Vous êtes sur la page 1sur 32

UNIT V

LESSON
9
INTERNATIONAL FINANCIAL MARKET
INSTRUMENTS
CONTENTS
9.0 Aims and Objectives
9.1 Introduction
9.1.1 Significance
9.1.2 Eurocurrency Interest Rates
9.2 Instruments and Rates of International Financial Market or Eurocurrency Market
9.2.1 Growth of the Eurodollar Market
9.2.2 Domestic Issues vs. Euro Issues
9.3 International Equities
9.4 Depository Receipt
9.5 American Depository Receipt (ADR)
9.5.1 Types of American Depository Receipts
9.5.2 Unsponsored and Sponsored ADR Facilities
9.5.3 American Depository Receipts Unsponsored Programmes
9.5.4 American Depository Receipts Sponsored Programmes
9.5.5 Benefits of ADRs
9.5.6 Ramifications of Indian ADRs
9.6 Global Depository Receipt
9.6.1 History of GDRs in India
9.6.2 Procedure for an Initial Issue of GDR
9.6.3 Characteristics of GDRs
9.6.4 Benefits and Uses of a GDR
9.7 Let us Sum up
9.8 Lesson End Activity
9.9 Keywords
9.10 Questions for Discussion
9.11 Suggested Readings
176
International
Financial Management
9.0 AIMS AND OBJECTIVES
After studying this lesson, you will be able to:
Understand the International financial market instruments
Learn about international equities
9.1 INTRODUCTION
The prominent instrument is the international financial market is the Eurocurrency. A
Eurocurrency is any freely convertible currency deposited in a bank outside its country
of origin. These deposits can be placed in a foreign bank or in a foreign branch of a
domestic US bank. Any convertible currency can exist in Euro e.g. we can have
Eurosterlings, Euroyen, Euromarks, Eurodollars and so on. The Eurocurrency market
consists of those banks which accept deposits and make loans in foreign currencies.
Banks in which Eurocurrencies are deposited are called Eurobanks. Thus Eurobanks
are major world banks that conduct a Eurocurrency business in addition to all other
banking functions. On the other hand, a Eurobond is a bond sold outside the country in
whose currency it is denominated. In the Eurobond market, these Eurobonds are issued
directly by the final borrowers, whereas the Eurocurrency market enables investors to
hold short-term claims on commercial banks, which then act as intermediaries to transform
these deposits into long-term claims on final borrowers.
For international trade the dominant Eurocurrency is the US dollar as the US dollar is
widely used by many foreign countries as a medium. However, the importance of the
Eurodollar has decreased over a period of time. Also, with the weakening of the dollar in
the latter parts of both the 1970s/80s, other currencies particularly the Deutsche mark
and the Swiss franc have increased in importance. Thus a Eurocurrecny market serves
2 important purposes. First, it is a convenient and efficient money market device for
holding excess corporate liquidity and Second, it is a major source of short-term bank
loans to finance corporate working capital.
Characteristics of the Eurocurrency Market: The various characteristics of the
international financial market or Eurocurrency market are:
1. It is a large international money market relatively free from government regulation
and interference, i.e., the market is essentially unregulated.
2. The deposits in the Eurocurrency market are primarily for short-term. This
sometimes leads to problems about managing risk, since most Eurocurrency loans
are for longer periods of times.
3. Transaction, in this market are generally very large with government, public sector
organisations tending to borrow most of the funds. This makes the market a wholesale
rather than a retail market. Also, approximately 80% of the Eurodollar market is
interbank, which means that the transactions take place between banks.
4. The Eurocurrency market exists for savings and time deposits rather than demand
deposits.
5. The Eurocurrency market is mainly a Eurodollar market. Generally, the Eurocurrency
borrowing rate depends on the creditworthiness of the customer and is large enough
to cover various costs as also build reserves against possible losses. Traditionally,
loans are made at a certain percentage above the London Interbank Offered Rate
(LIBOR), which is the interest rate banks charge one another on loans of
Eurocurrencies. Most loans are made on variable rate terms and the rate fixing
177
International Financial
Market Instruments
period could be one month, three months or six months. Because of the variable
nature of the interest rates, the maturities can extend into the future.
The Eurocurrency market has both short-term and medium-term characteristics. Short-
term Eurocurrency borrowings have a maturity of less than one year. Borrowing at
maturities exceeding one year is also feasible and is known as Euro credit. A Euro credit
consists of loans that mature in one to five years. These Euro credits may be in the form
of loans, lines of credit or medium and long-term credit including syndication. Syndication
occurs when several banks pool their resources to extend a large loan to a borrower so
as to spread the risk.
Another special feature of the Eurocurrency market is the difference in interest rates as
compared with domestic markets. Eurocurrency loans generally carry a lower rate of
interest than the rates in the domestic markets. Eurocurrency deposits generally tend to
yield more than domestic deposits because of large transactions and the absence of
controls and their attendant costs.
9.1.1 Significance
The Eurocurrency market plays a key role in the capital investment decisions of many
firms since it is a funding source for corporate borrowing. In addition, since this market
also rivals domestic financial markets as a deposit alternative, it absorbs large amounts
of savings from lenders (i.e., depositors) in many countries. In fact, the Eurocurrency
market complements the domestic financial markets, giving greater access to borrowing
and lending to financial market participants in each country where it is permitted to
function. Overall, the Eurocurrency market is now the worlds single most important
market for international financial intermediation.
The Eurocurrency market is totally a creation of the regulations placed by national
governments on banking. If the governments of various countries allowed banks to function
without the stipulation of reserve requirements, capital controls, interest rate restrictions
and tax, the Eurocurrency market would involve only the transnational deposits and
loans made in each countrys banking system. Instead, the governments, in order to
achieve the various benefits of monetary policy, heavily regulate the financial markets.
Thus, in order to overcome many of the limitations placed on domestic financial markets,
the Eurocurrency market provides a very important outlet for flow of funds. And since
most of the governments have found the impact of the Eurocurrency market on their
firms and banks to be favourable, they have allowed these markets to operate.
Thus, Eurocurrency markets serve two valuable purposes: (1) Eurocurrency market is a
major source of short-term bank loans to help meet the corporates working capital
requirements including the financing of imports and exports; (2) Eurocurrency deposits
are an efficient and convenient money market device for holding excess corporate liquidity.
For a Eurocurrency market to exist three conditions must be met. First, national
governments must allow foreign currency deposits to be made; second the country whose
currency is being used must allow foreign entities to own and exchange deposits in that
currency; third, there must be a significant reason, such as low cost or ease of use that
motivates individuals to use this market and not the domestic one. The phenomenal
growth of the Eurocurrency market testifies that it has met these conditions for the past
three decades now.
Many countries allow foreign currency deposits to be held in their banking systems.
While some countries impose restrictions like interest rate limits, capital controls, etc., on
both the foreign currency deposit as well as on local currency deposit, other countries,
specially most of the developed countries, do not impose restrictions on the foreign
178
International
Financial Management
currency deposits. These countries generally tend to be the Euromarket centres as
participants find them more acceptable due to favourable interest rates, greater availability
of funds and easy access for moving funds internationally.
The currencies which have become popular as Eurocurrencies and tend to be widely
used include the US dollar, the British pound, the French franc, the German mark and a
few others. The governments of countries whose currencies are being widely used have
generally consented to allow foreign banks, companies and individuals to hold and use
deposits denominated in those currencies.
9.1.2 Eurocurrency Interest Rates
The base interest rate paid on deposits among banks in the Eurocurrency market is
called LIBOR, the London Interbank Offered Rate. (Outside London, which is the centre
of the entire Euromarket, the base rate on deposits is generally slightly higher.) LIBOR
is determined by the supply and demand for funds in the Euromarket for each currency,
because participating banks could default (and, infrequently, do default) on their obligations
and the rate paid for Eurodollar deposits in addition to the spread over LIBOR in the
Euromarket. This also helps reduce the cost of using the Euromarket for borrowers. The
total cost of borrowing in the Euromarket for a prime US corporation historically was
marginally below the domestic US prime rate. Because of competition among lenders in
both markets, prime borrowers have been able to obtain the same rate in both markets
since the early 1980s.
Interest rates on other Eurocurrencies generally follow the same pattern, though when
capital controls exist in a particular country (e.g., France), borrowing rates may be higher
in the Euromarket (which is not restricted) than in the domestic market.
9.2 INSTRUMENTS AND RATES OF INTERNATIONAL
9.2 FINANCIAL MARKET OR EUROCURRENCY
9.2 MARKET
The most important characteristic of the Eurocurrency market is that loans are made on
a floating rate basis. Interest rates on loans to governments and their agencies,
corporations, and non-prime banks are set at a fixed margin above LIBOR for the given
period and the currency chosen. At the end of each period, the interest for the next
period is calculated at the same fixed margin over the new LIBOR.
The margin, or spread between the lending banks cost of funds and the interest charged
from the borrower, varies a good deal among borrowers and is based on the borrowers
perceived riskiness. Typically, such spreads have ranged from slightly below 0.5% to
over 3%, with the median being somewhere between 1% and 2%.
The maturity of a loan can vary from approximately three to ten years. Lenders in this
market are almost exclusively banks. In any single loan, there will normally be a number
of participating banks that form a syndicate. The bank originating the loan will usually
manage the syndicate. This bank, in turn, may invite one or two other banks to co-
manage the loan.
The managers charge the borrower a once-and-for-all fee of 0.25% to 1% of the loan
value, depending on the size and type of the loan.
Eurocurrency deposits are held predominantly in the form of fixed rate time deposits
with maturities ranging from overnight to several years. Most of the funds, however, are
held in the one month to six months maturity range. The balance of these deposits is
accounted for by negotiable certificate of deposits (CDs).
179
International Financial
Market Instruments
Eurocurrency CDs are issued in two forms: These are Tap CDs and Tranche CDs.
