ANALYSIS OF RELATIONSHIP OF ADR AND GDR PRICES WITH THE NATIONAL AND INTERNATIONAL MARKET

Transcription

1 ANALYSIS OF RELATIONSHIP OF ADR AND GDR PRICES WITH THE NATIONAL AND INTERNATIONAL MARKET Sharmistha Ghosh, Assistant Professor Department of Commerce, Shri Shikshayatan College, Kolkata Abstract The capital market of a country holds great significance with respect to its economic growth. Capital markets in India as well as across the globe are progressively getting interconnected. The new financial instrument for tapping the international markets may be termed as Depository Receipts (DRs). A depositary receipt is a negotiable financial instrument issued by a bank to represent a foreign company's publicly traded securities. It is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity that is issued by a foreign publicly listed company. Recently, Depository Receipts, especially, American Depository Receipts (ADR) and Global Depository Receipts (GDR) have become a popular investment alternative for the investors in India. ADR were first issued in 1927 and they account for the maximum number of trades in comparison to GDRs. Both ADRs and GDRs help investors looking to tap a new investor base, expand awareness, or raise capital. In this context, this paper aims at discussing the role of ADR and GDRs issuance. It also showcases the different aspects of Depository Receipt issues along with their relationship with the Indian and International securities market. Key Words: Depository Receipts, American Depository Receipt, Global Depository Receipt, Foreign Direct Investment, Regulation S. Introduction As the country grows and expands with the globalization of the economy, one important aspect with regard to the investment opportunities available to investors is the introduction of Depository Receipts (DRs) as an investment alternative. A DR is a tradable instrument that represents an ownership interest in securities of a foreign issuer typically trading outside its 114

2 home market. Most common types of Depository Receipts are the American Depository Receipts (ADRs) and Global Depository Receipts (GDRs). ADRs are issued by the United States (US) in lieu of a non-us company s shares which are traded on the US exchange although the companies itself are not listed on the US exchange. The DRs which are not listed on US exchange but in other country s exchanges most commonly in London or Luxembourg are termed as Global depository Receipts (GDRs). A depositary receipt where the issuing bank is European will sometimes be called a European Depositary Receipt (EDR). While by creating a depositary receipts program, the companies are able to gain the flexibility and access they need to achieve the company s strategic goals it also hold special appeal for investors because they make investing in a company beyond the investor s home borders easy and convenient. This attribute fuels investor appetite, which in turn has driven explosive growth in the depositary receipt market. So, from an investor s point of view the ADR or GDR is essentially a certificate issued by a bank that gives the owner rights over a foreign share. It can be listed on a stock exchange and bought and sold just like a normal share. The holder of an ADR or GDR is entitled to all benefits such as dividends and rights issues from the underlying shares but they are sometimes though not always able to vote. Initially, most of the issues were done through private placement route during the 1990 s but afterwards the exchange traded ADRs were introduced. In this respect this paper is organized as follows. Section 2 gives an overview of depository receipts and their benefits. Section 3 draws an analysis of ADR and GDR prices and studies their relation with the different market indices. Section 4 states the regulations regarding ADR GDR issue and divestment of shares in India. And finally the last section is devoted to conclusion and recommendations. Overview of Depository Receipts While depositary receipt (DR) programs can be structured in a variety of ways, there are two basic options: American Depositary Receipt (ADR) programs, which give companies access to the US capital markets, and Global Depositary Receipt (GDR) programs, which provide exposure to the global markets outside the issuer s home market and the institutional investor market in the US. 115

3 American Depository Receipts SAMZODHANA Journal of Management Research American Depositary Receipts (ADRs) offer the issuing company access to the world s largest and most active capital market. Correspondingly, ADRs provide investors in the US with a convenient way to directly invest in international companies while avoiding the risks traditionally associated with securities held in other countries. ADRs are dollar-denominated securities that trade, clear and settle like any other US security. Whether traded over-thecounter or on one of the major US exchanges, ADRs are a mainstream and popular option for investors. ADRs may be classified broadly into two: Unsponsored ADR and Sponsored ADR. Sponsored ADR may be reclassified as Level I, Level II and Level III and the Private Placement under Rule 144A (Fig: 1). The Unsponsored ADR program is one in which there is no deposit agreement set up between a depositary bank and an issuer client. One or more depositary banks create and issue ADRs due to market demand even without the issuing company s participation. FIGURE: 1 DIFFERENT CATEGORIES OF ADR Types of ADRs Unsponsored Sponsored Level I Level II Level III Private placement Hence they are not required to be listed on any exchange. They are exempted from reporting requirements of the SEC. The Sponsored ADRs are initiated by the issuer and it is established jointly by an issuer and Depository. The Depository helps to provide shareholders communication and other information to the ADR holders and it is through the Depository that the ADR holders may exercise their voting rights. Under the Sponsored category, a Level I ADR program is not listed on a stock exchange, but is available for retail investors to purchase and 116

