ADRs are receipts issued in the US, which are backed by shares held by a custodian in the country where the original securities were issued. For instance, let us assume that an IT company, which has issued shares in India, seeks to list on the NYSE. The depository receipts per se will be issued by a bank in the US. The two biggest issuers in the US are JPMorgan and Bank of New York Mellon. JPMorgan issued the first ADR as long ago as 1927. What will happen in practice is that the depository bank will acquire the shares of the IT firm in India. The shares will be deposited with a local custodian bank in India, such as the SBI. The depository bank will then issue receipts in the US where each receipt will correspond to a certain number of shares issued by the IT firm in India.
In practice, an ADR may be a multiple of the underlying Indian shares or, in principle, can even be a fraction of an Indian share. The objective is to primarily ensure that the American security trades at an appropriate price range in the US. Let us assume that the Indian shares are trading at R77 on the NSE, and that the exchange rate is rupees 55 per $. If the issuer were to go for a 1:1 ratio, then the ADRs will trade at approximately $1.40 in the US. To avoid such a situation, an ADR in such circumstances may be defined as being equivalent to 10 Indian shares. If so, the depository receipt will trade at approximately $14.
There could be instances where the foreign security is priced very high, in its home market. Let us assume for instance that shares of a company are trading at R11,000 in India. If we assume an exchange rate of R55 per $, then the ADR will be priced at approximately $200. In such a situation, the issuer of the receipts may specify that an ADR is equivalent to 0.25 Indian shares, and, as a consequence, the receipts will trade at about $50 each.
For a foreign company listing on a US exchange is attractive because these exchanges are among the largest in the world and are arguably the most efficient. The American market poses relatively fewer barriers to entry, which is attractive from the foreign companys standpoint. The US also has a substantial number of high networth investors. Such parties are financially well endowed and, equally important, they are well aware of the benefits of international portfolio diversification.
From an American investors standpoint, he gets access to a security priced in dollars. Investors can trade through their normal brokers and do not have to confront issues such as opening a brokerage or a demat account in a foreign country. Investors also receive dividends in dollars. There are also situations where the ADRs are more liquid then the underlying shares. Another reason for the popularity of such securities is that certain pension funds and money managers are required by law to invest in ADRs, if they seek to take a position in a non-American security.
From an Indian companys standpoint, an ADR issue entails compliance with US GAAP, and the rules and regulations of an exchange such as NYSE or Nasdaq. This usually implies a need to disclose a substantial amount of information, and the resultant transparency benefits not just the acquirers of ADRs in the US, but also domestic investors in India. Foreign listing also provides Indian companies with a platform for indirect advertising of their products and brands in the US. This also has implications for issues such as loan syndication.
Take, for instance, a Bangalore-based IT firm that is seeking to arrange for a US dollar loan. The chances of success are greater for a firm that is listed in the US compared to a firm that is listed solely in an emerging market such as India. An issue of shares outside of the home nation may, at times, help mitigate the risk of a hostile takeover. This is because the spread of shareholders across the globe reduces the probability of a raider being able to corner a sizeable number of shares and mount a takeover bid.
In certain cases, companies go in for an ADR issue because they perceive their domestic markets to be too small, from the standpoint of absorbing an issue of the magnitude that they are contemplating.
While this may not be a critical issue for prominent Indian firms, this fact has compelled Scandinavian and East European firm to seek access to foreign securities markets. The expertise possessed by foreign investors could also be a factor for inducing a company to seek access to a foreign market.
For instance, there was a time when global mining companies were making a beeline for Canadian exchanges, because of a perception that Canadian investors had greater expertise in evaluating such issues.
* For a foreign company listing on a US exchange is attractive because these exchanges are among the largest in the world and are arguably the most efficient
* From an Indian companys standpoint, an ADR issue entails compliance with US GAAP, and the rules and regulations of an exchange such as NYSE or Nasdaq
* This usually implies a need to disclose a substantial amount of information, and the resultant transparency benefits not just the acquirers of ADRs in the US, but also domestic investors in India.
* Foreign listing also provides Indian companies with a platform for indirect advertising of their products and brands in the US. This also has implications for issues such as loan syndication
* The writer is the author of Fundamentals of Financial
Instruments, published by Wiley India