The former are issued in relatively large denominations (commonly from $250,000 to $5
million) and for maturities of less than one year, whenever banks need to tap the
market for funds. Tranche CDs are issued in large aggregate amounts (typically $10
million to $50 million), but are offered to investors in small certificates (typically $10,000).
The volatility of interest rates since 1979 has led to the use of Eurocurrency Floating
Rate CDs (FRCDs) and Eurocurrency Floating Rate Notes (FRNs). Both are negotiable
bearer instruments with rates reset at every three to six months, thus protecting investors
against a decline in the principal value of the paper caused by rise in interest rates.
9.2.1 Growth of the Eurodollar Market
The origin of the Eurodollar market is rather obscure. However, it is generally agreed,
that it originated in the early 1950s by the desire of the Soviet Union and Eastern European
countries to place their dollar holdings in European banks to avoid the risk of such balances
being blocked if deposited in US banks.
Basically the Eurocurrency market has thrived on one basic reason, i.e., government
regulation. By operating in Eurocurrencies, banks, suppliers of funds are able to avoid
certain regulatory costs that would otherwise be imposed.
Briefly, the fast growth of the Eurodollar market in the 19651980 period has been
attributed mainly to the following four major factors:
1. Large deficits in the US balance of payments, particularly during the 1960s, which
resulted in the accumulation of substantial dollars held by foreign financial institutions
and individuals.
2. The restrictive environment which prevailed in the United States during the 1963
1974 period to stem capital outflows. These restrictions, which took the form of
both voluntary and mandatory controls, encouraged US and foreign multinational
companies to borrow dollars abroad.
3. The massive balance of payments surpluses realised by OPEC countries due to
sharp increases in oil prices in 1973 -1974 and again in 1978. A good proportion of
these petrodollars was deposited in financial institutions outside the United States.
4. The efficiency and lower cost base of the Eurodollar market. Being a wholesale
funds market, operating free of restrictions at a substantially lower cost than its
counterpart in the United States, it has been able to attract dollar deposits by offering
higher interest rates, as well as making dollar loans available to borrowers at lower
interest rates.
9.2.2 Domestic Issues vs Euro Issues
The following section now compares domestic issues with Euro issues:
Contd....
Domestic Issues Euro Issues
1. Prospectus is used for issue marketing. 1. Prospectus is a legal document; its
requirement is mandatory.
2. Underwriting of the issue is done in 2. Underwriting is done on the day of
advance. issue.
3. Pricing of the issue is done in advance. 3. Pricing is done on the day of issue.
4. The issue has to remain open for a 4. No such stipulation binding.
minimum of three trading days from the
date of opening.
5. Projected earnings and performance 5. Any kind of projections are prohibited.
are given in the prospectus.
180
International
Financial Management
Eurodollar Creation: The creation of the Eurodollar can be illustrated using the traditional
T accounts to show the sequence of transaction.
The following four transactions are given to you:
Transaction (1)
XYZ Co. (Netherlands) exported to ABC, Inc. (US) goods valued at $10,00,000. The
importer paid by a cheque drawn on Citibank (NY). XYZ Co. asked its bank (Algemene
bank of the Netherlands) to credit its account in Dutch guilders with the proceeds of the
transaction. (The exchange rate on the value date of the transaction S0F1/$ is 2.7715.)
Transaction (2)
Algemene bank places the $1,000,000 it has in Citibank (NY) as a time deposit in Shanghai-
Hong Kong Bank (Hong Kong).
Transaction (3)
Shanghai-Hong Kong Bank makes a loan of $9,00,000 to Nestle Co. (Netherlands).
Nestle Co. deposits the cheque in its account with the National Bank of the Netherlands
and asks its bank to credit its account with the equivalent in Dutch guilders. (The exchange
rate on the value date of the transaction is S0F1/$ = 2.7750.)
Transaction (4)
The National Bank of Netherlands makes a loan of $75,00,000 to Nova Industries
(Denmark). Nova Industries uses the loan to settle an import transaction with Bristol
Myers (NY) Bristol Myers maintains its accounts with Chase Manhattan Bank (NY).
6. Appraisal of the project from a 6. Any kind of projections are prohibited.
FI is desirable.
7. There has to be a justification for the 7. No such justification is required.
price demanded.
8. Highlights and risk factors must be 8. Not required.
mentioned in the prospectus.
9. Subscription is invited from the general 9. Can be subscribed only by Qualified
public. Institutional Buyers (QIBs).
10. A particular proportion of the issue has to 10. No such requirement, though a
subscribed to by the promoters, with a cooling off period of 45180 days a
mandatory lock-in period. generally follows the issue.
11. The regulatory frame work is dictated by 11. The regulations to be followed are
SEBI, RBI and the concerned stock exchange. dictated by the Ministry of Finance,
RBI, Department of Company Affairs
and the concerned SEs.
12. The subscription payment terms are flexible. 12. One time payment must be made.
13. Registration is done by SEBI. 13. Registration is done by the Ministry of
Finance.
14. It is governed by local laws. 14. It is governed by international laws.
15. Flotation costs are 812% of the issue size. 15. Flotation costs are 3-4% of the issue
size.
16. The securities are delivered to the holder in 16. The security is delivered in the form of
marketable lots. one jumbo certificate, which can be
broken down when needed.
17. Sufficient number of application forms have 17. Not required.
to be distributed to the stock exchanges,
bankers and underwriters.
18. The securities are held in the name of the 18. The securities are held in the name of
investor. the overseas depository.
19. No upper limit to the size of the issue. 19. The amount raised from this source
cannot exceed 51% of the capital of
the company.
20. All intermediaries have to be registered 20. Not required.
with SEBI.
181
International Financial
Market Instruments
Solution
a. Transaction (1)
Transaction (2)
Transaction (3)
Transaction (4)
Citibank (NY) Algemene Bank (Netherlands)
1. Deposits of ABC, Account with Citibank (1) Deposits of XYZ
Inc. - $1,000,000 (NY) +F12,771,500 Co. + F127,71,500
(Equivalent to
$1,000,000)
1. Deposits of Algemene
Bank + $1,000,000
Citibank (NY) Algemene Bank (Netherlands)
2. Deposits of Algemene (2) Account with
Bank - $1,000,000 Citibank (NY)
- $1,000,000
2. Deposits of Shanghai- (2) TD with Shanghai-
Hong Kong H. K. Bank +
Bank + $1,000,000 $1,000,000
Shanghai-Hong Kong Bank
2. Account with Citibank (2) TD of Algemene
(NY) + $1,000,000 Bank + $1,000,000
Citibank (NY) Shanghai-Hong Kong Bank
3. Deposits of Shanghai- (3) Account with
Hong Kong Citibank (NY)
Bank - $900,000 - $900,000
3. Deposits of National (3) Loan to Nestle
Bank of Netherlands Co. + $900,000
+ $900,000
National Bank of Netherlands
3. Account with (3) Deposit of Nestle
Citibank (NY) Co.+FL $2,497,500
+ $900,000 (Equivalent to
$900,000)
Citibank (NY) National Bank of Netherlands
4. Deposits of National (4) Account with
Bank of Netherlands Citibank (NY)
- $750,000 - $750,000
4. Deposits of Chase (3) Loan to Nova
Manhattan Bank Industries
(NY) + $750,000 + $750,000
Chase Manhattan Bank (NY)
4. Account with (4) Deposits of Bristol
Citibank (NY) Myers + $750,000
+ $750,000
182
International
Financial Management
b. Total amount of Eurodollar deposits created is $1,000,000 (time deposit of Algemene
Bank with Shanghai-Hong Kong Bank denominated in US dollars).
c. The value of the Eurodollar deposit multiplier here is unity.
The following section now discusses the International Equity Market, the International
Bonds Market and the Eurobond Market.
9.3 INTERNATIONAL EQUITIES
This constitutes the equity market on the international scene. The International Equity
Market can be divided into two categories:
Foreign Equity: If the equity issue is made in a particular domestic market (and in the
domestic currency of that market), it is known as a Foreign Equity Issue. For example,
an Indian company accessing exclusively the US market through an equity issue would
be called a foreign equity issue. The instrument available for the above case is called
American Depository Receipt (ADR). If a non-European country raises funds exclusively
from European countries through International/European Depository Receipts (IDRs/
EDRs), it is also a foreign equity issue.
Euro Equity: If a company raises funds using equity route through instruments like
Global Depository Receipts (GDRs) or Superstock Equity in more than one foreign
market except the domestic market of the issuing company and denominated in a currency
other than that of the issuers home country, it is known as Euro Equity Issue or Global
Equity Issue.
9.4 DEPOSITORY RECEIPT
A Depository Receipt (DR) is a negotiable certificate that usually represents a companys
publicly traded equity or debt. Depository receipts are created when a broker purchases
the companys shares on the home stock market and delivers those to the Depositorys
local custodian bank, which then instructs the depository bank, to issue Depository
Receipts. Depository receipts are quoted and traded in the currency of the country in
which they trade, and are governed by the trading and settlement procedures of the
market. The ease of trading and settling DRs makes them an attractive investment
option for investor wishing to purchase shares in foreign companies. Depository receipts
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. This is usually the way non-US shares
are traded in New York, where they are known as American Depository Receipts (ADRs),
since it allows a company to have access to the investors without the expense of actually
listing its shares on one of the US exchanges.
The most common DRs are the American Depository Receipts (ADRs) and the Global
Depository Receipts (GDRs). International Depository Receipts (IDRs) and the European
Depository Receipts (EDRs) are rarer forms of DRs. From a legal and settlement
standpoint, there is no difference between various types of DRs.
A company may issue DRs for a number of reasons:
To raise capital in foreign markets.
To increase consumer interest in their products by strengthening name recognition
in foreign markets.
