Depositary Receipts

[Sapphire Capital]

What Are Depositary Receipts?
by Reem Heakal

A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity, that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.

Since then, DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) (the other most common type of DR), European DRs and international DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in U.S. dollars, but can also be denominated in euros.

How Does the DR Work?
The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. Let us look at an example of how an ADR is created and traded:

Example
Say a gas company in Russia has fulfilled the requirements for DR listing and now wants to list its publicly traded shares on the NYSE in the form of an ADR. Before the gas company's shares are traded freely on the exchange, a U.S. broker, through an international office or a local brokerage house in Russia, would purchase the domestic shares from the Russian market and then have them delivered to the local (Russian) custodian bank of the depository bank. The depository bank is the American institution that issues the ADRs in America. In this example, the depository bank is the Bank of New York. Once the Bank of New York's local custodian bank in Russia receives the shares, this custodian bank verifies the delivery of the shares by informing the Bank of New York that the shares can now be issued in the United States. 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 be issued as representing one or more of the Russian local shares, and the price of each ADR would be issued in U.S. dollars converted from the equivalent Russian price of the shares being held by the depository bank. The ADRs now represent the local Russian shares held by the depository, and can now be freely traded equity on the NYSE.

After the process whereby the new ADR of the Russian gas company is issued, the ADR can be traded freely among investors and transferred from the buyer to the seller on the NYSE, through a procedure known as intra-market trading. All ADR transactions of the Russian gas company will now take place in U.S. dollars and are settled like any other U.S. transaction on the NYSE. The ADR investor holds privileges like those granted to shareholders of ordinary shares, such as voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate.

Pricing and Cross-Trading
When any DR is traded, the broker will aim to find the best price of the share in question. He or she will therefore compare the U.S. dollar price of the ADR with the U.S. dollar equivalent price of the local share on the domestic market. If the ADR of the Russian gas company is trading at US$12 per share and the share trading on the Russian market is trading at $11 per share (converted from Russian rubles to dollars), a broker would aim to buy more local shares from Russia and issue ADRs on the U.S. market. This action then causes the local Russian price and the price of the ADR to reach parity. The continual buying and selling in both markets, however, usually keeps the prices of the ADR and the security on the home market in close range of one another. Because of this minimal price differential, most ADRs are traded by means of intramarket trading.

A U.S. broker may also sell ADRs back into the local Russian market. This is known as cross-border trading. When this happens, an amount of ADRs is canceled by the depository and the local shares are released from the custodian bank and delivered back to the Russian broker who bought them. The Russian broker pays for them in roubles, which are converted into dollars by the U.S. broker.




The Benefits of Depositary Receipts
The DR functions as a means to increase global trade, which in turn can help increase not only volumes on local and foreign markets but also the exchange of information, technology, regulatory procedures as well as market transparency. Thus, instead of being faced with impediments to foreign investment, as is often the case in many emerging markets, the DR investor and company can both benefit from investment abroad. Let's take a closer a look at the benefits:

For the Company
A company may opt to issue a DR to obtain greater exposure and raise capital in the world market. Issuing DRs has the added benefit of increasing the share's liquidity while boosting the company's prestige on its local market ("the company is traded internationally"). Depositary receipts encourage an international shareholder base, and provide expatriates living abroad with an easier opportunity to invest in their home countries. Moreover, in many countries, especially those with emerging markets, obstacles often prevent foreign investors from entering the local market. By issuing a DR, a company can still encourage investment from abroad without having to worry about barriers to entry that a foreign investor might face.

For the Investor
Buying into a DR immediately turns an investors' portfolio into a global one. Investors gain the benefits of diversification while trading in their own market under familiar settlement and clearance conditions. More importantly, DR investors will be able to reap the benefits of these usually higher risk, higher return equities, without having to endure the added risks of going directly into foreign markets, which may pose lack of transparency or instability resulting from changing regulatory procedures. It is important to remember that an investor will still bear some foreign-exchange risk, stemming from uncertainties in emerging economies and societies. On the other hand, the investor can also benefit from competitive rates the U.S. dollar and euro have to most foreign currencies.

Conclusion
Giving you the opportunity to add the benefits of foreign investment while bypassing the unnecessary risks of investing outside your own borders, you may want to consider adding these securities to your portfolio. As with any security, however, investing in ADRs requires an understanding of why they are used, and how they are issued and traded.

[Sapphire Capital]

Bank of NY Mellon

An Overview of Depositary Receipts
Depositary Receipts (DRs), which include ADRs, GDRs, Euro DRs and NYSs, are negotiable U.S. securities that generally represent a non-U.S. company's publicly traded equity. Although typically denominated in U.S. dollars, Depositary Receipts can also be denominated in Euros. Depositary Receipts can trade on all U.S. stock exchanges as well as on many European stock exchanges.

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, they offer cost benefits and conveniences.


