risk), but still can not approach the UK regulator for any grievance against ICICI bank as the UK regulator may not have any control over ICICI bank which is listed in India. To circumvent these two important risks, all foreign equity listing is done through a depository which is a registered body in the home country of the investor. In fact, the depository is liable for any misconduct by the foreign company and the regulatory body of the investor can penalize the depository. The depository ensures that the foreign company abides by the listing and other regulatory requirements put forwarded by home country regulators from time to time. Before issuing DRs, the foreign company has to first appoint depository which is a registered body in the domestic market. The foreign company issues equity shares to the depository, which in turn issues depository receipts which are listed and traded in domestic stock exchange. For example, Deutsche Bank is the depository bank of Infosys ADR program. It is important to note that these depository receipts are denominated in the home currency of investors. For example, Infosys shares are quoted and traded in Indian Rupees in Indian stock exchanges, but Infosys ADRs are listed and traded in US Dollar in US stock exchanges.

7 In context to ADRs, many-a-times, we come across term American depository shares (ADSs). There is minor difference between ADRs and ADSs. The entire issue is called an American Depositary Receipt (ADR) and the individual shares are known as ADSs. Same is the case of GDRs and GDSs, or for that matter any depository receipt program But before we proceed to understand more about these ADRs/GDRs, let us understand little more on why companies issue these depository receipts first of all or for that matter why investors would prefer investing in ADR 33.3 Benefits/Costs of Depository Receipt to Issuers and Investors: As we know, unless both the issuer company and investors benefit from issuance/investment in a securities, no new type of securities will be ever issued. The security must have features so that it is a win-win proposition for the issuer company and the investors. In this section, we briefly highlight the benefits to both parties Benefits to Issuers Companies are able to raise capital denominated in USD and that to huge amount of capital which may be difficult to raise from the issuer s home country. By issuing securities in a new market, it is able to expand the investor base. When a foreign company s share listed in a domestic market, analysts in the domestic market start analyzing the company, its product, its market share etc., thus indirectly helping in advertising the company. When a foreign company s shares are listed in a domestic exchange and the foreign company wants to acquire another domestic company, then share swap can be an option for the foreign company. In fact many Indian companies having ADRs have swapped ADRs to acquire US based companies. The US investors would have no problem adding ADR to their portfolio. Without the ADRs, swapping domestic shares are not feasible as US investors may not be interested to hold shares of foreign company which is listed in foreign company s home country. Precisely for this reason, ADRs are known as M& A Currency. The report prepared by Citigroup titled ADRs in the M&A environment (available at highlights the benefit of ADRs. This report mentions that If a non-us company wants to make a US acquisition using equity, ADRs offer the most direct method. ADRs trade like US instruments. They can be held by investors prohibited from entering foreign markets.

8 Costs associated with DR issues: Companies have to pay for the, depository fee, listing fee, audit fee and also companies have to recast their annual report as per the GAAP of the foreign country. This cost can be substantial, specifically for an Indian company where the DR costs are denominated in USD. NASDAQ (National Association of Securities Dealers & Automated Quotations) requires the following fees for an ADR listing: Entry Fee (One time): Depending upon the Number ADS issued by a company. Table 33.2 A No. of Shares/ADSs Entry Fee Up to 30 million $125, to 50 million $150, to 100 million $200,000 Over 100 million $225,000 Annual Fees Table 33.2 B No. of Shares/ADSs Annual Fee Up to 10 million $30, to 50 million $37, to 75 million $42, to 100 million $50, to 150 million $50,000 Over 150 million $50,000 So an Indian company intending to list ADRs in may have to annually spend lakh rupees. Table 33.2A and Table 33.2B have been taken from NASDAQ listing fee document available at

9 Benefits to the Investors: Investors are able to invest in foreign company shares without taking foreign exchange exposure. Investors get the benefit of portfolio diversification without worrying to operate in foreign market. The article ADRs in the M&A environment (available at succinctly summarizes the benefits of ADRs. US Investors see the ADR as a great way to expand their portfolio geographically without having the burden of having foreign custody accounts. Since ADRs are reconciled to US Gaap, they trade, clear, and settle in accordance with well understood US market practices. They look and feel like domestic US securities, and maybe that s why 90 percent of ADR trading involves US buyers and US sellers. Furthermore, those transactions cost the same as trading US securities. This is significant since it is estimated that the cost for US investors to clear and settle trades in Europe is 20 times higher than the US Risk associated with DR investment: No investment comes without risk. DRs also pose certain unique risks. These are Financial Accounting and reporting standards followed by the foreign company. Exchange rate change affecting the dividend repatriation Change in withholding tax in the foreign country ADRs/GDRs are inherently illiquid as the proportion of ADRs/GDRs are less compared to the total outstanding equity shares of any company.