To potentially increase the liquidity of their shares by broadening shareholder base
(DRs facilitate cross border trading).
183
International Financial
Market Instruments
To gain visibility through financial market presence which can generate support for
and interest in potential mergers and acquisitions.
To allow employees outside the home market to participate in the parent company.
The depository bank acts as the agent for the issuer and provides all stock transfer
(reregistration) and agency services in connection with the depository receipt programme.
These include the custodial arrangement for the safe keeping of the ordinary shares,
issuance and cancellation of receipts, maintenance of the register of holders, pre-release
of receipts, clearance, shareholder services (customer service and information
disbursement), announcement and processing of corporate actions, and distribution of
dividends. Dividend payments are made by the issuer in its home market currency.
The depository will also withhold additional taxes as dictated by foreign tax treaties and
cross border country regulations.
Check Your Progress 1
State whether the following statements are True or False:
1. A Depository Receipt (DR) is a negotiable certificate that usually represents
a company's publicly traded equity or debt.
2. Depository Receipts are quoted and trade in the currency of the country in
which they trade, and are governed by the trading and settlement procedures
of the market.
3. The most important characteristic of the euro currency market is that loans
are made on a floating rate basis.
4. By operating in the Eurocurrencies, banks, suppliers of funds are able to
avoid certain regulatory costs that would otherwise be imposed.
9.5 AMERICAN DEPOSITORY RECEIPT (ADR)
An ADR is a dollar denominated negotiable certificate that represents a non-US companys
publicly traded equity. It falls within the regulatory framework of the USA and requires
registration of the ADRs and the underlying shares with the Securities Exchange
Commission (SEC). (In 1990, changes in Rule 144A allowed companies to raise capital
without having to register with SEC). Non-US companies have a choice of five types of
ADR facilities: unsponsored, three levels of sponsored ADRs, and one type of private
(Rule 144A) ADR facility.
The US is the worlds largest and most liquid capital market. All issues listed on the New
York Stock Exchange (NYSE) can access the US retail market network. For meeting
large requirements of funds, raising funds through ADR is the solution. Also, the size of
an ADR issue can expand or contract according to the demand, as the depository bank
can issue or withdraw corresponding shares in the local market.
To set up a successful ADR programme, the issuing company must be a significant
player in the global arena. Small companies would possibly be ignored by the market or
even if they are able to make a successful offering, their DRs may remain thinly traded.
It is generally recommended that ADRs should be made for above $300 million.
Accessing the individuals is not without drawbacks individual investors are known to
panic at the slightest sign of trouble.
The main hurdle in raising money in the US market is that most of the Indian companies
find it difficult to meet the US GAAP. An ADR will require complete recasting of the
184
International
Financial Management
accounts and corporates will have to disclose far more information than they are used
to. Also, an ADR would mean parting with the voting rights to individual investors whereas
in the case of GDRs, the voting rights rest with the depository. Another point that has to
be taken into account is that under the US law, the directors of the company are personally
liable to the shareholders. In comparison to GDRs, ADRs are not only more difficult but
also more expensive to raise.
GDRs have evolved as European based instruments while ADRs as US based instruments.
The differences that arise in the choice between the two are dictated by the county in
which they are listed and not by any inherent properties of the instruments themselves.
9.5.1 Types of American Depository Receipts
There are five principal types of ADR programmes. The type of ADR programme employed
depends on the requirements of the issuer. It can be broadly classified as under:
Unsponsored ADR Programme: initiated by a third party, not the issuing firm.
Sponsored ADR Programmes: are further categorised by different levels of
disclosure requirements:
a. ADR Programme Level I - is exempt from full compliance with the SECs
reporting requirements and cannot be listed on the national exchanges.
b. ADR Programme Level II - should be in full compliance with the SECs
registration disclosure and reporting requirements which allow ADRs to be
listed on NYSE, AMEX or NASDAQ. However, this type of ADR cannot be
used to raise capital through a public offering.
c. ADR Programme Level III - has the same requirements and privileges as
Level 11, plus it is allowed to raise capital through a public offering provided
that the issuer submits appropriate information to the SEC.
Rule 144 (A) ADRs: restricted ADRs are not required to comply with the full
SECs registration and reporting requirements and are used for private placement
to qualified institutional buyers. The trading of these securities is restricted to NASDs
PORTAL (Private Offerings, Resale and Trading through Automated Linkages)
System.
9.5.2 Unsponsored and Sponsored ADR Facilities
ADR facilities may be established as either unsponsored or sponsored. While ADRs
issued under these two types of facilities are in some respects similar (for example, each
ADR represents a fixed number of securities on deposit with a depository), there are
distinctions between them relating to the rights and obligations of ADR holders and the
practices of market participants.
1. Unsponsored Facilities: Unsponsored ADR facilities generally are created in
response to a combination of investor, broker-dealer and depository interest. Most
often, a depository is the principal initiator of a facility because it perceives US
investor interest in a particular foreign security and recognises the potential income
that may be derived from a facility. In other cases, one or more brokers familiar
with US investor interest and US trading activity in a foreign issuers securities may
request that a depository create a facility in order to facilitate trading.
Features
A depository may establish an unsponsored facility without participation by
(or even necessarily the acquiescence of) the issuer of the deposited securities,
185
International Financial
Market Instruments
although typically the depository requests a letter of no objection from such
issuer prior to the establishment of the facility. If the issuer is neither a reporting
issuer under the Exchange Act, nor exempt from such reporting pursuant to
the information supplying exemption, the depository requests that the issuer
establish such exemption. If the issuer does so, thereafter the depository files
a registration statement on Form F-6 for the ADRs.
Once the registration statement becomes effective, the depository begins to
accept deposits of securities of the foreign issuer and to issue ADRs against
such deposits. Deposited securities are usually held by a custodian appointed
by the depository (often a bank) in the country of incorporation of the foreign
issuer.
Holders of unsponsored ADRs generally bear all the costs of such facilities.
The depository usually charges fees upon the deposit and withdrawal of
deposited securities, the conversion of dividends into US dollars, the disposition
of non-cash distributions, and the performance of other services.
The depository of an unsponsored facility frequently is under no obligation to
distribute shareholder communications received from the issuer of the
deposited securities or to pass through voting rights to ADR holders in respect
of the deposited securities.
2. Sponsored Facilities: A sponsored ADR facility is established jointly by an
issuer and a depository. Sponsored ADR facilities are created in generally the
same manner as unsponsored facilities, except that the issuer of the deposited
securities enters into a deposit agreement with the depository and signs the
registration statement. The deposit agreement sets out the rights and responsibilities
of the issuer, the depository and the ADR holders. Like unsponsored ADR facilities,
sponsored ADR facilities usually involve the use of a foreign custodian to hold the
deposited securities.
Features
With sponsored facilities, the issuer of the deposited securities generally will
bear some of the costs relating to the facility (such as dividend payment, fees
of the depository), although ADR holders continue to bear certain other costs
(such as deposit and withdrawal fees).
Under the terms of most sponsored arrangements, depositaries agree to
distribute notices of shareholder meetings and voting instructions, thereby
ensuring that ADR holders are able to exercise voting rights through the
depository with respect to the deposited securities.
In addition, the depository usually agrees to provide shareholder
communications and other information to the ADR holders at the request of
the issuer of the deposited securities.
Although the terms of deposit for sponsored ADR facilities differ from those for
unsponsored facilities, sponsorship in and of itself does not result in different reporting or
registration requirements with the Commission.
9.5.3 American Depository Receipts Unsponsored Programmes
An unsponsored ADR programme is not initiated or controlled by the issuer but by a
bank in response to US investor demand. A broker acts as market maker for the issue
and works in conjunction with a US bank which, acting as the depository, will issue the
ADRs.
186
International
Financial Management
The depository and the issuer together submit an application to the Securities and Exchange
Commission (SEC) seeking exemption from the full reporting requirements of the Securities
Exchange Act of 1934. Upon receipt of SEC approval of the request for exemption, the
depository files the limited disclosure registration statement. Normally, the SEC grants
approval of the registration statement within a short period of time.
As unsponsored ADR programmes are exempt from full compliance with the SECs
reporting requirements, they can only be traded on the over-the-counter (OTC) market.
The SECs only requirement is that material public information published by the issuer in
its home country be supplied to the SEC and made available to US investors.
The depository will thus mail the issues annual reports and certain other public information
to US investors upon request. The SEC does not require this material to be translated
into English or adjusted for differences in US accounting practices.
Issuer Advantages of Unsponsored ADRs
They provide an inexpensive and relatively simple way of expanding the issuers
investor base in the US.
SEC compliance and reporting requirements are minimal.
The issuer has little, if any, control over the activity of the unsponsored ADR programme
because there is no Deposit Agreement between the issuer and one specific US depository
bank. Providing the issuer is in compliance with the SECs requirements governing
exemptions from reporting under, an unsponsored programme can be duplicated by other
depository banks without the consent of the issuer.
Converting from an unsponsored to a sponsored programme can provide the issuer with
greater control over its programme, but conversion requires the payment of cancellation
fees for outstanding unsponsored ADRs. These cancellation costs can be high.
9.5.4 American Depository Receipts Sponsored Programmes
A. Programe Level I
A Level I sponsored ADR programme is the easiest and least expensive means for a
company to provide for issuance of its shares in ADR form in the US. A Level I programme
is initiated by the issuer and involves the filing of registration statement. It allows for
exemption from full SEC reporting requirements.
The issuer derives greater control over the ADRs issued under a sponsored Level I
programme, since a Deposit Agreement is executed between the issuer and one exclusive
selected depository bank. Level I ADRs can, however, be traded only over-the-counter
and cannot be listed on a national exchange in the US.
Trading
Level I ADRs are traded in the over-the-counter (OTC) market, with bid and ask prices
published daily and distributed by the National Daily Quotation Bureau in the pink sheets.