What are Depositary Receipts?
Benefits to a Company
Benefits to an Investor
Types of Depositary Receipt Facilities
Sponsored Level I Depositary Receipts
Sponsored Level II and Sponsored Level III Depositary Receipts
Privately Placed and Offshore (SEC Rule 144A/Reg. S) Depositary Receipts
How Depositary Receipts Trade
World Leader in Depositary ReceiptsWhat are Depositary Receipts?
A Depositary Receipt is a negotiable U.S. security that generally represents a company's publicly traded equity or debt. Depositary Receipts are created when a broker purchases a non-U.S. company's shares on its home stock market and delivers the shares to the depositary's local custodian bank, and then instructs the depositary bank, such as The Bank of New York Mellon, to issue Depositary Receipts. In addition, Depositary Receipts may also be purchased in the U.S. secondary trading market. They 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.
Depositary Receipts may be more specifically called American Depositary Receipts (ADRs), Rule 144A Depositary Receipts or Global Depositary Receipts (GDRs). These names typically identify the market in which the Depositary Receipts are available: ADRs are publicly available to U.S. investors on a national stock exchange or in the over-the-counter market; Rule 144A ADRs are privately placed and resold only to Qualified Institutional Buyers (QIBs) in the U.S. QIB PORTAL market; and GDRs are generally available in one or more markets outside the foreign company's home country, although these may also be known as ADRs.


Benefits to a Company
Currently, there are over 2,250 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.


Types of Depositary Receipt Facilities
Depositary Receipt facilities may be unsponsored and sponsored. Unsponsored Depositary Receipts are issued by one or more depositaries in response to market demand, but without a formal agreement with the company.
Sponsored Depositary Receipts may be issued in different levels, available in various trading markets, and 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 U.S. or European stock exchange 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 with prices published in the Pink Sheets and on some exchanges outside the United States. Establishment of a Level I program does not require full SEC registration and the company does not have to report its accounts under U.S. Generally Accepted Accounting Principles (GAAP) or provide 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. The majority of sponsored programs are Level I facilities. In addition, because of the benefits of Depositary Receipt investing, it is not unusual for a company with a Level I program to obtain 5 percent to 15 percent of its shareholder base in Depositary Receipt form. Many well-known multinational companies have established such programs. Numerous companies have started with a Level I program and then upgraded to a Level II (listing) or Level III (offering) program.


Sponsored Level II and Sponsored Level III Depositary Receipts
Companies that wish to list their Depositary Receipts on a U.S. stock exchange (NASDAQ, American or New York), raise capital or make an acquisition using securities, use Sponsored Level II or Sponsored Level III Depositary Receipts. Level II and Level III Depositary Receipt programs require SEC registration and adherence to applicable requirements for U.S. GAAP. These types of Depositary Receipts can also be listed on some exchanges outside the United States. Level II Depositary Receipts are exchange-listed securities but do not involve raising new capital. Level III programs typically generate the most U.S. investor interest because capital is being raised. Generally, companies that choose either a Level II or Level III program will attract a significant number of U.S. investors.


Privately Placed and Offshore (SEC Rule 144A / Regulation S) Depositary Receipts
In addition to the three levels of sponsored Depositary Receipt programs that trade publicly in the U.S., a company can also access the U.S. and other capital markets through SEC Rule 144A and/or SEC Regulation S Depositary Receipt facilities without SEC registration. Rule 144A programs provide for raising capital through the private placement of Depositary Receipts with large institutional investors (often referred to as QIBs) in the United States. Regulation S programs provide for raising capital through the placement of Depositary Receipts offshore to non-U.S. investors in reliance on Regulation S. A Level I program can be established in addition to a Rule 144A program, and a Regulation S program may be merged into a Level I program after the restricted period has expired.


How Depositary Receipts Trade
A Depositary Receipt is a negotiable security that 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 Mellon, 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 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, compared to the costs associated with trading and holding ordinary shares outside the United States.


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. After notification, Depositary Receipts are issued and delivered to the initiating broker, who then delivers the Depositary Receipts evidencing the shares to the investor. Your 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.


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.


World Leader in Depositary Receipts
The Bank of New York Mellon is the leading depositary bank, managing substantially more sponsored Depositary Receipt programs than any other depositary bank in the world. We currently issue Depositary Receipts for more than 2,250 programs with companies from 70 countries. Our leadership in the Depositary Receipts industry is exemplified by our appointment as depositary bank for 65 percent of all public sponsored Depositary Receipt programs. Our overall success is based upon our unique, value-added services; technologically advanced securities servicing operating capabilities; a specialized approach to each market we service; and personalized administrative support and overall commitment to securities servicing.


Please refer to the DR Directory for a comprehensive list of Depositary Receipt programs.
This information and data is provided for general informational purposes only. The Bank of New York Mellon and our information suppliers do not warrant or guarantee the accuracy, timeliness or completeness of this information or data. We provide no advice nor recommendation or endorsement with respect to any company or securities. We do not undertake any obligation to update or amend this information or data. Nothing herein shall be deemed to constitute an offer to sell or a solicitation of an offer to buy securities.
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