ADRs: Going from strength to strength

It is now over 70 years since the first American depositary receipt (ADR) was launched and the consensus of opinion among the market’s key players is that the sector has never been in such great shape.

In the last couple of years much has been made of threats to the pre-eminence of ADRs as an investment tool for US investors, notably a move to dealing directly on foreign exchanges in foreign currency, or through such instruments as global registered shares (GRSs). But so far these threats have not been realized. New ADR programmes are constantly being launched and the value of the market is ever rising. For the time being, the ADR looks set to retain its position as the leading option for US investors looking to expand holdings in foreign companies.

As Patrick Colle, European head of ADRs at JP Morgan in London, says: “Generally, the market is very good. Trading is up across the board. More important, the issue of ADRs for capital raising is up significantly – 1999 was a quiet year on that front, but 2000 should see a 50% rise in capital raising. Over a number of years now the market has been good.”

Tim Oldfield, sales director for depositary receipts at Citibank, is in full agreement. “2000 has really seen the market take off,” he says. “You may have an odd year that’s quieter [like 1999] but in the last 15 years the trend has been for excellent growth.”

Figures from the Bank of New York certainly bear this out. The annual dollar value of listed ADR programmes in 1996 was $341 billion. That figure is expected to be up to around $1.35 trillion in 2000, more than double the 1999 figure of $667 billion.

But aren’t investors primarily worried by absence of liquidity in securities markets?

And isn’t there a problem created by splitting trading across two markets? Not so, says Michael Cole-Fontayn, vice-president and regional director of worldwide issuer services at Bank of New York. “Issuing ADRs does create the illusion of two pools of liquidity,” he says. “But thanks to the interchangeability of ADRs and ordinary shares, prices track each other on a daily basis. This question does sometimes arise in new issues, but it isn’t a problem.”

The large increase in value in the market from 1999 has been fuelled by a number of factors, not least the increasing use of ADRs as an acquisition currency by foreign companies.

This strategy is becoming increasingly popular among European or Asian companies. Colle says: “A main driver in the market has certainly been cross-border M&A transactions.

There have been several new deals this year, such as Vivendi buying Seagram and Terra’s purchase of Lycos, all of which have used ADRs as acquisition currency. Retail investment in ADRs has also grown as a result of cross-border M&A. Investors receive ADRs in exchange for their existing shares, so holdings have been transformed which has made ADRs a more popular and widely known investment option.”

The benefits of this technique to a company can be great. Oldfield says: “There’s an advantage in this technique as the acquiring company is able to use equity rather than cash. Another real benefit is that you have a local market in which to trade your shares. Therefore, it appeals to investors as they can trade their new shares easily in the US.”

Having a presence in the US market before embarking on an acquisition also smoothes the path for a merger or takeover, as it helps to create acceptance of a company in the US. A successful ADR programme serves to raise the profile of a company in the US and increases investor confidence in it. Consequently, the market has also been boosted by ADRs issued in order to achieve this before a company has even identified a target. “ADRs give a readily available acquisition currency if and when it is needed,” says Colle. “Having a successful ADR helps to gain acceptance among the existing holders of a target company. An example is BP’s acquisition of Amoco. BP had a very liquid ADR that was widely owned in the US which made it more visible and acceptable to US investors.”

Cole-Fontayn concurs. “Acquisitions strategy has certainly been fuelling the ADR market. We will see more and more of this as the years go by. Marconi is an example of a company that has launched an ADR to raise its profile in the US.”

Cole-Fontayn highlights the role played by changes in the US retail investment market in developing the ADR market. “What we have seen is portfolio theory being applied,” he says. “Diversifying holdings to increase returns while lowering risk.” He points out that historically the holdings of US retail investors have been almost exclusively in US-listed companies. Lately, investors have come to realize that returns can be improved and risk minimized by looking outside the US.

The simplicity of investing in ADRs has meant that individual investors have increasingly looked to them for diversification. Such individuals have, as Cole-Fontayn puts it, “never been more able to buy foreign securities”. He points out that ADRs are also a useful tool for managed funds, as US regulations often limit the number of foreign-listed shares they can hold.

