AsiaÆs DR revolution

The development of new products confirms Asia is no longer just an importer of capital.
Forty-six years after Sony became the first Asian company to use ADRs to list in the US, Asia could be on the cusp of a new trend that will see depositary receipts being used to attract international issuers into the major equity markets in the region.

Singapore has broken new ground by allowing global depositary receipts (GDRs) to list on its exchange with the aim of offering an alternative for overseas companies that otherwise would have ended up in London or Luxembourg.

However, there is more to this trend than simply snatching existing instruments away from their traditional homes, and industry bankers say work is currently going on with regard to the introduction of domestic DRs in Tokyo, Hong Kong, Korea and India, as well as the creation of an Asian DR that could trade seamlessly in all the major Asian markets.

While somewhat more ambitious than the domestic DRs, the Asian DR concept has moved well beyond the drawing board and should be a reality in less than six months, says Bank of New York Mellon, which is the bank behind this product. At least one other major DR bank is currently working on a similar concept, but doesnÆt feel ready to talk about it in public just yet.

All these developments would mark something of a reversal of the traditional use of DRs as a means for Asian companies to gain access to international capital through a listing in New York or London. However, bankers say the initial DR listing targets for the exchanges in Tokyo, Singapore, Hong Kong and Seoul wonÆt be non-Asian companies, but rather companies from elsewhere in the region, specifically India, Taiwan, China, Korea and Hong Kong.

Still, this new trend will serve as a confirmation that Asia is no longer mainly an importer of capital, but rather has transformed into a place where years of household savings are now beginning to be put to work. And deeming from the phenomenal gains in the regional stock markets since the August correction some of it is clearly going into stocks.

The potential introduction of DRs in Asia should also be seen in the context of the ongoing consolidation among the worldÆs stock exchanges and the increasing competition between bourses as they fight to be one of the five or so markets that really matter. Attracting more companies to list is key in this respect, either through the targeting of companies in new geographies or through the introduction of new asset classes that appeal to a different category of issuer.

Hong Kong, which is under additional pressure as more and more of the Chinese companies that have traditionally sought to list in the territory are currently going public in Shanghai instead, has admitted companies from Malaysia and Australia over the past year and has ventured as far as Kazakhstan in its efforts to attract new listing candidates. Singapore has carved a niche for itself with its Reit and business trust products, as well
as the earlier mentioned GDRs.

DRs û in all forms û could become a great help in these efforts, industry bankers say, noting that this is a well-known and proven instrument that wonÆt take too much explaining for potential issuers.

ôItÆs an easy, low-cost way for a market to establish if it can attract overseas issuers, as the opportunity cost is low,ö says Kenneth Tse, Asia-Pacific head of the depositary receipts group at JPMorgan.

So far only two companies have listed GDRs in Singapore since this possibility became available in June 2006 û steel manufacturer Uttam Galva Steels and Webel-SL Energy Systems, a producer of solar cells and modules. Both of them are from India, which is likely to be the primary target for the exchange given the frequency by which Indian companies are issuing GDRs. Sources say there are about four or five other Indian companies in the pipeline which have chosen Singapore as a listing destination over London or Luxembourg. The next step in the marketing effort for this product is expected to be Taiwan. According to Tse at JPMorgan, which is the depositary bank for both the GDRs that have listed in Singapore so far, the benefits of choosing Singapore over the usual European destinations include a quicker time to market, a lower cost than London (but about the same as Luxembourg) and the fact that India is in roughly the same time zone as Singapore. Many Indian companies also have convertible bonds listed in Singapore and know that market already.

Like they would be in London or Luxembourg, the GDR is dollar-denominated, open only to institutions and high net-worth individuals and settled by Euroclear, meaning it isnÆt really an Asian instrument as such. However, it does help boost the overall market cap of the exchange and also does give access to more overseas-listed companies for the investors who can trade them.

By comparison, the ôdomesticö DRs are securities that are designed for domestic trading, clearing and settlement, but not for being transported across borders. Korea and India have both amended their regulations over the past three months to enable the listing of KDRs and IDRs, respectively, and Tokyo and Hong Kong are looking at introducing JDRs and HDRs. These instruments will all be trading in the domestic currency and will be open to retail investors.

According to sources, Korea is expected to list its first KDR in November for Hong Kong-listed Huafeng Textiles and Tokyo could be rolling out such an instrument during the course of next year. Hong Kong is still very much at the early stages of planning, they say, although Hong Kong exchange officials have mentioned the plans in public, which suggests that they too are serious about this.

