At present, the most popular way for them to raise international capital is through the issuance of DRs, which offer a way around local laws in many of these countries that prevent domestic companies from having shares that are registered abroad and thus make it impossible for them to seek a dual listing in another market. DRs û whether American depositary receipts (ADRs) or global depositary receipts (GDRs) û offer a solution since they are merely certificates that represent a certain number of common shares that are still registered in the companyÆs home market. The great majority of them are listed either in New York (ADRs) or London or Luxembourg (GDRs).
Companies in emerging markets are typically very familiar with DRs, which means that even if they donÆt have to use these instruments for regulatory reasons, they tend to be their preferred choice. One advantage over a secondary listing in another market is that DRs provide better liquidity since investors have the option of converting the DRs back into common shares.
In 2006 and 2007, 74 companies from India, Kazakhstan and Russia raised a combined $42.8 billion of capital through the sale of GDRs, according to data provided by Dealogic.
ôHKEx sees these emerging markets as an opportunity for Hong Kong, except we donÆt have a DR regime. When we approach these companies, it seems we are trying to sell something we cannot deliver,ö says Lawrence Fok, head of the business development & investor services division at Hong Kong Exchanges and Clearing (HKEx), which is the operator of the local stock exchange. This, he adds, puts Hong Kong at a disadvantage versus many other major exchanges, including Singapore, that already offer the possibility to issue DRs.
For some time, Fok has been speaking at overseas seminars and conferences to promote the Hong Kong stock market to companies in Korea, Japan, Taiwan, Vietnam, Malaysia, Kazakhstan, Outer Mongolia, India and Russia. He says HKEx is getting inquiries about listing possibilities from companies in several of these markets and with a DR platform in place he believes Hong Kong has the potential to become a real alternative to a listing of GDRs in London or Luxembourg.
ôHong Kong is very international because we allow complete free-flow of capital and there are many foreign brokers operating here,ö he says. ôIt is also a market that has been dealing with companies from China for the past 15 years and as a result, investors here are used to high growth, and sometimes high risk, emerging market companies.ö
Platform for Chinese investments overseas
Indeed, during the past three years, HKEx has helped raise $97.2 billion for mainland Chinese companies through new listings alone, according to Dealogic. But perhaps more importantly, Hong Kong also holds the promise of a significant inflow of future liquidity through the proposed pilot scheme that will supposedly allow Chinese individuals to invest in the Hong Kong stock market. The scheme, which is commonly referred to as the ôthrough train,ö was first announced in August last year but has yet to get the official approval from Beijing.
ôThe DRs will provide Chinese investors with a platform to more effectively invest overseas through the Hong Kong stock exchange. I would see having Hong Kong as a one-stop shop for Chinese investors as a key advantage for the Hong Kong market in attracting HDR issuers,ö says Kenneth Tse, Asia-Pacific head of the depositary receipts group at JPMorgan.
The proximity to China is another potential selling argument for Hong Kong as many of the companies that are considering a DR issue are natural resources-related and do at least some degree of business with China. These companies need lots of capital and Hong Kong investors have proven over the past few years that they are quite willing to invest in various stocks from the metals and mining and basic materials sectors. There are also a significant number of analysts based in Hong Kong who cover these sectors.
Bankers from the big four DR banks are also busy speaking with potential issuers of Hong Kong DRs, or HDRs as they are referred to within the industry, as they try to position themselves to become the first bank to bring such an issue to Hong Kong investors. To begin with, they see companies from within Asia as the most likely DR listing candidates, particularly those in India and Korea that have large capital-raising needs, although Kazakhstan will remain a key focus for their lobbying efforts.
ôI would say the target is basically the emerging markets within Asia,ö says Siu-chan Kwan, a director and Asia-Pacific sales head for depositary receipts at Citi. ôIt makes sense for them since it is the same time zone and Hong Kong is a regional capital market with a lot of liquidity and a lot of profile.ö
Aside from resources-related players, companies that have been inquiring about HDRs, bankers say, include shipping firms, consumer goods manufacturers and technology companies û the latter perhaps encouraged by the impressive valuation multiple achieved by Alibaba.com when it listed in November last year.