Prices may also be posted on the OTC Bulletin Board (OTCBB). Due to the SECs
permanent approval of the OTCBB system, however - effective April 1, 1998 - all non-
US equity securities, including ADRs, must be registered with the SEC pursuant to
Section 12 of the 1934 Securities Exchange Act to remain eligible for quotation in the
OTCBB system. Those that wish to continue relying on their exemption will trade
exclusively on the pink sheets.
187
International Financial
Market Instruments
Regulations and Disclosure
Level I ADR programmes currently require minimal SEC registration. The issuer seeks
exemption from the SECs traditional reporting requirements. With that exemption, the
company agrees to send to the SEC summaries or copies of any public reporting
documents required in its home market (including documents for regulatory agencies,
stock exchanges, or direct shareholder communications). The depository, working with
the issuer, also files the Form F-6 registration statement with the SEC in order to establish
the programme.
Issuer Advantages of Level I Programme
Virtually cost-less to set up.
It avoids full compliance with the SECs reporting requirements.
By working with a single depository bank, the issuer has greater control over its
ADR programme than would be the case with an unsponsored programme. The
depository acts as a channel of communication between the issuer and its US
shareholder base. Dividend payments, financial statements and details of corporate
actions are to be passed on to US investors via the depository.
Can support a Rule 144A ADR facility.
Can be used to maintain investor interest.
Issuer Disadvantages of Level I Programme
It cannot be listed on any of the national exchanges in the US. As a result, investor
interest might be somewhat restricted which may limit the issuers ability to enhance
its name recognition in the US.
Capital raising is not permitted under a Level I programme.
B. Programme Level II
A sponsored Level II ADR must comply with the SECs full registration and reporting
requirements. In addition to filing Form F-6 registration statement, the issuer is also
required to comply with the SECs other disclosure rules, including submission of its
annual report which must be prepared in accordance with US GAAP. Registration allows
the issuer to list its ADRs on one of the three major national stock exchanges.
Level II sponsored programmes are initiated by non-US companies to give US investors
access to their stock in the US. As with a Level I programme, a Deposit Agreement is
signed between the issuer and a depository bank. The agreement defines the
responsibilities of the depository, which usually include responding to investor inquiries,
mailing annual reports and other important material to shareholders as well as maintaining
shareholder records.
Trading
Level II ADRs can be listed and traded on one of the US securities exchanges (including
NYSE, AMEX, and others). Alternatively, they can be quoted on NASDAQ.
Regulations and Disclosure
Level II ADR programmes must comply with the full registration and reporting
requirements of the SECs Exchange Act, which entails the following:
Form F-6 registration statement, to register the ADRs to be issued.
Form 20-F registration statement, which contains detailed financial disclosure about
the issuer, including financial statements and a reconciliation of those statements to
US GAAP, to register the listing of the ADRs.
188
International
Financial Management
Annual reports and any interim financial statements submitted on a regular, timely
basis to the SEC.
Issuer Advantages of a Level II Programme
More attractive to US investors than a Level I programme because the ADRs are
fully registered with the SEC and may therefore, be listed on one of the major US
exchanges. This raises the profile of the ADR programme to investors, thus
increasing the liquidity and marketability of the securities.
Listing and registration also enhance the issuers name recognition in the US.
SEC disclosure regulations enable the issuer to monitor the ownership of its shares
in the US.
ADRs at Level II may be used to fund ESOP and management compensation and
bonus plans and as an acquisition currency.
Issuer Disadvantages of a Level II Programme
More detailed SEC disclosure is required than for a Level I programme. For example,
the financial statements must conform to US GAAP, or a detailed summary of the
differences in financial reporting between the home country and the US must be
submitted.
SEC regulations do not permit a public offering of ADRs under a Level II programme.
It is more expensive and time-consuming to set up and maintain a Level II
programme than a Level I programme because of the more stringent reporting
requirements and higher legal, accounting and listing costs.
C. Programme Level III
Level III sponsored ADRs are similar to Level II ADRs in that the issuer initiates the
programme, deals with one depository bank, lists on one of the major US exchanges, and
files Form F-6 and 20-F registration statements with the SEC.
The major difference is that a Level III programme allows the issuer to raise capital
through a public offering of ADRs in the US and this requires the issuer to submit a Form
F-1. (Similar to S-1 for US companies.)
Trading
Level III ADRs can be listed and traded on one of the US securities exchanges (including
NYSE and Amex) or on NASDAQ.
Regulations and Disclosure
Level III ADR programmes must comply with various SEC rules, including the full
registration and reporting requirements of the SECs Exchange Act. This entails the
following:
Form F-6 registration statement, to register the ADRs.
Form 20-F registration statement, an annual filing that contains detailed financial
disclosure from the issuer, including financial statements and a full reconciliation of
those statements to US GAAP.
Form F-1, to register the equity securities underlying the ADRs that are offered
publicly in the US for the first time (including a prospectus to inform potential
investors about the company and the risks inherent in its businesses), the offering
price for the securities, and the plan for distributing the shares.
189
International Financial
Market Instruments
Annual reports and any interim financial statements submitted on a regular, timely
basis to the SEC and to all registered public shareholders.
Issuer Advantages of a Level III Programme
All of the advantages of a Level II programme.
It permits public offerings of ADRs in the US which can be used for a variety of
purposes, including the raising of capital to finance acquisitions.
Issuer Disadvantages of a Level III Programme
SEC reporting is more detailed than for Level I or II programmes.
The costs of setting up and maintaining a Level III programme can be high.
Set-up costs, which would include listing, legal, accounting, investor relations and
roadshow costs can be substantial.
Rule 144A American Depository Receipts
Rule 144A, or Restricted ADRs are depository receipts which are placed and traded in
accordance with Rule 144A, which was introduced by the SEC in April 1990 in part to
stimulate capital raising in the US by non-US issuers. Some of the former Rule 144
restrictions governing resale of privately placed securities (or restricted securities) have
been lifted under Rule 144A, provided the sale is made to Qualified Institutional Buyers
(QIBs).
A QIB is currently defined as an institution, which owns and invests on a discretionary
basis at least US$ 100 million (or, in the case of registered broker-dealers, US$ 10
million) in securities of an unaffiliated entity. At present, there are in excess of 4000
QIBs but the SEC may decide to broaden the definition of a QIB to allow a larger
number to participate in the Rule 144A market. Non-US companies now have easy
access to the US equity private placement market and may thus raise capital through the
issue of restricted ADRs without conforming to the full SEC registration and reporting
requirements. Additionally, the cost of issuing 144As is considerably less than the cost of
initiating a sponsored Level III ADR programme.
Issuer Advantages of 144As
ADRs offered under Rule 144A do not have to conform to full SEC reporting and
registration requirements. QlBs may, however, demand certain financial disclosure,
unless the reporting exemption under Rule 12g 3-2(b) has been granted, as in the
side-by-side ADR structure where the 144A coexists with the Level I.
They provide a cheaper means of raising equity capital than through a public offering
and they can be issued more easily and quickly.
Launched on their own or as part of a global offering.
Traded through the NASDs PORTAL system and cleared through the DTC.
Issuer Disadvantages of 144As
144As cannot be created for classes of shares already listed on then US exchange.
Can only be sold in the US to other QIBs. Although they are in excess of 4000
potential QlBs, the 144A market is not as liquid as the public US equity market.
9.5.5 Benefits of ADRs
Depository Receipts are negotiable certificates issued by a US commercial bank, referred
to as the depository, which represent shares of a non-US company that are deposited
190
International
Financial Management
with the depositorys overseas custodian. Depository receipts are registered with the
US Securities and Exchange Commission and trade like any other US security in the
over-the-counter market or on a national exchange. Depository Receipt investors enjoy
rights which are comparable to those of holders of the underlying securities, plus they
have the benefits, convenience and efficiency of trading in the US securities markets.
Benefits to the Issuing Company
For issuers, there are several reasons for launching and managing an ADR programme:
An ADR programme can stimulate investor interest, enhance a companys visibility,
broaden its shareholder base, and increase liquidity.
By enabling a company to tap US equity markets, the ADR offers a new avenue
for raising capital, often at highly competitive costs. For companies with a desire to
build a stronger presence in the United States, an ADR programme can help finance
US initiatives or facilitate US acquisitions.
ADRs can provide enhanced communications with shareholders in the United States.
ADRs provide an easy way for US employees of non-US companies to invest in
their companies employee stock purchase plans.
Features such as dividend reinvestment programmes can help ensure a continual
stream of investment into an issuers programme.
ADR ratios can be adjusted to help ensure that an issuers ADRs trade is in a
comparable range with those of its peers in the US market.
May increase local prices as a result of global demand / trading through a more
broadened and a more diversified investor exposure.
Benefits to the Investors
Increasingly investors aim to diversify their portfolios internationally. Obstacles, however,
such as undependable settlements, costly currency conversions, unreliable custodial
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. As negotiable securities, ADRs are quoted in US
dollars and pay dividend or interest in US dollars. They overcome the obstacles that
mutual funds, pension funds, and other institutions may have in purchasing and holding
securities outside the local market. Enumerated below are the principal advantages to
the investors:
1. Depository Receipts are US securities: Depository receipts are registered with
the US Securities and Exchange Commission and trade like any other US security
in the over-the-counter market or on a national exchange. Depository receipt
investors enjoy rights which are comparable to those of holders of the underlying
securities, plus they have the benefits, convenience and efficiency of trading in the
US securities markets.
2. Depository Receipts are easy to buy and sell: Investors purchase and sell
depository receipts through their US brokers in exactly the same way as they
purchase or sell securities of US companies. Many regional NASD brokers/dealers,
and virtually all New York brokers/dealers, make markets in and know how to
create depository receipts.