The concept isnÆt new, however. In fact Singapore, Taiwan and Korea already have versions of domestic DRs, but in all three cases they have failed to take off. In Singapore, only one company has chosen this option; Taiwan have five TDRs; and Korea, which allowed foreign companies to issue KDRs as early as 1995, has not seen a single issue so far. However, the Korean Stock Exchange hopes that the amendment to the DR listing regulations should rectify this situation and the fact that Huafeng Textile has been planning a KDR since December last year does seem promising.A key reason why domestic DRs did not take off, observers say, was a lack of liquidity as each of these markets are quite small. In the case of Singapore, it allowed for the listing of SDRs in 1994 û long before it became a regional hub for asset managers of various kinds. Some companies may have felt that the need to comply with onerous local regulations and disclosure requirements may have been too time consuming in return for just a small number of retail investors.

ôOne of the reasons why GDRs have become so popular is that it is a very simple product. Issuers basically donÆt have to do anything more than they already do or disclose in their home market and it is targeted to professional investors so they donÆt have to disclose as much information as they would if retail investors were involved,ö says Kwan Siu-Chan, a director and North Asia sales head for depositary receipts at Citi.

However, Kwan says he is optimistic that at least some of these markets will see their DR programmes take off, partly because of AsiaÆs growing importance in a global context and its rapidly growing economies.

ôGenerally speaking, Asia is booming and the emerging markets in particular have companies that are expanding very quickly and need to raise a lot of capital. But quite often the domestic markets are not developed enough to cater for large fundraisings, which means these companies need to go overseas,ö Kwan says.

So far, he says, companies from the likes of Vietnam or the Central Asian states such as Kazakhstan have primarily turned to London but through DRs, Hong Kong and Tokyo have the opportunity to offer these companies an Asian alternative.

ôAnother reason (why domestic DRs might work better this time around) is that a secondary listing quite often has nothing to do with capital raising but rather is about building your profile. Right now Asia is very æhotÆ and I will not be surprised if in the longer term some multinational companies that are listed in the US may consider having a secondary listing in Hong Kong or other parts of Asia for profile reasons,ö he adds.

ôThe markets have come a long way since the mid-1990s when the SDRs were introduced,ö agrees another DR banker. ôWe now live in a global world where barriers to investment are significantly lower. There are also many new types of investors, including hedge funds, and the regulatory regimes have become much more amenable to allow investments in domestic markets.ö

The banker points to the fact that even Indian markets have become quite sophisticated and deep and companies from neighbouring smaller countries such as Sri Lanka might want to capitalise on its huge retail investor base and more sophisticated institutional investor base by listing DRs there.

Meanwhile, Bank of New York Mellon is working on something which it refers to as an Asian DR. While essentially a modified version of the GDR, the Asian DR builds on the idea that certain global companies would like to have their stocks listed in several markets û be it as a service to their investors, to allow their overseas staff to trade the companyÆs shares or simply as a show of commitment to certain markets.

Back in the late 1990s, Deutsche Bank was instrumental in the introduction of so called ôGlobal Registered Shares,ö which were common shares listed in multiple markets. The product was meant to deal with cross-listings of shares for large corporations following cross-border mergers that involved large numbers of retail investors. DaimlerChrysler became the first corporation to adopt this in 1999 and was later followed by others like UBS.

However, attempts at cross-listings, including the global registered shares, have for the most part fallen flat, partly due to the lack of a synchronised settlement system and partly because the majority of the trading has tended to migrate to the most liquid market where spreads are the tightest. In the case of IBM this was New York, while for DaimlerChrysler it was Frankfurt, leaving the security in the other market (or markets) as something of an orphan. Tokyo alone has seen more than 100 foreign companies abandon their secondary listings in this market because of liquidity issues.

In the absence of a common Asian settlement system, along the lines of Euroclear or Clearstream in Europe, that could settle equity trades in all Asian markets, the Asian DR is designed to overcome these barriers by being eligible in all the settlement systems. This means you could have the same security trade in all the markets. To make this work Bank of New York Mellon has put in place a support network with agents in all target markets who are in a position to receive and deliver DRs.

ôThe DR mechanism provides a guaranteed settlement (and) we are taking the place of an Asian central securities depositary by facilitating the transfer of DRs in each market,ö explains Hernan F Rodriguez, managing director at Bank of New York Mellon.

Like their counterparts in the US or Europe, Asian DRs are also one step removed from the underlying security by being priced in fractions or multiples of the original instrument. They are also denominated in the local currency of the market they trade in.