ôNo companies seem to have made any concrete decisions yet, but there is a lot of curiosity about the way the Hong Kong DRs are going to work, the requirements for listing and the potential advantages,ö says Sameer Shah, Asia-Pacific head of global equity services at Deutsche Bank. One advantage, he says, is that Hong Kong will provide access to retail investors, so for issuers who want to expand into the retail investor base HDRs will make ôperfect senseö. ôFor companies in the FMCG [fast moving consumer goods] sector, retail investors tend to be very good brand ambassadors so these companies might want to have a component of their shareholding with individual investors.ö
While details of the proposed HDRs have yet to be finalised, Fok stresses that they will not be introduced to make it easier for companies to list. Rather, all listing candidates will have to go through the same listing procedure whether they plan to list common shares or HDRs. For overseas companies that are already listed in a foreign jurisdiction this means ensuring that the shareholder protection that they adhere to in their home market is at least as good as that in Hong Kong and if it isnÆt, the gap will have to be filled in by adding extra clauses in their constitution documents.
ôWe are not compromising on our regulatory standard. If we do, there will be a potential for what we call æregulatory arbitrageÆ and we donÆt want that to happen,ö Fok says, noting that about 30% of the Hong Kong market is still held by retail investors, who have to be adequately protected.
The fact that the HDRs will be available to retail investors will be a key difference compared with GDRs, which are only sold to institutional investors. HDRs will also trade in Hong Kong dollars. For Hong Kong investors, buying locally listed DRs in a foreign company rather than their overseas-listed common shares means they will receive dividends in Hong Kong dollars and will not have to register share ownership or pay tax in any other jurisdiction. But above all it will provide easy access to markets where it is still quite difficult for foreign investors to open a trading account and buy local shares.
Need for diversification
HKEx has been actively trying to diversify away from its dependency on Chinese companies for some time as it seeks to deal with the fact that more and more mainland companies are choosing û with the encouragement of the authorities û to list in Shanghai. In its 2007-2009 strategic plan, the HKEx says its listing facility ôwill be expanded to include more overseas jurisdictions and will be promoted to selected markets in order to develop an Asian focusö.
Fok isnÆt worried that all the China-related business will migrate across the border any time soon, but argues that as the only exchange in a financial centre like Hong Kong, HKEx has a ôdutyö to build the local market for the long term. And just like the listing of H-shares and red-chips was very slow at the beginning, the development of HDRs will take time. The same was true for the Hong Kong warrant market, an HKEx initiative that was criticised at launch because of the thin interest but is now one of the most active in the world.
ôIÆm not saying that DRs will immediately contribute substantially to our revenue as thatÆs not true, but IÆm sure that Hong Kong, in another 10 to 15 years, will be a much more international exchange,ö says Fok, adding: ôOur strategic plan is very clear, we have to go beyond mainland China, but having said that, mainland China will still be our most important source of listed companies because of the huge size of the economy and because it is still growing very fast.ö
HKEx first announced its intention to establish a DR framework in June 2007 and earlier this year put together a draft of listing rule amendments to accommodate this new instrument. There will be no public consultation since the introduction of DRs will involve no change of policies or standards, but the draft was done in consultation with the four major DR banks û Bank of New York Mellon, Citi, Deutsche Bank and JPMorgan û and has also been shown to various investment banks. A final DR framework is expected to be ready by the third quarter this year. However, there may be no rush: according to bankers, many issuers have put their plans on the backburner as a result of the volatility and negative equity market sentiment that have ruled in the first quarter.
ôWe are expecting to see something happening this year,ö says JPMorganÆs Tse, who believes there could be a stream of DR prospects in Hong Kong once the issuers realise the benefits of this market, including its robust infrastructure and credible regulations. ôThere are some deals under discussion and the number will evolve,ö he says. ôThe efforts of HKEx and its roadshows during the past few years are beginning to pay off with issuers from countries that Hong Kong investors arenÆt used to seeing.ö
This story was originally published in the April issue of FinanceAsia magazine.
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