Depositary receipts: Europe gets its own ADR

Since 1927, when the first American depositary receipt was launched by JP Morgan for UK department store Selfridges, thousands of non-US companies have used ADRs to list in New York. This has enabled them to sell their equity to US institutional and retail investors in a manageable form. In 1990, global depositary receipts (GDRs) were created for companies that wanted to list and trade on other exchanges, notably London and Luxembourg.

The latest product in the line is the European depositary receipt, designed by Citibank in cooperation with the Paris Bourse. Its creators hope the EDR will fire the imagination of investors and equity issuers alike, tapping into the huge growth potential offered by the euro-dominated equity capital markets of Europe. This market will become the world’s second largest from January 1999 and, according to many analysts, may even overtake the US within five years. EDRs will also enable companies to tap growing retail equity investment in a region where concerns about the inadequacy of state pension provisions are growing.

Potential EDR issuers include many of the publicly quoted companies from emerging markets, which have already set up dollar-denominated ADR programmes. Such firms, it is hoped, will relish the chance to raise capital in a third major market. The aim is to create complete transferability between ADRs, ordinary shares and EDRs, so that the strongest bid from the US, the home market or Europe will pull up the valuation of the companies’ entire public equity.

Following months of intense marketing, Citibank believes that between 10 to 12 companies might set up EDR programmes in the first half of 1999. In this first wave, it is targeting Latin American blue chips.

Although the crisis in world financial markets may make this an inauspicious time to launch EDRs, proponents insist that there is demand. Many European investors, including mid-size institutions and wealthy individuals, regret having missed out on the early Latin American privatizations that performed so strongly in the mid-1990s. It is from these investors that EDRs are expected to gain support. Bankers hope that, if markets improve, Asian companies might also set up programmes, possibly in the second half of 1999.

Beyond that, it is thought that companies from developed economies such as the US might also use EDRs – particularly those with long-term funding requirements in Europe. To date, the largest ADR programmes are for European blue-chip companies that have substantial operations in the US. The biggest include Royal Dutch Petroleum, Unilever, SmithKline Beecham and BP. It is likely to be some time, however, before the situation is mirrored in Europe, with US companies ranking as the biggest takers of EDRs.

A development that will provide extra business for banks is the growing use of depositary receipts as acquisition currency, cashing in on the tax advantages of all-stock transactions. The merger between British oil company BP and US counterpart Amoco is the latest manifestation of this trend, and will lead to the largest-ever issue of ADRs, expected to be worth up to $60 billion. Amoco’s NYSE-listed common stock will be replaced with ADRs as the merged entity will be incorporated in the UK.

The launch of EDRs may help Citibank to gain further share of a market already dominated by just three banks. JP Morgan, Citibank and Bank of New York have a market share of 97% between them. Bankers Trust hangs on the edges with a niche in emerging-market GDRs. But the attempts of Chase, Morgan Stanley Dean Witter and Nomura to break into the market have failed.

“I would be surprised if there are more than three, maybe even two, players in this market in five years,” says James Donovan, global managing director of depositary receipts at Citibank. “Companies are attracted to banks with experience due to the complicated structure of a depositary receipt deal.” Patrick Colle, head of European depositary receipts at JP Morgan, agrees that banks are put off the market by the level of competition. “Clearly this is a business where the cost of entry is high versus low expectations,” he says. New entrants may only win the lowest-performing programmes.

Another characteristic of the market is that the bulk of investment is concentrated in a small number of programmes. JP Morgan research shows that of the almost 2,000 ADR or GDR programmes in existence, just 48 account for 80% of all institutional ownership. Many others are virtually empty. JP Morgan is proud to point out that, although it has the lowest number of clients in the market, it has the highest value of investment.

Bank of New York boasts of its 60% market share, but rivals are quick to say that this is by number of programmes rather than volume of investment. They criticize the bank for flooding the market with non-performing programmes. But Bank of New York claims it is a specialist bank and devotes more staff to depositary receipts than all of its competitors put together. “We don’t try to be all things to all people,” says Christopher Sturdy, the bank’s managing director of issuer services. “We don’t dilute our core businesses by dabbling in investment banking.”

So will EDRs do anything to expand the market for depositary receipts? Rivals dismiss them as a marketing ploy and an alternative version of products already available. “It is a GDR quoted in euros and traded in Paris,” says Colle. “I’m sceptical about what it brings to issuers and investors.” But Donovan hopes that the EDR will “extend the toolset of companies that wish to raise capital efficiently”. Rebecca Bream