4 trade in the over-the-counter market via NASDAQ s Pink Sheets. A Level I program does not create new capital in the US; rather, it gives the company an opportunity to develop or expand its shareholder base by establishing a foothold in the US market. It maintains home market accounting and disclosure standards. They use existing shares to satisfy investor demand and liquidity. New DRs are created by issuing and canceling ordinary shares in the issuer s home market. These Level I ADRs are registered with the US Securities and Exchange Commission. A Level II ADR uses existing shares to satisfy investor demand and liquidity. New ADRs are created from deposits of ordinary shares in the issuer s home market. Because these securities are listed or quoted on a major US exchange, Level II ADRs reach a broader universe of potential shareholders and gain increased visibility through reporting in the financial media. These are more expensive than the Level I ADRs. Listed securities can be promoted and advertised, and may be covered by analysts and the media. In addition, listed securities can be used to structure incentives for an issuer s US employees, or could be used to facilitate US mergers and acquisitions. Level III ADRs are a public offering of new shares into the US markets. These capital raisings have a high profile and are most expensive. They are followed closely by the financial press and other media, often generating significant visibility for the issuer. Apart from all these, the Rule 144A ADR is the unique one. It is the quickest, easiest, and most costeffective way to raise capital in the United States. New, restricted shares are created and then privately placed with institutional investors. Rule 144A facilitates the resale of privately placed securities to Qualified Institutional Buyers (QIBs) in the US. These do not need to conform to the full SEC reporting and registration requirements. Global Depository Receipts The typical GDR structure offers DRs in Europe or other non-us markets pursuant to Regulation S (Reg. S) promulgated under the US Securities Act of The predominant listing venues for Reg. S GDRs are the London and Luxembourg Stock Exchanges, with GDRs having also been listed on the Singapore Exchange, Frankfurt Stock Exchange and Nasdaq Dubai. Rule 144A GDRs trade in the U.S. over-the-counter market. When GDRs are offered simultaneously in Reg. S and Rule 144A form, but in separate and distinct tranches, they exist inside what is known as a 117

5 bifurcated GDR program. When the GDRs are offered simultaneously in Reg. S and Rule 144A form, but not in separate and distinct tranches, they exist inside what is known as a unitary GDR program. The ability of retail investors to purchase GDRs will depend on the type and location of the listing. In general, however, GDR offerings are aimed at institutional investors and depending on the exchange, they can then be purchased by retail investors in the secondary market. GDRs are usually offered to institutional investors through a private offering, in reliance on exemptions from registration under the Securities Act of These exemptions are Regulation S (Reg. S) for non-u.s. investors, and Rule 144A for U.S. investors that are Qualified Institutional Buyers (QIBs). The availability of these exemptions for GDR deals makes them an efficient and cost-effective means of implementing a cross-border capital-raising transaction. Due to the general flexibility afforded by GDRs, issuers from a variety of regions, including Europe, the Middle East and Africa; Asia Pacific; and Latin America, have been utilizing GDR programs to help meet their capital-raising needs on an increasing basis. FIGURE: 2 DIFFERENT TYPES OF GDR ISSUE TYPES OF GDR REGULATION S GDR RULE 144A GDR BOTH UNDER REGULATION S AND 144A GDR BIFURCATED GDR PROGRAM UNITARY GDR PROGRAM Literature Review Several research studies have been carried out in the area of Depository receipts issues both in India and abroad. Chakrabarti (2003) stated that several factors are likely to influence the dynamics of ADR prices and volume. Since ADRs are dollar-priced entitlements to foreign shares, movements in their prices and returns are naturally expected to be affected by those in 118