Alternatively, investors can deposit their non-US securities directly with a
depositorys custodian and request the issuance of depository receipts. Investors
may also return depository receipts to the depository for cancellation and have the
underlying securities released back into the local market.
191
International Financial
Market Instruments
3. Depository Receipts are liquid: Depository receipts are as liquid as their underlying
securities because they are interchangeable. For example, if a US broker/dealer
cannot purchase or sell a depository receipt in the US, it can always create a
depository receipt by purchasing the underlying non-US securities for deposit with
the depository, which will then issue depository receipts for the securities.
Alternatively, the broker/dealer can sell the underlying non-US securities, surrender
the depository receipts and instruct the depository to deliver the underlying securities.
Liquidity and ease of execution are major reasons why many institutions invest in
depository receipts.
4. Depository Receipts are global: Investors can choose from more than 1500
different equity depository receipts and several debt depository receipts from 50
countries, including Australia, Brazil, United Kingdom, France, Germany, Hong
Kong, Italy, Japan, Mexico, Singapore, Spain, Sweden and Thailand. Most of the
companies are researched by US analysts, while others have a local following.
5. Depository Receipts are convenient to own
(i) Depository receipt trades clear and settle through standardised US clearance
systems within three business days; while direct investments in non-US shares
are subject to complicated and varied standards for international trades.
(ii) Depository receipts are negotiable US securities. They are quoted in dollars,
pay dividends or interest in dollars, and trade exactly like any other US security.
(iii) Unlike many non-US securities, which are issued in bearer form, depository
receipts are issued in registered form, thus protecting the holder in the event
the certificates are lost.
(iv) Depository receipts overcome the obstacles that many mutual funds, pensions
and other institutions may have in purchasing and holding securities abroad.
6. Depository Receipts are cost-effective
(i) Global custodian safe keeping charges are eliminated, saving depository receipt
investors up to 30 basis points annually.
(ii) Dividends and other cash distributions are converted into dollars at competitive
foreign exchange rates.
(iii) The standard three-day settlement for depository receipts significantly lowers
the fail rate on trades and consequently the costs associated with financing
failed trades.
(iv) Investors enjoy both market liquidity and arbitrage opportunities. Depository
receipts may be bought and sold in the US or the depository receipts can be
cancelled and the underlying securities released into their home market.
(v) Holding depository receipts may facilitate the process of reclaiming excess
withholding on dividends and reduce transfer taxes.
Benefits of ADRs vs Foreign Shares
Transaction Cost Savings: Transactions executed in foreign markets, in general,
have higher costs than US domestic transactions (ADRs are domestic securities)
as well as have many procedural differences.
192
International
Financial Management
Settlement: Any investor in foreign equity will be concerned with the differing
systems and structures in settlement bookkeeping costs.
Custody: Global custody fees are substantially higher than those for domestic
services and the process is complex and requires substantial monitoring. ADRs are
domestic securities.
Transparency: Data, analysis, records, reporting, disclosure are all available through
the ADR programme structure this cannot be said for the majority of foreign
shares.
Legal Restrictions: Many US institutions are still restricted to custody within their
own state or within the US ADRs and US securities.
Research Coverage: Though competing investment banks and brokers provide
research on foreign securities, many to a high standard, the ADR research base,
which is driven by domestic demand, provides US comparables, reconciled financials
as well as easily digested information in American terms. ADRs also attract more
US based research coverage and thus greater comparability.
Liquidity: Many ADRs are now as liquid or more so than the underlying security,
as the US Capital Market creates its own trading base. A holder of ADRs always
has the option of selling the underlying shares into or buying from the local market.
Dividends, Reorganisation, Corporate Action: Information on these issues is
essential to an investor and is sadly wanting in the foreign security universe. The
depository bank for an ADR is responsible for supplying this information to holders
in an efficient and timely manner. Dividend distributions for ADRs are in dollars.
SEC: ADRs are SEC registered securities and hence, timely, accurate reports
from the company are regularly available in English.
Price Translation and Fungibility: ADRs trade at a straight spot currency
translated price. Arbitrage and electronic information flows ensure this. The ADR
is a receipt and thus actually represents ownership of the underlying share, therefore,
it is more than fungible it is actual.
Trading Hours: ADRs are traded during normal US trading hours as well as in
other time zones. Prices are publicly quoted in the US for valuation purposes.
Foreign Exchange: ADRs are traded in US dollars but fluctuate in dollar value
with the underlying shares at the spot forex rate. No forex transaction is necessary
for the customer.
9.5.6 Ramifications of Indian ADRs
The ramifications of ADR s for corporate India and Indian markets are a mixed lot. It
involves a combination of economy wide as well as corporate wise issues. The Indian
ADRs will also open a number of challenges to the functioning of the exchange regulatory
body, the Securities and Exchange Board of India (SEBI). An attempt has been made to
club the ramifications into positives and negatives impact on the economy and the
corporates involved.
The Positives
1. Huge pool of funds: Indian companies that have emerged strong out of the post-
reform turbulations, aspiring to globalise and are willing to embrace transparency
would be able to access the huge pool of US funds and enhance their global image.
This would be of critical importance specially when the domestic market is in a
193
International Financial
Market Instruments
bear phase whereas the foreign markets are in a bull phase. Again, as corporates
are aspiring to be globally competitive, it would serve a twin purpose of providing a
global outlook to the world as well as enhancing the image of the country.
2. Improved quality of disclosure: Access to ADRs requires adherence to stringent
accounting and transparency practices, which, in turn, increase the quality of
disclosures of the companies. And, not just the accounting, the qualitative aspects
like the issues of corporate governance also play a key role in enabling a company
getting listed in the US. As more and more companies begin adopting tougher and
transparent accounting standards and benchmark themselves with best governance
practices, the corporate culture will, undeniably, undergo a positive qualitative change,
that no amount of regulation could achieve so far.
3. Capital formation: As for the economy, the ADR funds are a boon. For, unlike
foreign portfolio investments, ADR funds do not represent hot money that keeps
flowing back and forth with the slightest hint of trouble. To some extent this argument
holds true for Foreign Direct Investment (FDI) as well. The distinctive feature of
this money is that these funds lead to asset formation in the country without resulting
in foreign exchange outflow at the time of capital redemption. Since ADRs are
traded abroad, investors can enter and exit in the US market itself. But the catch
here is that companies that raise ADRs are free to decide to deploy the funds in the
US or in India. However, in either case, the Indian company continues to enjoy the
return on investments it makes.
4. Broaden global visibility: An ADR issue enhances a companys visibility among
the global investing community. This broadens the shareholder base and results in
enhanced liquidity of the companys stock. A resultant benefit of a valuation by the
international investor base would further open up new avenues for accessing capital
in the international markets at highly competitive costs. This is a critical factor
since various markets can be tapped to raise capital, as the dependency on a few
markets will no longer be the case.
5. Better valuations: The US market is one of the most efficient markets in the
world and would provide valuation that is close to the actual value of the company.
As companies that are undervalued in the domestic market would take this
opportunity to actually enhance their value, a second purpose that of getting the
domestic market in close synchronisation with the international prices would also
be achieved. In the hindsight, it can be carefully said that companies will be equally
rewarded and punished for their business operations and with increasing
transparency investors will be equally informed.
6. Merger and Acquisition (M&A) advantage: The last decade saw the emergence
of stocks becoming the currency of acquisitions. The role of cash as a mode of
payment in M&As has lowered significantly over the years. For the domestic
companies with ambitions of going global, going through the M&A route is inevitable.
This wouldnt be possible with locally traded stock. In other words, ADRs will
broaden the M&A financing capabilities of the corporates. It can be achieved in
two ways one being the stock to stock swap option and the second by raising of
money from the US market to finance takeovers. Thus, a foreign listing becomes a
sine qua non for companies with global ambitions.
7. Employee Stock Options (ESOPs): The rise of knowledge based industry also
brought in its wake, the practice of stock compensation, known as ESOPs for
employees. Knowledge industry that rides on the strength of human resources
rather than machinery, unlike the conventional brick and mortar business, needs to
194
International
Financial Management
nurture and retain talent to survive and thrive. Therefore, for domestic companies
it also becomes necessary to have globally traded stock to compete on par with the
global players in terms of creating and maintaining the attractiveness of their ESOPs.
With the globalisation of companies, it becomes imperative to recruit global talent.
Attracting and retaining local talent requires provision of compensation and other
benefits that match with those provided by overseas companies. An ADR issue
creates a currency for issuance of dollar-denominated stock options to employees
and provides a competitive edge in recruiting and retaining global talent. Hence, it
is not only a way of raising capital but also a strategy for achieving competitive
advantage.
8. Corporate segmentation: The post ADR era will see an unfolding of corporate
segmentation happening in the economy. It will be further segmented into blue chip
stocks that can raise money anywhere in the world and those that do not. The blue
chip companies will be able to effectively access all the resources, including human
resources and capital from the best source across the globe. This will further enhance
their competitiveness. The other companies would need to get their act together
quickly and gear up to meet international standards, or soon they will be relegated
to history.
Flip Side
On the flip side there are some concerns. Chief among them is the concern related to the
fate of domestic market and investors.
1. Indian investors unable to invest in good companies: With the prospect of more
Indian companies joining the ADR bandwagon, the number of companies with
transparent and good governance practices is likely to increase. Since ADRs would
be accessible to only good companies that are usually above the rest in the domestic
market, the cream of the companies may increasingly raise money from abroad
rather than the Indian market. Thus, while the companies undergo a qualitative
change, yet, they would not be tapping the domestic market any more. The strategic
advantages of an ADR issue, state of the domestic market and the sheer size of
the US market may compel the corporates to do so. Again, technically there is
nothing that forbids a company from getting delisted in India while keeping the
ADRs alive. This could be a tough bargain for the domestic investors, as they
would lose out on the opportunity of creating wealth through investment in such
companies. An example of Satyam Infoway can be cited in this regard. The company
could not make an IPO in India, since it didnt meet the SEBIs IPO flotation
criteria.
