The global financial crisis has helped spur growth in this market. As of March the value of GDRs held by investors totaled approximately $700 billion nearly double the $360 billion owned in 2008, according to Nancy Lissemore, global head of Citis depositary receipt services in New York. Issuers like them because they offer access to a vast universe of potential investors, and buyers like them because depositary receipts facilitate diversification into non-U.S. securities, she says.
The process is simple: A global depository bank issues receipts on shares purchased in the local market by a custodian (which can either be a standalone entity or a separate division of the issuing bank); in most cases, one receipt equals one share, traded in hard currency on the relevant exchange. Bank of New York Mellon Corp., No. 1 on Institutional Investors ranking of the Worlds Largest Global Custodians for a fifth consecutive year, is also the dominant player in the DR space. It is the depositary bank for more than 2,500 of the 3,500 DR programs that were operating in some 75 countries as of March. That figure includes sponsored programs those initiated with the cooperation of the companies whose stocks back the receipts and unsponsored, which are issued without company participation. (For more information about our annual survey of custodians, including firms ranked by gains in both dollar and percentage terms, please visit our website, institutionalinvestor.com.)
DR trading volume climbed 14 percent last year, to 171 billion, with a value of $3.8 trillion (up from $3.4 trillion in 2010), J.P. Morgan reports; some 56 issuers raised more than $15 billion in capital through DRs in 2011. In the first six months of this year, according to BNY Mellons Depositary Receipts Midyear Market Review, investors traded nearly 80 billion DRs, with a value of $1.5 trillion. During the same period 11 transactions raised $1.25 billion through IPOs and secondary offerings.
Although DR plans are garnering a lot of interest and attention these days, the concept is hardly new. J.P. Morgan created the first such offering in 1927 as a way for U.S. investors to buy into Selfridges & Co., a popular London-based retailer. British companies at that time were prohibited from registering their shares overseas unless they worked with a transfer agent located in the U.K., so the bank pioneered a way for equivalent instruments to trade on a U.S. exchange and clear, settle and pay dividends in dollars. Thus, the American depositary receipt was born. Dubbed an access product, it eliminated the very real burden of investors having to navigate foreign banking and legal systems, evolving financial infrastructures such as clearinghouses and stock exchanges, and complex tax codes.
These hardships can be especially onerous even now, in emerging and frontier markets, where much of the current DR growth is taking place.
The so-called BRIC countries Brazil, Russia, India and China accounted for more than three quarters of the DRs offered via IPOs and some 70 percent of those furnished through follow-on deals last year, according to Christopher Kearns, New Yorkbased deputy CEO of BNY Mellon Depositary Receipts. That has shifted somewhat given the macroeconomic issues, he says, but emphasizes that emerging markets still represent the biggest opportunity and none more so than China.
The bank recently surveyed about 650 large issuers, 30 percent of which identified greater China as the primary focus of their efforts to reach new equity investors. Many of these issues are done for broader strategic reasons, such as, China is my biggest export market or Maybe I need to better align myself with the government or regulators in China, he says.
The Hong Kong Stock Exchange introduced depositary receipts in 2010, and to date three companies have opted to offer HDRs: Coach, a New Yorkbased luxury goods company; SBI Holdings, a financial services firm headquartered in Japan; and Brazil-based multinational mining corporation Vale. J.P. Morgan is the depository bank for all three.
On the flip side Chinese companies offering DRs through foreign exchanges Internet video site operator Tudou Holdings was the best performer among the names listed on BNY Mellons ADR index, skyrocketing 205.3 percent in the first half of the year. (In August former rival Youku acquired the company; the new entity is named Youku Tudou.) China Sunergy, a manufacturer of solar panels, saw the second-highest gain; its DRs bolted more than 118 percent from January through June.
Frontier markets also offer promise. Last year Zambias Lusaka Stock Exchange became the first in Africa to list DRs, for First Quantum Minerals, a metals and mining outfit headquartered in Canada; BNY Mellon is the depository bank.
Sub-Saharan Africa is opening up to depositary receipts, Kearns says. They are following a typical DR pattern: The market opens, and its very exotic and hairy. Investors are interested but not in attendant issues like determining how to receive corporate actions. If they were to invest in Kenya, for example, they would have to find a subcustodian in the country that meets their requirements. Thus, DRs make these markets more accessible.
Were already reacting to early demand from more-adventurous institutional investors, says Citis Lissemore. However, she cautions that some frontier markets are taking their time as they think through such issues as how to protect capital flows.
Dennis Bon, New Yorkbased global head of J.P. Morgans depositary receipts business, says the trend is just beginning to take off. We will see more and more issuers coming out of the frontier markets, he predicts.
One reason? Liquidity. In many places, DRs were there before the market was, Kearns says. And liquidity begets liquidity.
DRs offer another advantage: enabling issuers to provide noncash compensation to employees outside the home country. Its not just about finding investors, he adds. Its waving the flag.