6 the underlying shares and the relevant exchange rate. The host country (the US) market becomes the natural candidate for such a factor, since American investors, who are obviously affected by the movements in the US market, trade ADRs. Thus, the US market movements constitute a usual suspect in the study of ADR prices and returns. He further empirically investigated that how much of the variation in ADR prices may be explained by different variables affecting them and found that ADR issuance often has a temporary positive effect on the underlying stock price, but usually does not materially alter the stock s relationships with the US and Indian markets. Saxena (2005) analyzed the trend in ADR premiums and the movement in ADR premium levels over period. He also analyzed the relation in movement of ADR prices with the prices of underlying equity and concluded that ADR prices do not move in lock-step with underlying equity prices. A study conducted by Bank of New York, Mellon (2007) to provide an independent, robust analysis of the value and liquidity effects of depositary receipts (DRs) established by companies from emerging markets analysed DR programs of 628 firms covering the period The study covered the BRIC countries of Brazil, Russia, India and China along with Asia, Eastern Europe, Middle East countries and Africa. It was shown empirically that DR programmes established by firms in emerging markets add significant value and improve home-market liquidity to the benefit of both issuers and investors. DRs additionally provide a strong signal of willing disclosure, greater transparency and superior governance, particularly important from emerging, less-regulated markets. Likewise, several research studies were carried out on various aspects of ADR/GDR issues but not much work has been done in Indian context. The present study aims at fulfilling this vaccum. Objective of study The paper aims to analyze the relationship between the ADR prices with their underlying equity prices and the S&P 500 Index. It also tries to show the sensitivity of the underlying equity prices to one of the Indian stock market index i.e. BSE Sensex. In addition, the paper draws the relationship between the different Indian stock market Indices (CNX Nifty and BSE Sensex) to the US stock market Index S&P

7 Methodology For the purpose of the study, secondary data was collected from different websites and data was analyzed using SPSS software. Analysis and findings The first ADR in India was issued by Infosys Technologies in All Indian ADRs are sponsored ones and belong to Level II and Level III category. It is found from the established literature and data that India ranks the highest in issuance of Depository Receipts among various other countries. Table: 1 YEAR Total ADR/GDR Issues US $ Million Source: Handbook of Statistics, SEBI Descriptive Statistics ADRs: N Minimu m Maximu m Mean Std. Deviation ICICI BANK LTD. $ INFOSYS LTD. $ REDIFF.COM $ SESA STERLITE Ltd. $

8 SIFY $ DR REDDYS LAB $ HDFC BANK LTD. $ TATA MOTORS LTD. $ WIPRO $ MTNL $ Valid N (listwise) 61 Minimu m Maximu m Std. Deviation N Mean STOCKS : ICICI BANK LTD. Rs INFOSYS LTD. Rs SESA STERLITE Ltd. Rs DR REDDYS LAB Rs HDFC BANK LTD. Rs TATA MOTORS LTD Rs WIPRO Rs MTNL Rs Valid N (listwise) 61 INDICES: S & P BSE SENSEX CNX NIFTY S & P 500 N 61 Valid N (listwise) 61 Minimu m Maximu m Mean Std. Deviation

9 It is observed that HDFC Bank ADR is having the highest average price among the others with the highest standard deviation as well. While in the domestic market Infosys ltd. shares has the highest mean price. In case of indices, S&P 500 has the lowest deviation from its mean. The correlation between the ADR prices and the underlying stock prices of these companies was studied (Table 6, also Refer to Annexure 1) and it was found that all the eight companies of the sample showed significant correlation in their ADR prices and their underlying stocks except that of HDFC Bank Ltd. which shows a negative correlation and Tata Motors which showed a considerably lesser correlation of 40% only. This suggests that the ADR prices move in tandem with their underlying stocks in the Indian market. Summarized result (1) ADR NAME CORRELATION WITH CORRELATION WITH S & P UNDERLYING EQUITY 500 ICICI BANK LTD. $ INFOSYS LTD. $ REDIFF.COM $ SESA STERLITE Ltd. $ SIFY $ DR REDDYS LAB $ HDFC BANK LTD. $ TATA MOTORS LTD. $ WIPRO $ MTNL $ A correlation analysis was also done between the ADR prices and S&P 500 index (Table 7, also refer to Annexure 2) and it was observed that the ADR prices and their correlation with the S&P 500 Index is not so significant in case of the sample companies except that of Tata Motors Ltd., Dr. Reddy s Lab and ICICI Bank Ltd. On the contrary, the underlying stocks of these companies being traded on BSE (Table 8, also Refer to Annexure 3) showed more or less a significant correlation with the S&P BSE Sensex (except MTNL stock which showed a negative correlation). But an analysis of the S&P500 Index with the S&P BSE Sensex and CNX Nifty (Table 9) showed a greater degree of correlation between them. This suggests over the given time period the Indian Market and the US market was sufficiently correlated which may be due to the high 122