2. Tough times for Mutual Funds: Though Indian mutual funds have been given the
freedom to invest in them, they would be competing with the biggies of the Wall
Street whose sheer financial muscle gives them enormous advantage. The Indian
mutual funds need to pull their socks up to face global competition.
Company Profile
Infosys Technologies Limited, started in 1981, is the largest professional-owned software
company in India. The company provide quality software services and products to
customers across the globe. The company pioneered, and are acknowledged experts, in
cross-border collaborative software development. Infosys offices, spread across North
America, Europe, Japan and India, along with the numerous development facilities, not
only helps the company to stay in close touch with all their customers, but also exploit
time-zone differences to create a 24-hour workday.
195
International Financial
Market Instruments
Products: The Infosys Enterprise Banking Solution embodies the future of banking
information technology. It goes beyond the traditional realm of branch banking to cover
the requirements of the entire banking enterprise. The Infosys Enterprise Banking Solution
provides the bank with the New Generation architecture to progress into the future in an
evolutionary manner. The Infosys Enterprise Banking Solution is designed to encompass
all the constituents of the banking space - the management of the bank, the employees of
the bank and the customers of the bank. This solution provides banks with the agility
required to compete in this new networked age. Infosys Enterprise Banking Solutions
comprises Bancs2000TM, BankAwayTM, BancsMartTM, IFTS, Treasury solutions.
Check Your Progress 2
State whether the following statements are True or False:
1. A Eurocurrency is any freely convertible currency deposited in a bank outside
its country of origin.
2. For international trade the dominant Eurocurrency is the US dollar.
3. The Eurocurrency market is totally a creation of the regulations placed by
national governments on bankings.
4. Many countries totally disallow foreign currency deposits to be held in their
banking systems.
5. If the equity issue is made in a particular domestic market and in the domestic
currency of that market, it is known as Foreign Equity Issue.
9.6 GLOBAL DEPOSITORY RECEIPT
It is a global finance vehicle that allows an issuer to raise capital simultaneously in two or
more markets through a global offering. GDRs may be used in either the public or
private markets inside or outside the US. They are marketed internationally, mainly to
financial institutions. A GDR then is an instrument to raise capital in multiple markets
outside the issuers domestic market through one security which is traded in a foreign
stock market. A GDR may represent one or more shares and the holder can, at any time,
convert it into the number of shares it represents. The underlying shares are already
listed in the domestic stock exchange and the depository releases them from its original
inventory. Till conversion they do not carry any direct voting rights and pose little exchange
risk as no remittance has to be made on conversion. GDRs allow purchasers to gain
exposure to companies which are listed on foreign markets without having to purchase
the shares directly in the market in which they are listed. For example, a European
investor wanting an exposure in Indian securities could do so via two routes:
a. Enter the Indian stock market and buy the companys stock on one of the Indian
markets. But this would also expose the investor to exchange risks and statutory
rules and regulations governing purchase and sale of securities in the Indian markets.

CapitaI Raising Events
Date Shares # Price $ VaIue $ Lead Manger
4/16/99 2,070,000 34.00 70,380,000 Nationsbanc
Montg_mery1ecs
Trading Data
Period Shares # VaIue $
1999 17,998,000 1,794,495,000
2000 40,794,000 7,477,607,000
2001 34,036,000 2,310,593,000

Program DetaiIs
CUSP 456788108 (Active)
Company name nfosys Technologies Ltd.
Stock symbol NFY
Country ndia
Depositary Deutsche (Sponsored)
Structure ADR
Flags
Ratio (ORD-AERS) 1 : 2
Exchange NASDAQ
Active Date 4/16/99
nActive Date
MSC ndustry Business & Public Services
Lead Manager
196
International
Financial Management
b. Through GDRs, which would give the investor ownership of the Indian companys
stock without being subject to Indian stock market regulations to a great extent.
GDRs have become synonymous with selling equity in the euromarkets. This is so because
fresh shares are issued by the company which is raising money from the markets, and
transferred to a depository which, in turn, issues a receipt which is quoted and traded at
any stock exchange where it is listed.
Considering that a company does not need to be evaluated by the international rating
agency before marketing GDRs which suits Indian companies just fine they are easy
to issue. Not only is the cost of selling a GDR issue comparatively low, this instrument
provides access to a broad investor base spread across various continents. And best of
all, the time lag between concept and execution can be as short as seven weeks.
As companies are slowly beginning to discover, there are several smart variations to
plain vanilla GDRs. For example, there could be call options, which allow the issuer to
limit the benefits accruing to equity holders by insisting on conversions of the GDR into
more equity beyond certain limits.
Thus, a GDR is a negotiable instrument denominated in dollars or some other freely
convertible currency. It is used as a funding vehicle for raising capital simultaneously in
two or more markets. The GDR structure allows for simultaneous issuance of securities
in multiple markets. This facilitates greater liquidity through cross border trading. GDRs
can be issued in either public or private markets in the US or other countries.
A GDR gives its holder the right to get equity shares of the issuer company against the
GDR as per the terms of the offer. Till such exchange or conversion takes place, the
GDR does not carry any voting rights. The shares represented by a GDR are identical to
other equity shares in all respects.
Once a GDR is issued, it can be traded freely among international investors. GDRs are
freely tradable in the overseas market like any other dollar denominated security either
on a foreign stock exchange or in the OTC market.
ADRs vs GDRs
Comparison between ADRs and GDRs
GDR
The LSE is not as large as the NYSE overall, but
is the global centre for international equities,
which dominate in turnover.
Unlike the NYSE, the LSE makes no demands
requiring companies to give holders the right to
vote. The NYSE insists on this point.
Detailed information required on the company,
but less onerous for GDR listing than full equity.
LSE satisfied with a statement of the difference
between the UK and Indian Accounting Standards.
ADR
Centre
The NYSE is the largest stock exchange in the
world by both value and turnover; foreign equities
play a minor role.
Instrument
No legal or technical difference between an ADR
and a GDR. The US has three levels of ADR
programme: Level III is suited to fund-raising.
Disclosure
Comprehensive disclosure required for F-1, the
US prospective which must accompany a public
offering.
GAAP
Foreign companies listing in the US must
reconcile their accounts to US GAAP.
Contd...
197
International Financial
Market Instruments
GDRs vis--vis Direct Foreign Investment
The following points compare the characteristics of GDRs with those of FDI (Foreign
Direct Investment):
1. A GDR is denominated in US dollars, while the shares held in the domestic market
by Foreign Institutional Investors (FIIs) are denominated in Indian rupees.
2. GDR holders need not register with any Indian regulatory agency, while FIIs need
to register themselves with SEBI.
3. Shares of the FII are held by the custodian for an additional charge. GDR holders
need not pay this additional amount, thereby making GDR a good 10-25 basis
points cheaper than ordinary shares.
4. Investments via the GDR route are not subject to the cumulative 24% of the issued
equity capital of the company and individual 5% cap prescribed for the FII. However,
the investments made through Euro issues should not exceed 51% of the issued
and subscribed capital of any company. Investments made by off-shore funds and
FIIs through direct foreign investments do not form a part of this stipulation.
5. GDRs are generally offered to investors at a discount at the domestic price, while
FIIs have to invest in a companys shares at par in the domestic market.
6. Since payment is made in US dollars by the depository, GDR holders do not carry
any exchange rate risk. FIIs directly operating in the domestic market are subject
to the risk of unfavourable exchange rate movement.
7. The RBI Special Account procedure is not required for GDR holders; they can
repatriate proceeds even without opening a new foreign currency account.
8. Settlement on transfer of GDRs is linked to international clearing houses and
settlement systems, while FIIs have to depend on the domestic settlement systems.
9. GDRs have a cooling off period of 45-180 days (not mandatory, but generally
followed) during which the lead managers try to stabilise the market price. There is
no such time period in domestic markets.
9.6.1 History of GDRs in India
India entered the international arena in May 1992, with the first GDR issue by Reliance
Industries Limited, which collected US $150 million. This was followed by Grasim
Industries offer of US $90 million in November. Then, the GDR markets witnessed a
lull till 1993-end in the wake of the securities scam and the consequent fall in the domestic
markets, during which time the only Indian offering came from HINDALCO in July
1993, which raised US $72 million.
The end of 1993 saw a flood of Indian paper hit the Euromarkets with Bombay Dyeing,
Mahindra and Mahindra, SPIC and Sterlite Industries raising funds. This boom continued
GDR listing on the LSE is comparatively
inexpensive. Initial costs likely to be in the range
US $2,00,000 to US $4,00,000.
Over 5,000 US QIBs accessed, but ordinary
investors cannot participate. US demand
therefore not maximised.
Legal liability of a company and its directors is
less than in the case of an ADR.
Cost
US listing could be expensive. Total initial costs
likely to be in the range of US $10,00,000 to US
$20,00000.
Retail
A public offering in the US allows an issuer to
access the US retail market. This provides extra
source of demand.
Liability
Legal liability of both a company and its
individual directors increased by a full US listing.
198
International
Financial Management
till mid-1995, after which a combination of factors political instability, falling markets,
reduced profitability due to a liquidity crunch pulled down the GDR market again, till
the end of 1996, during which time, the only notable exception was the US $370 million
offering by the State Bank of India.
The biggest Asian GDR issue in 1997 was the $350 million issue from SBI. It was also the biggest
foreign equity offering by a non-Japanese Asian bank ever. By not taking undue advantage of the $850
million demand its GDRs generated, and pricing the depository receipt at only a small premium, the
bank assured itself of sufficient demand in the after market. It is regarded as one of the most liquid
GDRs listed on the London Stock Exchange, where an incredible nine investment banks are making
market in the scrip.