ADRs can also reduce costs for investors buying foreign stocks. If dealing in ordinary shares, custodians enter the frame, forcing costs up. Investing in ADRs removes the need for global custody. Consequently, many investors have sought to convert holdings in foreign ordinary shares to ADRs. Bank of New York presents this option to its clients through its DR Converter service. This looks at the costs incurred by a portfolio and suggests an investment strategy using ADRs that minimizes costs and maximizes benefits.

According to Alex Hickson, vice-president at BoNY, the bank’s position as the world’s leading global custodian puts it in an ideal position to offer this service. “Bank of New York offers clients the complete package,” he says. “Our position in global custody gives us a unique perspective on this. This service is one of the benefits of our integrated approach which allows us to save our clients money.”

The challenge to ADRs of the global registered share (GRS) and of the euro-denominated depositary receipt (EDR) has failed to materialize. Up to now, only three GRSs have been issued, the most prominent being those issued by DaimlerChrysler and UBS Warburg, with limited success. As Oldfield puts it: “I have no fear at all that these will eat into ADRs. ADRs have just got bigger and better with more and more companies using them. The appetite for them among issuers and investors is still very strong.”

Cole-Fontayn explains further: “In a perfect world with just one system, we wouldn’t need ADRs. But at the moment the GRSs issued have not achieved their aims of more liquidity and more visibility. They are not really global shares. Legally the DaimlerChrysler GRS is a German share and the UBS one a Swiss share.

This brings legal and operational issues that are obstacles to this vision being fulfilled. At the moment, GRSs are complex and costly and have not really attracted investors.”

He is, however, keen to support the idea in principle. “I think we need to be constructively critical of the GRS. It’s an idea that’s ahead of its time but a useful vision.”

Colle also has reservations. “Looking at the facts of what’s happened with the GRSs that have been issued so far, we can’t say that they bring investors any advantages that ADRs don’t. If an instrument is more complicated and expensive to use [than ADRs] then why bother? ADRs have been around for 70 years and are still growing, so my view is that in a few years they’ll still be around and growing.”

Colle is more scathing about EDRs. “When this idea was launched two years ago, we said it wouldn’t work,” he says. “Now it’s two years later and there are still no EDRs.” Oldfield feels that the problems experienced by the euro have contributed to the lack of interest in the EDR up to now. “There is always a possibility that different structures will be developed, but I can’t see the situation changing in the short to medium term. ADRs and GDRs are still the core products.”

A key source of new ADR launches is the emerging markets. Colle says: “The privatizations and deregulation taking place in countries like Taiwan and Korea have certainly triggered more programmes. The emerging markets are tapping international capital through ADRs.”

Examples include the deals that JP Morgan has coordinated in such countries as Turkey and Russia. “This year saw the first NYSE listed ADR from Turkey, issued by Turkcell. Also, Russia is coming back with deals like the offer of ADRs from MTS [telecommunications],” says Colle. “We have a lot of new issues in the pipeline from all the regions – Latin America, Asia (including China) and a lot in Europe. We’ve also gone big in India recently, with deals like Wipro, which is pretty much a new country for us.”

Bank of New York has been particularly active in Russia. While acknowledging the problems foreign investors have experienced there, Cole-Fontayn argues that now such problems have been addressed, Russia can play a big part in the ADR business. “We’ve been active successfully in Russia for the past five years,” he says. “So far, 82 programmes have been issued from Russia and Bank of New York has acted for 81 of them.”

Colle is also excited by the future for JP Morgan thanks to the merger with Chase. “The merger is fantastic news for us, as Chase doesn’t have an ADR business,” he states. “Our main strength has always been our expertise as an investment bank and we will be adding to this a much stronger infrastructure in terms of e-commerce, transaction management and the like. Now is the most promising time we’ve ever had in ADRs. We’ve had our strongest year ever and now have an excellent platform from which to develop.”