Fordham International Law Journal Volume 17, Issue 5 1993 Article 6 American Depositary Receipts: An Overview Joseph Velli∗ ∗The Bank of New York Copyright c 1993 by the authors. Fordham International Law Journal is produced by The Berke- ley Electronic Press (bepress). http://ir.lawnet.fordham.edu/ilj AMERICAN DEPOSITARY RECEIPTS: AN OVERVIEW Joseph Ve~li* INTRODUCTION I would like to thank everybody involved for providing me with this opportunity to speak to you about the wonderful world of American Depositary Receipts ("ADRs"). Today I will attempt to provide you with an overview of the ADR market. I will talk about the different types of ADR programs available, and I will talk about the growth that has occurred over the last several years. Before I start, though, I thought it would be useful to set the stage a little bit. I just want to mention a few points. As Bill Decker mentioned earlier,1 for the first time, last year Glaxo, a non-U.S. company out of the United Kingdom, was the most ac- tively traded stock on the New York Stock Exchange ("NYSE"). That, in and of itself, is very impressive. About 275 billion Glaxo ADRs were traded on the NYSE traded last year. But what I think is more impressive is that over 350,000 U.S. investors own Glaxo ADRs, and Glaxo's market capitalization here in the United States is approximately U.S.$20 billion. So the trading volume is impressive, but so is the number of shareholders and their market capitalization. It is also important to realize that, excluding Canadian com- panies, the vast majority of non-U.S. companies use ADRs when they decide to list in the United States. In fact, some of these companies are more actively traded in the United States than in their home country. For example, for Hong Kong Telecom out of Hong Kong, Repsol out of Spain, Telemex out of Mexico, there is more trading volume both in share terms and in dollar * Executive Vice President, The Bank of New York, New York, N.Y.; B.A., William Paterson College; M.B.A., Fairleigh Dickenson University. Mr. Velli established The Bank of New York's Depositary Receipt business in 1984. He is a member of the Inter- national Operations Association and the Securities Industries Association. 1. See William E. Decker, The Attractions of the U.S. Securities Markets to Foreign Issuers and the Alternative Methods of Accessing the U.S. Markets: From the Issuer's Perspective, 17 FoRDHAm INT'L L.J. S1O (1994) (discussing increased attraction of non-U.S. companies to U.S. capital markets and options available accessing into those markets). S38 AMERICAN DEPOSITARY RECEIPTS: AN OVERVIEW S39 terms in the United States than in their respective home coun- tries. I. ADRs: GENERAL BACKGROUND A. Operation of ADR Programs What are ADRs? How do they work? Very simply, an ADR is a receipt that is issued by a U.S. depositary bank, such as The Bank of New York, that actually represents the shares that are held overseas. So the ADR is merely a receipt that is issued in certificate form in the United States that represents the actual shares of a non-U.S. company. Once the ADR program is established, the ADRs trade freely in the United States, like any other U.S. security. They can trade on the over-the-counter market or they can trade on one of the exchanges, such as NASDAQ the American Stock Exchange ("ASE"), or the NYSE. ADRs can also be used to raise equity capital. I think one recent trend is that people have gotten away from calling depositary receipts "American depositary receipts." Now, they basically either call them "global depositary receipts" ("GDRs"), or simply, as I prefer, "depositary receipts." In order not to confuse anybody, though, I will use the most common term, "ADRs." The best way to understand how an ADR works is to look at an example of a trade. Again, let's go back to Glaxo, which trades on the NYSE. Glaxo did not raise capital here; the com- pany simply listed on the NYSE without conducting a public of- fering. Let's assume that the very first trade takes place here in Glaxo's ADRs. A U.S. investor, whether it's an institutional inves- tor or a retail investor, would simply call up his U.S. broker and say, "Buy me 1,000 or 10,000 Glaxo ADRs." In many cases the investor is not even aware that he is buying an ADR; all he really knows is that he's investing in Glaxo. So he calls up his broker (for argument's sake Merrill Lynch or Goldman Sachs) and says, "Buy me 1,000 Glaxo