Depositary Receipts 102: Going Global for Individual Investors Has Never Been Easier (part 2)
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Anthony Moro, the Managing Director and Head of Emerging Markets for Bank of New York Mellon’s (NYSE: BK) depositary receipts business, discusses the finer points of the DR business, and explains why there has been an explosion in DR participation as well as the need for BNY Mellon to create its DR University for all classes of investors.
[continued from part 1]
Nick Slepko: So, help me understand this: If an ADR of a Japanese company is trading at USD 10 – and it’s a one to one ratio – is it essentially the equivalent of USD 10 in yen at the current exchange rate. Are the share prices totally in sync or is there a slight (or large) variation?
Anthony Moro: If there are no artificial constraints on the market like taxes that local regulators impart, then for the most part there are no variations. There will be guys that sit at arbitrage desks all day that take out the local price and the dollar price. So you can assume that well within one percent the price in Tokyo is the same as in New York.
Slepko: Why does a company work with BNY Mellon – or one of the other three depositary banks, Citigroup (NYSE: C), Deutsche Bank (NYSE: DB), and JPMorgan (NYSE: JPM) – to get an ADR? Why not just list directly on the New York Stock Exchange?
Moro: Settlement issues mostly. So if Toyota is listed in Tokyo, then to also list in New York you would have to create a separate class of securities and it wouldn’t be fungible with each other and the prices wouldn’t be tied together through that arbitrage mechanism. The beauty of a DR is the fungibility between the two markets. Almost no company in the world would do a separate class of security on the New York Stock Exchange. It would fragment liquidity, it wouldn’t be good for shareholders, it’d be two separate classes of reporting – it would just be a logistical nightmare.
Slepko: So, that brings up the sponsored versus unsponsored DR divide. Is one safe and the other not?
Moro: Here’s the difference. A sponsored DR is when the issuing company has a relationship with one, and only one, of the four depositary banks. Unsponsored means any of the four depositary banks can establish the program (and all four can establish the program at the same time).
Unsponsoreds have been around a long time, but their popularity is relatively new. Because there are only four depositary banks and because the world is a big place it’s hard to get every potentially affected issuer to request that 12g-exemption from the SEC. So we have capacity constraints up against demand from brokers and investors for specific companies. If we have that demand, we’ll create an unsponsored.
In terms of overall trading volume, unsponsored is a small proportion. However, in terms of number of companies, unsponsored is a little bit bigger. Basically, there are a lot of companies that don’t trade very actively.
Also, there are F-shares (‘F’ as in “foreign”), which have historically done what unsponsored DRs do. Any quote (that is not a Canadian company) which has five letters with an F at the end is essentially a foreign stock trading in the US. There are thousands of these and their full cost of ownership is not well disclosed by the brokerage community. Unsponsored ADRs are used to rationalize this market and the most efficient structure has been to use DRs for all quality non-US companies trading in the US. DRs simply are much more transparent to the end investor than F Shares.
Slepko: It appears there has been a ~30% increase in the number of DRs over the last couple years. Why is that?
Moro: After fifty years, the rules governing unsponsored programs were modernized in 2008, which resulted in over a thousand new unsponsored DRs being created. The change reflected reality in that much more company specific information was available in English on foreign companies’ websites. The SEC allowed this information to qualify a company to trade in the US as an OTC DR. So, today, an investor can buy more than 3,500 of the world’s best companies right here in the US markets – OTC or on the NASDAQ or NYSE.
As the world continues to globalize, more investment opportunities are found far beyond US borders. DRs help investors take part in those opportunities.
Nick Slepko has no position in any company mentioned here at the time of publication. The Motley Fool owns shares of Citigroup Inc and JPMorgan Chase & Co. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.