ôThe fact that it is one step removed brings in a whole cadre of traders, market makers and speculators who love to arbitrage between the DR and the underlying security, thus adding liquidity to the market,ö Rodriguez says. ôTherefore, if we are going to cross-list foreign securities or exchange traded funds in Tokyo, it makes sense to put a DR wrapper on them in order to entice all these market makers.ö

And there are likely to be no shortage of demand for such an instrument. Bankers say there are numerous European and international companies that have an interest in establishing an equity presence in this region, because Asia is such an important market for them. According to Rodriguez, Asian DRs are already 60-70% on the way, although to become reality they still need to be approved by local regulators and stock exchanges. This is presenting some challenges as they have to be listed as foreign securities and the regionÆs domestic stock markets havenÆt traditionally been set up to facilitate cross-border trading. It gets particularly tricky as they are new instruments that donÆt readily fit into existing categories such as securities, derivatives and ETFs.ôKeep in mind that the stock markets are very competitive vis-a-vis one another. Hong Kong and Singapore are always looking at what the other one is doing and trying to work out if they can do it faster, better and quicker,ö Rodriguez says. ôBut they are interested in getting more listings and to be honest they probably donÆt care how it is done as long as the companies come over.ö

Consequently, Bank of New York Mellon is now confident that it will be able to launch the first Asian DR by the first quarter next year.

The good thing about these various developments û Asian DRs, domestic DRs or regionally listed GDRs û is, however, that they can co-exist both within Asia and in each individual market. Indeed, without going into any specific plans, Rodriguez indicates that Japan may be the most likely birth place for Asian DRs given the size of the market in terms of capital, even though the Tokyo Stock Exchange is also busy putting JDRs into play.

ôA mid-cap company with large operations in Japan but no wish to expand anywhere else in Asia that wants to show a commitment to the Japanese market may opt for a JDR, while an Asian DR may be more suited for a company that has pan- Asian presence and want to show a commitment to multiple markets, such as a large pharmaceutical, software or auto company,ö he says.

Hong Kong, which has shown its ability to digest billions and billions of dollars worth of Chinese state-owned enterprises for years, is also of interest, while Taiwan û despite its small size û has a lot of cash available for investment.

Asian DRs are also seen as an ideal instrument for bringing successful US or European ETFs to the Asian markets. ETFs are one of the fastest growing asset classes in the US at the moment and by using the DR format, the PowerShares QQQ, which tracks the Nasdaq-100 index, or the SPDRs, which are based on the S&P 500 index, could be transported to Asia and give investors access to the same liquidity that US investors enjoy in their home market.

The SPDR ETFs, commonly referred to as ôSpiders,ö are already cross-listed on the Singapore exchange, but because of the liquidity issues mentioned earlier they are rarely traded.

While domestic DRs should be able to enjoy the same benefits in terms of liquidity as the Asian DRs since they too will be one step removed from the underlying security, both instruments face other issues that could hamper their development. As mentioned earlier, the fact that these instruments will be available to retail investors means they will be subject to much more stringent regulations than, for example, a GDR, as the local regulators try to protect the investing public. This typically means a longer listing process and higher costs. This is a big issue in Japan where overseas companies need to comply with domestic financial reporting standards, which require them to file a financial report according to Japanese GAAP (generally accepted accounting principles) twice a year, in Japanese. Meeting these requirements can cost as much as $1 million per year.

At present the same rules apply whether an overseas company were to issue ordinary shares for a proper cross-listing or JDRs. However, in a September report JapanÆs Ministry of Economy, Trade and Industry (METI), which is in charge of promoting JDRs, called on the Japanese regulators to exempt foreign issuers from adopting Japanese GAAP and instead allow them to use IFRS (international financial reporting standards).

ôIf they succeed, it is likely to open the door for more overseas issuers,ö says Tse at JPMorgan.

An issue for Hong Kong is that it doesnÆt have an obvious target market in Asia for potential HDRs, the way that Singapore has a long-standing connection to India to build on (aside perhaps from Taiwan). The Hong Kong Exchanges and Clearing, which owns and operates the local bourse, has recently been approaching stock exchanges in Russia and Dubai, however, which suggests it is hoping to one day see companies from these two countries trade in Hong Kong and vice versa.

ôI think Asian markets will be only the first step for HDRs. I do see Hong Kong eyeing markets outside of the region as well and one option would be to bring ETFs from the US to Hong Kong in the form of DRs,ö Tse says.

The big four DR banks (Bank of New York Mellon, Citi, Deutsche Bank and JPMorgan) are all involved with several of the mentioned stock exchanges, lending their expertise and providing advice during the build-up phase to try and make the domestic DR concept work. And they are all following the developments closely to see how they can participate actively if there will be demand from issuers. However, they acknowledge that it is likely that the local banks in each of these countries will also step up to handle the actual issuance of domestic DRs.

A couple of DR bankers note that these products could open up opportunities for their custody services, however, as the domestic DR banks will need a custody network around the world that can take in shares in markets such as India and the US, and as this business develops further, perhaps from less developed markets like Russia or Brazil where they are unlikely to have a presence.

The story first appeared in the October issue of FinanceAsia magazine.

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