10 33.4 Types of Depository Receipts: In this section, different types of Depository Receipts are discussed. DRs Sponsored Unsponsored Level I Level II Level III Privately Placed Figure 33.2: Types and Levels of Depository Receipts. DRs can be of two types: Sponsored, Unsponsored depending on whether the actively involved in the issuance of the DRs or not. Sponsored ADRs: In a sponsored DR issue, the company solicits depositories to issue and list DRs in a foreign country exchanges. The DRs are issued by the active participation of the company. Sponsored DRs also come in three different types: Level I, Level II, Level III and based on Rule 144A. The issuing company and the depositories enter into depository agreement before the DRs are issued. The depository receives the bulk amount of dividend in the foreign company s home currency on behalf the DR investors and converts the dividend into the investors home currency and then sends these to the respective DR holder. The depositories also arrange DR holders to exercise voting rights. For all practical purpose, the depository acts as the front of the DR issuing foreign company. It is very important to note here that there can be only one depository for a sponsored DRs issue. The difference among Level I, Level II, Level III and Privately Placed are discussed after the unsponsored DRs aspects have been discussed.

11 Unsponsored DRs: Unsponsored DRs are issued by one or more depositaries in response to market demand, but without a formal agreement with the company. For unsponsored DRs, depositories are not required to take permission or even inform the foreign companies before issuing the unsponsored DRs. In an unsponsored ADR issue, the depository buys the shares of foreign company and deposits these shares into a custodian. Then it issues DRs which investor can invest. Hence there could be multiple unsponsored DR programs for a given company. For example, Depository 1 buys let us 50,000 shares Suzlon India and issues 25,000 ADRS with each ADR representing 2 equity shares of Suzlon. Depository 2 buys 100,000 shares of Suzlon and issues 100,000 ADRs with each ADR representing 1 underlying share. Hence ADRs issued by these two depositories are completely different when though both ADRs represent Suzlon. Also the dividend distributed to US investors may vary depending on the day on which the depositories convert Indian Rupee dividend to USD. For example, Suzlon credits the Indian Rupee Dividend to both Depositories on July 15 th Depository 1 converts this amount to USD on let us say, on 17 th July Depository 2 may convert the dividend on 20 th July. There could be big difference in INR/USD rate between 17 th and 20 th July. Hence the dividend received by both sets of depositories may vary significantly. Both depositories may charge different service fee to the ADR investors thus making the matter even more confusing. Level I, II, III and Privately Placed DRs: Level I: Sponsored Level I Depositary Receipt program is the easiest ways to list DRs. Hence Level 1 DRs are the fastest growing segment among all sponsored DR programs all over the world. In a Level I DRs, the company cannot raise any fund by issuing new securities as DRs. Companies issuing Level I DRs do not have to abide by the listing requirements set by the regulatory body. These DRs normally trade in the OTC (Overthe-Counter) market. Level I DRS are subjecting to easy/no listing requirement. In fact, Level 1 ADRs does not require the issuing company to recast its accounting statement as per US GAAP(Generally Accepted Accounting Principle) and provide full SEC disclosure. For example, The Sarbanes Oxley Act is not applicable to companies issuing Level I ADRs.

12 Sarbanes Oxley Act 2002 was enacted by the SEC of USA after some high ticket corporate failure ( Enron, Worldcom, Tyco International, Adelphia etc) due to misreporting of actual facts and figure about companies. This act is also known as Public Company Accounting Reform and Investor Protection Act as well as popularly SOX ACT. The act made all public listed companies in USA more accountable and covered a gamut of issues like auditor independence, corporate governance, internal control assessment, and enhanced financial disclosure. Level II and Level III Sponsored ADRs: Level II Depositary Receipts are exchangelisted securities but the issuing company cannot raise capital. In a Level III programs, the company can list its DRs in foreign stock exchanges as well as raise capital from the foreign investors. Both Level II and Level III DRs require the company to abide by all listing and reporting requirement. Level II DRs programs are easier than the Level III DR programs. Privately Placed DRs: The issuing company may privately place DRs with QIBs (Qualified Institutional Buyers). The SEC rules pertaining the issuance and subsequent trading of these DRs are governed by Rule 144. Hence many-a-times, when these DRs are issued through this route these are known as Rule 144 category of DRs. Rule 144 A securities are also known as restricted securities. When investors buy restricted shares, the DRs Certificates are stamped as restricted. The restricted tag does not allow the holders to sale these certificates to general public without SEC exempting these from being restricted shares.

