Depositary Receipts 101: The Individual Investor’s Bridge to the Global Economy
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For over two decades, Akbar Poonawala has been creating depositary receipts – effectively foreign stocks that trade in local markets. Originally from Pune, India’s most economically diversified and livable city, he has spent his professional career helping Deutsche Bank (NYSE: DB) bring far-flung investment opportunities within reach of local investors. In addition to establishing the first Indian stock on an American exchange in 1999 – the iconic Infosys – among the other 970+ DRs he oversees includes Finland’s Stora Enso, the world’s oldest company.
Nick Slepko: Talking with Deutsche Bank, Bank of New York Mellon (NYSE: BK), Citigroup (NYSE: C), and JPMorgan (NYSE: JPM) – not to mention the Hong Kong, London, and New York exchanges, particularly NYSE Euronext (NYSE: NYX) – it becomes apparent that all are deeply invested in the business of depositary receipts, though their strategies vary and the role DRs play in their overall business can be quite divergent. What are depositary receipts, and what’s so great about them for individual investors?
Akbar Poonawala: Essentially, the depositary receipts Deutsche Bank facilitates are the bridge between investors and companies in countries all around the world.
DRs can be issued in the form of American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs). As the names suggest, ADRs are issued in the US market, whereas GDRs are principally issued in non-US markets. DRs enable international investors to acquire and trade foreign securities without concern for the differing settlement timetables and other problems typically associated with investing directly in overseas markets.
However, I think what is so great about them was best summed up in a letter I received from a school teacher in Boston whose shares of [India’s] Infosys had been doing well. He wrote, “Thank you for making a company like this accessible to individual shareholders like me...”
DRs reduce the volatility in investment portfolios by offering wider choices to investors. The world is made up of far more than US securities, and in some cases, the non-US securities offer fantastic potential and appreciation. You can pick the risk you want and pick the markets and sectors you want to go into. If you want exposure to minerals, technology, fashion, then why are you just looking at those US securities? Why not look at a wider portfolio that can allow you diversify even further? (And hopefully get you better returns.) Many of these depository receipts offer much better, much higher (even dividend yields) return of interest to individual investors.
Slepko: Can you explain all the different ADR levels?
Poonawala: ADRs comply with US rules, regulations, and do all the US filings required depending on their gradations. ADRs have three levels. The higher the level, the higher the threshold of pain, which is to say, the higher the threshold you have to meet to comply with the regs. In 1999, Deutsche Bank helped Infosys with its first ADR launch. Infosys chose to do a Level-3 capital raising ADR launch on the NASDAQ.
Level-1 is non-capital raising, and not on a US exchange.
Level-2 is capital raising, and on a US exchange.
Level-3 is capital raising, and on a US exchange, and complies fully with Sarbanes-Oxley and US GAAP – these are the whole enchilada.
Level-1s don’t have to meet or comply with the same level of regs as do Level-2 and Level-3. Nestle for instance is a Level-1 ADR, and is not listed on the exchanges, but is listed over-the-counter. All the Level-1s will be on OTC or OTC Pink.
Level-2 is non-capital raising as well – meaning they don’t raise new capital, they just make existing foreign shares available to US investors to invest as if they were US securities.
As for Level-1s, take Daiwa Securities in Japan (which is a Level-1 and traded over-the-counter in the US). With a Level-1, Daiwa doesn’t capital raise, they just say that for foreign investors interested in shares of their company they appoint Deutsche Bank to be the depositary bank and then [Deutsche Bank] can create ADRs on the back of underlying local shares.
So, let’s say an institutional investor like CalPERS wants to buy USD 5 million worth of Japanese exposure because it believes Japan is currently a better risk than the US or Europe. So it comes to a depository bank, in this case Deutsche Bank, and asks us to help them buy USD 5 million worth of Daiwa. Now Daiwa isn’t raising new capital, but by virtue of the fact that Deutsche Bank is the depositary bank, we will take possession and keep in custody in Tokyo the ordinary shares and then issue American securities of Daiwa.
Also, when the dividend comes, Daiwa pays in yen and we then convert that into dollars for the holders of the ADR. Moreover, if there’s an annual general meeting (and depending on the terms and conditions) we pass on the voting rights to the end investors.
We are the bridge.
Poonawala: In theory, any financial institution can become a depositary bank, but the FI has to be a trust company in the US, or a bank with trust powers. Additionally, this FI has to be a registered transfer agent with the SEC. These two requirements could be barriers to entry for other institutions intending to get into the DR business.
Slepko: Why is Deutsche Bank the only non-American bank in the club?
Poonawala: The DR business of Deutsche Bank is a legacy Bankers Trust [US] business. Historically, many banks – American and non-US – have been in the DR space, including Irving Trust [US], Nomura [Japan], HSBC [UK], Chase Manhattan Bank [US], and Marine Midland [US]. The industry has consolidated over the years through various acquisitions: Bank of New York Mellon buying Irving's book, HSBC acquiring Marine Midland's book which in turn was acquired by BNY, Deutsche Bank buying Bankers Trust, etc. For many years now there have only been these four remaining players in the DR business.
Nick Slepko (hukgon) has no position in any company mentioned here at the time of publication. The Motley Fool owns shares of Citigroup Inc , JPMorgan Chase & Co., and NYSE Euronext. Motley Fool newsletter services recommend NYSE Euronext. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!