9.6.2 Procedure for an Initial Issue of GDR
GDRs are marketed through a syndication process which is the responsibility of lead
managers. The lead manager is involved in the issue structuring, pricing and obtaining
market feedback on the issue timing. The lead manager also prepares in-depth research
and offer documents for circulation to prospective institutional investors. He/she also
assists in the selection of the foreign depository, foreign legal advisors and compliance
with the listing requirements of the stock exchanges. The steps in Euro issue management
in chronological order are as follows:
Pre-issue Discuss strategy, obtain approvals, obtain legal advice. Prepare tentative
plan and size of the issue.
Week 0-4 Nominate lead manager.
Discuss plan and other roles with lead manager/co-manager.
Depository/bankers/auditors to the issue provide information to the lead
manager for drafting of offer documents and agreements.
Week 5-7 Meetings between lead managers, legal advisors and auditors and the issuers
executives. Preparation of offer circular completed.
Week 8 Lead manager completes and sends preliminary offer documents to co-
managers and other underwriters.
Week 9 Roadshows, investor meets abroad. Lead managers and issuer decide to
send different teams to focus on geographical locations. Agreement
documentation finalised after final discussions between concerned parties.
Week 10 Launch and syndication by the lead managers and co-managers. Foreign
listing and trading approvals received.
9.6.3 Characteristics of GDRs
Most investors in GDRs look for long-term capital appreciation; hence, the fundamentals
of the company count the most in a GDR issue. The prospects of the industry in which
the company is operating, along with the companys market share and the characteristics
of the major markets in which the company is present and its comparison with its
competitor are also judged by investors.
Typically, a minimum turnover of around Rs 500 crores and a market capitalisation of
Rs 1,300 crores Rs 1,700 crores ($400 million $500 million) are considered the
minimum eligibility criteria by investors. Otherwise, the issue cost would become
unjustifiably high.
The issuing company must obtain the necessary clearances for doing so from the
Department of Economic Affairs, Ministry of Finance, Government of India, Reserve
Bank of India, Securities and Exchange Board of India and other bodies.
199
International Financial
Market Instruments
i. Pricing of the Issue: Normally, the price fixed for a GDR issue used to be at a
discount to the domestic price. This was done to attract investors and also to provide
them with a safeguard against disadvantageous exchange rate movements.
Nowadays, GDRs are issued at a slight premium in lieu of the advantages of better
liquidity, trading and settlement systems and depository facilities that foreign investors
get over domestic ones. Moreover, GDR holders do not need to pay custodial
charges to the custodian for the custody of their GDRs. Further, a dilution in the
equity (through a GDR issue) results in a fall in the EPS, and existing shareholders
need to be compensated for this. This is done through the additional premium being
paid by GDR subscribers being added to the total net worth of the company, thus
raising the book value, and, consequently, the market value, of these shares.
However, care should be taken to ensure that the price differential is not large
enough to tempt investors into cashing in on an arbitrage opportunity provided due
to variation in the domestic and international prices of the same security. Bankers
feel that a discount of 10-20% at a premium of 2-5% to the domestic price is
reasonable. However, the pricing strategy is only a prudential precaution to ensure
subscription, and not a regulatory restriction.
The GDR price is essentially a function of the firms prospective earnings per
share (of the expanded equity), the current domestic or international market price
and the price earnings ratio. The price of the issue is decided on the opening day of
the issue, based on the market response and domestic market price. The various
criteria to be considered in the pricing of an issue are enumerated below:
1. Prospective earnings: Since investment in GDRs is made in anticipation of
long-term capital gains, the future earnings potential of the company is one of
the most important criteria for the pricing of a GDR.
2. Current market price: The current market price of the share is taken as a
benchmark in the pricing of the companys securities. Price is fixed at a
discount or premium to the current price.
3. Price earnings ratio: The P/E ratio between 15 and 20 is considered optimal
for developing countries. The P/E ratio is taken after considering the effects
of dilution of equity through the GDR offering. Approximate optimal P/E
ratios of some other developing markets are Malaysia 20, Thailand 17,
Korea 17, Mexico 15.
4. Fundamental analysis: A fundamental analysis must be done to determine
the intrinsic value of the share of the company on its expanded equity base.
Other important factors to be researched and mentioned are: the industrys,
firms growth prospects, market image, market share, technological quality,
labour costs, etc. Low leverage companies are preferred to high geared ones.
ii. Size of the Issue: The size of the issue is linked to the demand for the securities of
the company. The actual size is decided only after the roadshows are complete and
the investors response is analysed by the company, the lead managers and
underwriters. The issue may be made to the extent of 60-70% of the demand so as
to ensure adequate secondary market dealing after listing.
For instance, within weeks of being listed on the Hong Kong Stock Exchange, the
price of Reliance GDR fell sharply to $14.25 from the opening level of $16.35, a
drop of nearly 13%. The fall was attributed to the increase in the size of the issue
from $100 million to $150 million. As a result of this, almost all potential investors
could get GDRs allotted and there was no demand for the Reliance GDRs in the
secondary market, and its price fell.
200
International
Financial Management
iii. Issue Cost: The issue cost depends upon the size of the issue the smaller the
issue, the higher the issue costs as a proportion of the amount raised and vice
versa. On an average, the cost of raising funds in the Euromarkets is approximately
3-5% of the issue amount. The various expenses entailed are given below:
Legal Expenses US $ 100,000-150,000
Printing Expenses US $ 50,000
Roadshows Expenses US $ 50,000
Management Fees 0.75-1.00% of the issue size
Underwriting Commission 0.59-1.75% of the issue size
Selling Concession 1.50-3.00% of the issue size
iv. Voting Rights: The fear of losing control of the company to foreign shareholders
does not arise in a GDR issue, since a GDR does not entitle the holder to any voting
rights. The Indian Companies Act does not allow companies to issue non-voting
shares. Hence, voting rights are not outrightly rejected, but contractually suspended,
wherein the overseas investor by way of an agreement with the depository, instructs
it not to vote.
v. Listing: The main purpose of a listing is to satisfy the investment restrictions to
which many institutional investors such as pension funds and insurance companies
are subjected. These restrictions prohibit the investors from acquiring securities
unless they are listed on recognised stock exchanges.
GDRs are listed in Luxembourg and traded at two other places besides the place
of listing. The reason why Luxembourg is selected is that the listing requirements
here are very simple; less expensive and do not require any major disclosures or
recasting of accounts. On the other hand, the listing requirements of the Securities
Exchange Commission in the US are very elaborate and the minimum stipulations
of turnover and size of company are very high. Similarly, in London there are
inconveniences like the entire equity has to be listed, for which the company has to
follow the UK GAAP, which is not possible for most Indian companies. Almost all
the Euro issues made by Indian companies are on a private placement basis in the
US under Rule 144A wherein registration under the Securities Act is not required
or is exempt.
vi. Fungibility: An investor who wants to cancel a GDR by sending it back to India
can do so without any lock-in period. In other words, the instrument is now perfectly
fungible. Previously, there was a mandatory lock-in period of two years for Indian
GDRs; this has now been done away with by the finance ministry; instead, lead
managers advise a cooling-off period of between 45 and 60 days, after which
GDRs become fungible. During this period, when trading is informally suspended,
lead managers try to stabilise the price of the GDRs.
The modus operandi is as follows The GDR holder approaches the depository
directly or through a foreign broker to cancel his GDR. The depository directs the
custodian to release the share to the counterparty broker. The custodian asks the
companys register to release multiples of the GDR share certificates which the
local broker sells in the domestic market. The proceeds are sent back to the
custodian, who converts them into dollars and pays to the investor after deducting
the capital gains tax at applicable rate.
Alternatively, the investor can get his GDR converted into shares and hold them
instead. However, this option is not considered to be very attractive, since the
201
International Financial
Market Instruments
investor would find it difficult to cope with Indian laws and regulations when he
wants to sell these shares in the local market at a later date.
Indian GDRs do not yet have full fungibility, since an investor can convert his
GDRs into shares and sell them in the local market, but the company cannot convert
share certificates into GDRs to sell to foreign investors at will. This narrows the
market for the instrument, while the country loses out on foreign exchange when
an investor cancels his GDR, without a corresponding inflow of foreign exchange
through fresh sales. In other words, Indian GDRs have one-way fungibility as
opposed to two-way fungibility.
9.6.4 Benefits and Uses of a GDR
Benefits to an Issuing Company
Currently, there are over 1600 Depository Receipt programmes for companies from
over 60 countries. Companies have found that the establishment of a depository receipt
programme offers numerous advantages. The primary reasons why a company would
establish a depository receipt programme can be divided into the following considerations:
Access to capital markets outside the home market to provide a mechanism for
raising capital or as a vehicle for an acquisition.
Enhancement of company visibility by enhancement of image of the companys
products, services or financial instruments in a marketplace outside its home country.
Expanded shareholder base which may increase or stabilise the share price.
May increase local share price as a result of global demand/trading through a
broadened and a more diversified investor exposure.
Increase potential liquidity by enlarging the market for the companys shares.
Adjust share price to trading market comparables through ratio.
Enhance shareholder communications and enable employees to invest easily in the
parent company.
Benefits to an Investor
Increasingly, investors aim to diversify their portfolios internationally. Obstacles, however,
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. As negotiable securities, depository receipts are
usually quoted in US dollars and pay dividends or interest in US dollars. Deposit receipts
overcome obstacles that mutual funds, pension funds and other institutions may have in
purchasing and holding securities outside of their local market. Global custodian safe
keeping charges are eliminated, saving depository receipt investors 10 to 40 basis points
annually. Dividends and other cash distributions are converted into dollars at competitive
foreign exchange rates. Depository receipts are as liquid as the underlying securities
because the two are interchangeable. Thus, the advantages of GDRs to the investor are
They facilitate diversification into foreign securities.