10 correlation between the ADR prices and their underlying stock prices because the underlying securities prices showed a greater degree of sensitivity to the S&P BSE Sensex. Summarized Result (2) STOCK CORRELATION WITH S& P BSE SENSEX ICICI BANK LTD. Rs INFOSYS LTD. Rs SESA STERLITE Ltd. Rs DR REDDYS LAB Rs HDFC BANK LTD. Rs TATA MOTORS LTD. Rs WIPRO Rs MTNL Rs Correlation between CNX Nifty and S&P 500 and SENSEX and S&P 500 Correlations S & P 500 CNX NIFTY S & P 500 Pearson Correlation 1.776(**) Sig. (2-tailed).000 N CNX Pearson NIFTY Correlation.776(**) 1 Sig. (2-tailed).000 N ** Correlation is significant at the 0.01 level (2-tailed). 123

11 Correlations S & P BSE SENSEX S & P 500 S & P BSE SENSEX Pearson Correlation 1.736(**) Sig. (2-tailed).000 N S & P 500 Pearson Correlation.736(**) 1 Sig. (2-tailed).000 N ** Correlation is significant at the 0.01 level (2-tailed). Conclusion and Recommendations ADR and GDR have emerged as an innovative instrument of investment. The relation between the different ADR prices, their stock market indices, the change or trend in the underlying stocks were examined which may provide with the general idea about the status of trading in these instruments in the domestic market and the US market as well. It may also be concluded that for a developing country like India, these depository receipts have enabled the investors as well as the companies to tap the global market and become an international player. Although the ADRs are a derivative of underlying equity, yet there may exist a significant difference in the ADR prices compared to the price of underlying equity (i.e. the ADR premium). So before going for investing in such avenues it is a must to note the trend in their prices and the prices of their underlying securities also. Moreover, the introduction or permission for two way fungibility scheme for the DR issues has paved the way for arbitraging opportunity in a more realistic way. Hence, we can look forward to the companies and investors for more participation in such issues in the years to come. References 1. Chakraborti, R. (2003). An Empirical Study of Exchange Traded ADRs from India, Money and Finance, ICRA Bulletin. 2. Fenn, G.W., (2000). Speed of issuance and adequacy of disclosure in the Rule 144A high-yield debt market, Journal of Financial Economics 56,

12 3. Jayaraman, N., Shastri, K., Tandon, K., (1993). The impact of international cross listings on risk and return: The evidence from American depositary receipts, Journal of Banking and Finance, vol. 17, pp Jitendranathan, T., T.R. Nirmalanandan and Tandon, K. (2000). Barriers to international investing and market segmentation: Evidence from Indian GDR market, Pacific-Basin Finance Journal, vol. 8, pp Kadapakkam, P., Misra, L., Tse, Y., (2003). International Price Discovery for Emerging Market Stocks: Evidence from Indian GDRs, Review of Quantitative Finance and Accounting, September 2003, pp Karolyi, A, (1998), What Happens to Stocks that List Shares Abroad? A Survey of Evidence and its Managerial Implications, NYU Salomon Brothers Center Monograph series, 7, #1. 7. Miller, D.P., (1999). The market reaction to international cross-listings: Evidence from depositary receipts, Journal of Financial Economics, vol. 51,103, Moel, A., (2000). The Role of ADRs in the Development of Emerging Markets, Working Paper. Harvard Business School. 9. Pinegar, J.M. and R. Ravichandran, (2002). Global and local information asymmetries, illiquidity and SEC Rule 144A/Regulation S: The case of Indian GDRs, Journal of Banking and Finance, vol. 26, pp Saxena, S. (2006). Premia in the Indian ADR Market- An Analysis of Trend and Causes, available at www. 11. Eaton.T, Nofsinger.J, and Weaver, D. (2007). Disclosure and the cost of equity in international cross-listing, Review of Quantitative Finance and Accounting, Volume 29, Number 1, pp