ADRs." The broker, because there are no ADRs outstanding here, goes to the foreign market, in this case the London market, buys 1,000 Glaxo shares off the London exchange, deposits those ac- S40 FORDHAMINTERNATIONAL LAWJOURNAL [Vol. 17:S38 DEPOSITARY RECEIPT SETTLEMENT ADR TO ADR 3 ADR 2 TRADES LOCAL MARKET NEW YORK 1NEW YORK MARKET INVESTOR MARKET AKAMAKER MKER 4 7U.S. STOCK MARKETS DEPOSITARY LOCAL STOCK OTC TRUST NASDAQ MARKET COMPANY AMEX PSE NYSE THE ANK OF LOCAL 4-- NEW YORK CUSTODIAN DEPOSITARY tual shares with the depositary bank (for example The Bank of New York) and then the depositary bank issues 1,000 ADRs in the U.S. marketplace. So the shares are deposited by the broker and The Bank of New York would issue 1,000 ADRs. That's how an ADR is created. Once the ADR is issued and outstanding, it freely trades like any other security. In the very next trade, if another investor calls up his broker and says, "I want to buy 500 Glaxo ADRs," the broker has a choice: he can either buy the ADR that is already existing in the U.S. marketplace, or he can repeat the process just described by going to the London Stock Exchange. The last point on the trading aspect is what we call ADR cancellation. If I own 1,000 Glaxo ADRs and want to sell those ADRs, but cannot find a buyer, I simply would cancel those ADRs and sell the actual shares back into the home market, in Glaxo's case, in London. Thus, ADRs can be created or issued, they can be transferred here like any other U.S. security, or they can be canceled. B. Rationale Behind EstablishingADR Programs There are several different reasons why non-U.S. companies establish ADR programs. Some of them were covered today and I will not harp on them. Basically, companies establish ADR pro- 1994] AMERICAN DEPOSITARY RECEIPTS: AN OVERVIEW S41 grams as a way of entering the U.S. markets to, hopefully, tap some demand for their securities. Many companies have found that by establishing ADR programs and enabling U.S. investors to buy their ADRs, they are able to get a better valuation for their share price. There are a couple of reasons for this. First, in many industries or many sectors here, such as the telecommunications sector, the U.S. investment community may put a higher valuation or price/earnings ratio ("P/E") on that sector. As a result, if you are a company in France and you're in the telecommunications business and your P/E in France is 14 and the P/E in the United States for telecom stocks is some- where around 18, by establishing an ADR program you should receive a higher valuation for your shares. Second, the simple fact of a non-U.S. company establishing an ADR program here, enabling U.S. investors to buy the shares simply here, usually translates into a higher stock price for the company. Third, companies establish ADR programs as a means of raising capital in the United States. In many cases, when a com- pany is making an offering, their home market cannot absorb it - for example, YPF, an Argentine oil company, earlier this year did a U.S.$3 billion global offering that was part of a privatiza- tion. There was no way YPF was going to be able to raise U.S.$3 billion in the Argentine market. As a result, they raised roughly U.S.$500 million locally, they raised U.S.$2 billion in the United States, and U.S.$500 million in Europe. Companies also establish ADR programs for other reasons. A great example is Roche, the Swiss pharmaceutical company. Roche established an ADR program for one reason: they have about 40,000 U.S. employees who wanted to invest in the parent company. By establishing an ADR program, the company was able to give their executives in the United States stock options, it was able to offer a 401-K savings plan for their U.S. employees, and the program enabled the U.S. employees to buy Roche ADRs. C. Investor Perspective From the investor's standpoint, U.S. investors buy ADRs for three main reasons: convenience, cost, and liquidity. From the convenience side, ADRs trade and settle just like any other U.S. S42 FORDHAM INTERNATIONAL LAWJOURNAL [Vol. 17:S38 security. There is no difference between buying Glaxo ADRs and buying IBM, AT&T, or General Motors stock. It works ex- actly the same way, you pay the same commission rates. ADR dividends are paid in U.S. dollars and they settle just like any other U.S. security. So there is virtually no difference between buying and selling an ADR and buying and selling any other U.S.