Trade, clear and settle in accordance with requirements of the market in which
they trade.
Eliminate custody charges.
Can be easily compared to securities of similar companies.
202
International
Financial Management
Permit prompt dividend payments and corporate action notifications.
If DRs are exchange listed, investors also benefit from accessibility of price and
trading information and research.
In addition to the benefits DRs have to offer to the issuing company and the investor,
they are also increasingly being used by governments to facilitate the process of
privatisation. They have also been used to raise capital in the process of acquisition of
other companies by the issuer.
Two-way Fungibility
Delivering on the promise of budget 2001-02, the Reserve Bank of India (RBI) has
permitted two-way fungibility of American Depository Receipts (ADRs) and Global
Depository Receipts in a limited way. Earlier, only one-way fungibility - investors in
ADRs/GDRs could convert their shares into underlying domestic shares, but could not
reconvert them into ADRs/GDRs - was allowed.
This meant a gradual reduction in the availability of ADRs/GDRs in the overseas market
as only a fresh issue of ADRs/GDRs could make up for the conversion. The RBI has
now permitted re-issuance of ADRs/GDRs to the extent of ADRs/GDRs that have
been redeemed into underlying shares and sold in the domestic market.
However, this re-issuance is subject to some non-resident investor wanting to invest in
ADRs/GDRs. In other words, conversion is demand driven. On such a request, the
concerned broker would purchase the required number of shares after verifying with the
custodian the extent of re-issuance permissible, as there are certain restrictions on the
number of ADRs/GDRs that can reissued.
For instance, Depository Receipts are treated as direct foreign investment and so re-
issuance would be subject to sectoral FDI caps. This two-way fungibility would result in
the alignment of prices of ADRs/GDRs with the prices of their respective underlying
shares in the domestic market. So far, there has been a significant difference in the
prices of depository receipts of Indian companies and their underlying shares in domestic
market.
But because two way fungibility was not allowed, there was no way one could arbitrage
between the two markets, which would have resulted in narrowing down of the price
difference. For instance, suppose Infosys' ADR was trading at almost a 60 per cent
premium to its price in the domestic market. With two-way fungibility, it is possible for a
non-resident investor to ask for re-issuance of ADR of Infosys subject to the specified
conditions, and sell the same in the international market to take advantage of the huge
premium there.
This arbitrage opportunity would lead to selling pressure in the ADRs and buying emerging
in domestic market, which would lead to the two prices converging. However, this
alignment in prices would be subject to the number of ADRs that can be reissued. If
ADRs in Infosys have not been converted into domestic shares, the question of re-
issuance does not arise.
Thus, for the domestic investors, the two-way fungibility would mean greater liquidity
and most certainly a price appreciation, given the premium in international markets.
9.7 LET US SUM UP
The International Financial Market or the Eurocurrency market plays a key role in the
capital investment decisions of many firms since it is a funding source for corporate
borrowing. The market is totally a creation of the regulations placed by national
governments on banking.
203
International Financial
Market Instruments
The currencies, which have become popular as Eurocurrency and tend to be widely
used include the US dollar, the British pound, the French franc, The German mark and a
few other currencies.
Domestic issues are different from Euro issues. Some of the important points of distinction
are first, underwriting and pricing of the issue is done in advance for domestic issues
while it is done on the day of the issue for Euro issues. Second, the risk factors are
highlighted and mentioned in the prospectus while there is no such requirement in Euro
issues. Also the registration is done by SEBI for domestic issues while it is done by the
Ministry of Finance for Euro issues.
Depository Receipts were created in 1927 to help US investors who wished to purchase
shares of non-US companies. Since then, depository receipts have grown into a popular
and flexible instrument which enables issuers world-wide to gain equity exposure outside
their home market.
When companies make a public offering in a market other than their home market, they
must launch a depository receipt program. Depository receipts represent shares of
company held in a depository in the issuing company's country. They are quoted in the
host country currency and treated in the same way as host country shares for clearance,
settlement, transfer and ownership purposes. These features make it easier for
international investors to evaluate the shares than if they were traded in the issuer's
home market.
There are two types of depository receiptsGDRs and ADRs. Both ADRs and GDRs
have to meet the listing requirements of the exchange on which they are traded.
Global Depository Receipts (GDRs) are usually traded on major international exchanges
outside the United Statesmainly the London Stock Exchange (LSE) - and in the US
Over-the -counter market. A company issuing GDRs does not have to comply with US
Generally Accepted Accounting Principles (GAAP) or full disclosure requirements of
the US Securities and Exchange Commission (SEC). Thus, GDR programs allow
companies to enjoy the benefits of an internationally traded security without changing
their reporting practices. Companies that wish to offer their securities to US institutional
investors and list their shares on a US stock exchange use American Depository receipts
(ADRs), which usually require adherence to US GAAP and more stringent SEC disclosure
requirements.
There are five kinds of ADR programmesunsponsored ADR programme, sponsored
ADR programme Level I, Level II, Level III and Rule 144(A) ADRs. ADRs are
beneficial both to the issuing company and to the investors. The positives for the
ramification of Indian ADRs are huge pool of funds, improved quality of disclosure,
capital formation, broadens global visibility, better valuation, the M&A advantage and
corporate segmentation. On the flip side, the main concern is that the Indian investors
are unable to invest in good companies.
GDRs can be distinguished from ADRs and Direct Foreign Investment. The main
advantage of a GDR to an issuing company is that it gives them access to capital markets
outside the home markets. The investor gets benefited as it facilitates diversification into
foreign securities.
9.8 LESSON END ACTIVITY
Identify a few companies that have issued ADRs and GDRs in the last 5 years. How
was the pricing of the issue arrived at? Has the two-way fungibility benefited the
company's? Analyse and comment on the benefits and problems of the various issues.
204
International
Financial Management
9.9 KEYWORDS
Foreign Equity: If the equity issue is made in a particular domestic market (and in the
domestic currency of that market), it is known as a Foreign Equity Issue.
Euro Equity: If a company raises funds using equity route through instruments like
Global Depository Receipts (GDRs) or Superstock Equity in more than one foreign
market except the domestic market of the issuing company and denominated in a currency
other than that of the issuers home country, it is known as Euro Equity Issue or Global
Equity Issue.
Transaction Cost Savings: Transactions executed in foreign markets, in general, have
higher costs than US domestic transactions (ADRs are domestic securities) as well as
have many procedural differences.
Settlement: Any investor in foreign equity will be concerned with the differing systems
and structures in settlement bookkeeping costs.
Custody: Global custody fees are substantially higher than those for domestic services
and the process is complex and requires substantial monitoring. ADRs are domestic
securities.
Transparency: Data, analysis, records, reporting, disclosure are all available through
the ADR programme structure this cannot be said for the majority of foreign shares.
Legal Restrictions: Many US institutions are still restricted to custody within their own
state or within the US ADRs and US securities.
Research Coverage: Though competing investment banks and brokers provide research
on foreign securities, many to a high standard, the ADR research base, which is driven
by domestic demand, provides US comparables, reconciled financials as well as easily
digested information in American terms. ADRs also attract more US based research
coverage and thus greater comparability.
Liquidity: Many ADRs are now as liquid or more so than the underlying security, as the
US Capital Market creates its own trading base. A holder of ADRs always has the
option of selling the underlying shares into or buying from the local market.
Dividends, Reorganisation, Corporate Action: Information on these issues is essential
to an investor and is sadly wanting in the foreign security universe. The depository bank
for an ADR is responsible for supplying this information to holders in an efficient and
timely manner. Dividend distributions for ADRs are in dollars.
SEC: ADRs are SEC registered securities and hence, timely, accurate reports from the
company are regularly available in English.
Price Translation and Fungibility: ADRs trade at a straight spot currency translated
price. Arbitrage and electronic information flows ensure this. The ADR is a receipt and
thus actually represents ownership of the underlying share, therefore, it is more than
fungible it is actual.
Trading Hours: ADRs are traded during normal US trading hours as well as in other
time zones. Prices are publicly quoted in the US for valuation purposes.
Foreign Exchange: ADRs are traded in US dollars but fluctuate in dollar value with
the underlying shares at the spot forex rate. No forex transaction is necessary for the
customer.
205
International Financial
Market Instruments
GDR price: It is essentially a function of the firms prospective earnings per share (of
the expanded equity), the current domestic or international market price and the price
earnings ratio.
Prospective earnings: Since investment in GDRs is made in anticipation of long-term
capital gains, the future earnings potential of the company is one of the most important
criteria for the pricing of a GDR.
Current market price: The current market price of the share is taken as a benchmark
in the pricing of the companys securities. Price is fixed at a discount or premium to the
current price.
Price earnings ratio: The P/E ratio between 15 and 20 is considered optimal for
developing countries.
Fundamental analysis: A fundamental analysis must be done to determine the intrinsic
value of the share of the company on its expanded equity base.
9.10 QUESTIONS FOR DISCUSSION
1. Explain the characteristics of GDRs and how they are priced?
2. Give similarities and differences between domestic issues and Euro issues.
3. What are foreign currency convertible bonds? Are they more beneficial to the
issuer than a GDR?
4. What are the characteristics of the Eurocurrency market? What purpose does this
market serve?
Check Your Progress: Model Answers
CYP 1
1. True
2. True
3. True
4. True
CYP 2
1. True
2. True
3. True
4. False
5. True
9.11 SUGGESTED READINGS
Madhu Vij, International Financial Management, Excel Books, New Delhi, IInd Edition, 2003.
V. Sharan, International Financial Management, 4th Edition, Prentice Hall of India.
Alan. C. Shapiro, International Financial Management, PHI.
Levi, International Finance, McGraw Hill International Series.
Adrian Buckly, Multinational Finance, PHI.