13 The following table shows sample list of different types and level of DRS issued. Table 33.3 : Types and Levels of Depository Receipts Source: DEPOSI NAME EXCHANGE LEVEL SPONSORSHIP TARY TYPE 3I GROUP PLC OTC LEVEL I Unsponsored BNY ADR 3SBIO INC NASDAQ LEVEL III Sponsored JPM ADR 4IMPRINT GROUP PLC OTC LEVEL I Sponsored BNY ADR 51JOB INC NASDAQ LEVEL III Sponsored JPM ADR 7 DAYS GROUP HOLDINGS LTD NYSE LEVEL III Sponsored CIT ADR A&D PHARMA HOLDING NV PORTAL 144A Sponsored CIT GDR A&D PHARMA HOLDING NV LONDON REGS Sponsored CIT GDR ABB LTD NYSE LEVEL II Sponsored CIT ADR ABENGOA SA OTC LEVEL I Unsponsored BNY, DB ADR ABERTIS INFRAESTRUCTURAS SA OTC LEVEL I Unsponsored BNY ADR ABL BIO- TECHNOLOGIES LTD LUXEMBOURG REGS Sponsored DB GDR ABSA GROUP LTD OTC LEVEL I Sponsored BNY ADR ACCENTIA TECHNOLOGIES LTD SINGAPORE REGS Sponsored JPM GDR BNY : Bank of New York, JPM : JP Morgan DB : Deutsche Bank CIT : Citibank Table 33.3 clearly indicates the different levels, different exchanges among the sponsored/unsponsored exchanges. It is interesting to note here that Bank of New York and Deutsche Bank have issued unsponsored ADR program for ABENGOA SA of Spain.

14 Multiple Choice Questions: 1. Cross listing refers to a. When a home country company lists its shares in a foreign stock exchange denominated in home country currency. b. When a home country company lists its shares in a foreign stock exchange denominated in foreign country currency. c. When a foreign company lists its shares in domestic stock exchange denominated in foreign company s home currency d. When a foreign company lists its shares in domestic stock exchange denominated in domestic currency i. Only a & c is correct ii. Only b &d is correct iii. All correct iv. None correct 2. In an unsponsored depository receipt issue a. The depository need to take permission from the company b. The depository need to inform the company c. The company has to take the permission from its home country regulator before issuing the DRs d. The depository neither informs nor takes permission from the company. 3. ADRs/GDRs refers to a. When a home country company lists its shares in a foreign stock exchange denominated in home country currency. b. When a home country company lists its shares in a foreign stock exchange denominated in foreign country currency. c. When a foreign company lists its shares in domestic stock exchange denominated in foreign company s home currency d. When a foreign company lists its shares in domestic stock exchange denominated in domestic currency i. Only a & c is correct ii. Only b &d is correct iii. All correct iv. None correct

15 4. Which type of ADR is the most difficult to issues a. Level I b. Level II c. Level III d. Private placement of Level III 5. Which type of ADR issue cannot be sold in the stock exchanges to general public. a. Level I b. Level II c. Level III d. Private placement of Level III Short Questions: 1. What role the depository plays in the issuance and maintenance of depository receipts? 2. What are the main differences between sponsored and unsponsored depository receipts? 3. What benefits would accrue to an issuer issuing IDR? 4. If an Indian company intends to issue ADR, then which type it should prefer? Level I, II or III or Private placement? Answer to Multiple Choice Questions: 1. (ii) 2. C and D 3. (ii) 4. C 5. D

16 References: 1. Tim V. Eaton, John R. Nofsinger and Daniel G. Weaver ( 2007), Disclosure and the cost of equity in international cross-listing, Review of Quantitative Finance and Accounting, Volume 29, Number 1,pp H. Kent Bakera, John R. Nofsingera2and Daniel G. Weavera (2002), International Cross-Listing and Visibility, Journal of Financial and Quantitative Analysis, Vol. 37, pp: Andreas Charitou, Christodoulos Louca and Stelios Panayides ( 2008), Why do Firms Cross-List? The Flip Side of the Issue, 4. ADR Universe details: 5. ADR Arbitrage : 6. INSTANEX SKINDIA DR INDEX AND CONSTITUENTS, Source: