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Croatia, Morocco, Egypt and Lithuania usually only rub shoulders in the horse-trading for rotating seats on the UN Security Council or in the preliminary qualifying rounds of the World Cup. What they have in common this year, however, is that companies from these four countries have issued global depositary receipts (GDRs) for the first time. These issues illustrate the growing importance of the GDR market. Global depositary receipts accounted for around a quarter of total depositary receipt (DR) issuance in the first nine months of this year, with a further two thirds in the form of American depositary receipts (ADRs) and the remainder in either Rule 144A issues or European depositary receipts. GDR issues are either becoming bigger and fewer in number, from the better established markets, or are being made by companies that are breaking fresh ground. The new issuers indicate how the supply of GDRs will keep renewing itself, even if the ease of dealing directly in other markets eventually obviates the need for issues from the longer-established sources. As the table on page 88 shows, the number of GDR programmes has expanded rapidly during the 1990s; GDRs now account for a rising proportion of the total number of programmes and are of growing importance to emerging markets issuers. However, some investors maintain that the differences between ADRs and GDRs are, as ING Barings director, Maurice de Bunsen, puts it, “rather semantic”. Both are receipts issued against an underlying stock held in a depositary bank and, in that respect, the only difference is where they settle. Echoing this sentiment, emerging markets fund manager Giles Neville of Schroders says: “When I talk about a DR I’m not bothered whether it’s listed in London, Luxembourg or New York, or whether it’s a Chinese company listed in Hong Kong.” It is true that the choice of whether to issue an ADR or a GDR sometimes can be based simply on geographical convenience, or force of habit. Latin American companies, with their traditional orientation towards the US as a source of foreign capital, tend to look to the ADR market. In the case of Chile, this predilection is enforced by central bank requirements for any overseas equity issuance to be on the New York Stock Exchange. GDRs by Latin American companies, therefore, have been a rarity: Celesc in Brazil and Uruguay’s Banco Commercial are the exceptions to the rule. The global depositary receipt remains inherently different from its American cousin, however. Advocates of the instrument, such as global products manager for DRs at Bankers Trust, Peter Duggan, maintain that the GDR has a number of critical advantages for emerging markets issuers. The first is that it offers a wider investor base than an ADR, which trades only in the US. By issuing under Rule 144A, a GDR can be sold to US investors as well as to the core of European investors, who will typically take 80% of an issue. The second advantage is that it is a lot cheaper than an ADR, which requires a New York Stock Exchange or Nasdaq listing. In any case, many of the companies that need funds would have problems satisfying New York listing requirements, not least because of the time needed to convert at least three years of their accounts to US GAAP requirements. The GDR, therefore, offers a quicker route to raise urgently needed capital. Although there may be instances in which the specialist investor base in New York may justify an ADR issue for example, matching a mobile telephone operator in Bombay to specialist telecom funds in New York usually the GDR market can supply adequate liquidity. According to Duggan, liquidity for GDRs has improved in the past two years, particularly since the London stock exchange eased its listing requirements to lure more of the GDR business away from Luxembourg, where lax listing requirements had encouraged the market to develop. In the first nine months of the year, 16.1% of total DR issuance was through London and 6.4% through Luxembourg. Traders, however, do not necessarily agree that liquidity is good; even in the big Indian issues in London, according to one trader, “the market is so illiquid that someone can go out and buy 10,000 GDRs and then there’s a short in the market”. “Everyone knows who the customers are and they’ll speak to three or four different market makers at the same time, so everyone knows what’s going on and everything’s either bid up or pushed down”. Simplicity at a premium Whatever the advantages of GDRs, the underlying rationale for issuing them remains the same across different countries and continents: the need to bypass obstacles to investment in the domestic market. Foreign ownership ceilings in Korea and Taiwan have made their companies into leading issuers of GDRs. The two issues made by Croatian companies, drug group Pliva and Zagrebacka Banka, owed much to the cost of maintaining custody accounts in Croatia and, as elsewhere, the complications of exchanging dividend payments back into an investor’s home currency. The dollar-denominated clearing and settlement of GDRs through Euroclear and Cedel in Europe and DTC in the US, “takes away all those concerns and problems”, says Duggan. Richard Fairgrieve of Hermes Investment Management bought Pliva and Zagrebacka and agrees: “I’ve never dealt directly in the Croatian market. The GDR is a much easier vehicle than having to do the FX yourself. It’s dollar, boom, done. The liquidity is better. You know you can always move at least some to the market makers, as opposed to dealing directly out there, wherever it might be.” Such reassurance and simplicity are achieved at a price: the premium between many GDRs and the underlying stock. But it is not only hassle-free settlement that creates premiums. Market distortions also create pricing anomalies, which can lead, for example, to some Korean GDRs trading at huge premiums: Korea Mobile Telecom was trading at close to a 100% premium in October, Hyundai at 60% and Samsung, the main name in the market, was between 35% and 40%. The problem is all to do with conversion. In a totally free market, arbitrageurs would be able to take advantage of price disparities and soon eliminate discrepancies between the GDR price and the underlying price. The relationship between the two should reflect the exchange rate and nothing else, a situation that has virtually been achieved for Mexican ADRs. However, regulations often frustrate the arbitrageurs, as in the case of India, for example. It is possible to buy the GDR in London or Luxembourg and cancel it back into India, but once cancelled, the GDRs cannot be re-issued. In other words, the arbitrage only works in one direction. Hence, says BT’s Duggan, in countries where GDRs are being issued for the first time it is important to persuade the authorities to adopt regulations that permit two-way trading. The performance of the underlying Bombay market and the effect it has had on GDR issuance is characteristic of DR markets as a whole. It helps explain the popularity of eastern European issues, which have performed well this year in line with the underlying markets. Hungary, for example, was up more than 100% in dollar terms in the year to mid-October, and Russia’s equity market has been another outstandingly good perfomer. Disillusioned Do not read too much, however, into the number of GDR issues by eastern European companies. Some, such as the two Croatian issues, have performed well, much to the satisfaction of investors. Pliva rose from $18.71 at issue in April 1996 to $50 in mid-October, while Zagrebacka Banka was trading at $19.50, compared with an issue price of $8.50. Analysts are, however, sceptical about the significance of issues by Hungarian and Russian companies. Tom Chadwick, Hungarian equity analyst at Merrill Lynch in London, points to the fact that only one of the two leading Hungarian pharmaceutical companies, Gedeon Richter, has issued a GDR, even though the two have tracked one another closely in just about every other regard. “A GDR doesn’t even improve name recognition outside Hungary for a serious stock,” claims Chadwick, although he does concede that it has a “slightly different appeal for those who can’t invest directly”. The liquidity of the Hungarian market means that there is no appreciable premium for Hungarian GDRs. Duggan has more serious reservations about the large number of Russian DR progammes established during 1996, which accounted for nearly 10% of those established in the first nine months of the year. “Companies did level-one programmes from an investor relations point of view and to get their name into the market. They’ve been oversold and many are inactive and have never had a share issued into the programme,” he says. Duggan believes the companies are disillusioned by the experience of maintaining the programmes, which have been orchestrated by banks that want to prove they have a large share in the depositary business. Most issues in 1996 have not been for capital-raising purposes so much as to raise companies’ liquidity, profile and share price; in many cases, shares experienced a short-term price surge ahead of the DR programme. Gazprom, which raised around $400 million in October from an American depositary share (ADS) issue in London, is something of a special case, given the problems in trading its shares domestically. The existence of management pre-emption rights over any purchase makes it difficult to buy the shares and as little as $5 million changes hands during a week. In addition to the doubts about Russian activity this year, there are other concerns. These are bound up with the laxity of the reporting requirements for securities listed on the Luxembourg exchange and the danger that inexperienced investors buy GDRs in the belief that they are buying the equivalent of a Luxembourg or Swiss or Dutch company, whereas it’s an insider’s market and it’s difficult to know what’s going on. Immediate problems aside, the demise of the ADR and GDR markets has been predicted in the past because of the process of market reforms. “As domestic regulatory, custodial and settlement issues are sorted out and if transaction costs and spreads come down, GDRs will become less important,” says Schroders’ Neville. But he also recognizes that “there will be new countries coming in for whom the easiest way to raise money will be a DR or a listing on another market”. Over the longer term, for example, Korea’s membership of the OECD is likely to lead to the removal of restrictions on share ownership and to erode the premium at which GDRs trade. India is also taking steps in the right direction as regards tidying up market practices. The most important and long-awaited change will be the introduction of share depositaries in India, which will immobilize the vast quantities of share certificates being shipped between custodians’ vaults. Shares of the first eight companies were expected to be placed in the National Securities Depositary, run by the National Securities Exchange (NSE), as early as October, and an ambitious plan envisages shares representing 65% of market capitalization being immobilised within two years. Indian backlog However, these changes are unlikely to signal the imminent disappearance of the Indian GDR. Given that it is the government controlled Industrial Development Bank of India and Unit Trust of India that are promoting the depositary, along with the NSE, progress is not expected to be as rapid as it would be with the private sector in the lead. Although the Bombay Stock Exchange is considering its own depositary, the timing of its establishment is not clear. As a result, observers expect teething troubles for at least the first one or two years. Even if the National Securities Depositary meets its timetable, other problems such as registration as an officially approved foreign institutional investor and capital gains tax unless investment is routed via a Mauritian subsidiary will still act as deterrents to direct investment and ensure that demand continues to exist for the GDR instrument. The backlog of Indian companies that have postponed issues from this year means supply will be forthcoming. Most observers expect India to remain at the core of the GDR market, but the extent to which its companies are able to continue issuing in 1997 will depend on the health of the underlying market. The same applies to eastern Europe. The strong performance of the Hungarian, Russian and Polish markets this year has improved sentiment towards the region, but a growing proportion of the expected GDR activity is likely to be from eastern Europe’s peripheral markets. A second Lithuanian company is considering following Vilniaus Bankas in making an issue, and the first Slovenian issue could be coming to the market soon. Where north Africa and the Middle East are concerned companies could follow the path of Lebanon’s Banque Audi and Morocco’s Banque Marocaine du Commerce Exterieur. New GDR programmes in 1996GDR market growthGDRs as a percentage of the total depositary receipt (DR) market
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