Unsponsored DRs multiply with newfound ease

It may have been a quiet eight months in terms of new equity issuance, but US investors have had no shortage of new American depositary receipts to buy in recent months, following a rule change that has made it easier for DR banks to set up unsponsored DR programmes.

The data is quite fluid with new programmes being both created and withdrawn, but since early October when the rule change took effect, more than 1,300 unsponsored programmes have been set up by the four DR banks. Since many issuers have been targeted by more than one bank, not all of these have resulted in new choices for investors, but according to data compiled by Bank of New York Mellon, 766 new companies from 47 countries had become available for investors to trade by the end of April. Of the new programmes, 366 are for companies based in Asia-Pacific, primarily Japan and Australia, but Hong Kong/China and Singapore have also got their fair share.

Previously, a foreign company had to apply in writing for an exemption from registering with the US Securities and Exchange Commission under Rule 12g3-2(b) (essentially an exemption from US reporting and from complying with Sarbanes Oxley) before an unlisted ADR programme (also referred to as a Level 1 DR) could be set up, whether it was sponsored or unsponsored. But the rule change in October means that companies are now automatically exempt as long as they meet three basic criteria: They have to be listed on another stock exchange and comply with its reporting requirements; at least 55% of their trading volume must be on exchanges outside the US; and they have to publish on their website -- promptly and in English -- any information that they are required to file with their home exchange.

This has meant that the DR banks can now determine whether an issuer qualifies simply by checking the company's website. No contact with the management is necessary and when it comes to unsponsored ADRs, which are set up by a DR bank without the participation of the company itself, the company doesn't even need to know about it.

Since many foreign companies that previously didn't have a 12g3-2(b) exemption now qualify automatically, the SEC has in one swift move enabled the creation of hundreds of new products for US investors -- which was indeed the main idea behind the rule change in the first place.

"Seeing the activity since October, there was clearly a lot of pent-up demand for some of these issuers, such as blue-chip or household names in Japan and China, and that demand is now being satisfied," said Tom Murphy, transaction manager for depositary receipts at Deutsche Bank in London.

Christopher Kearns, head of depositary receipts for Asia-Pacific at BNY Mellon, noted that it would have been hard to pick a worse time than October last year to launch a lot of new products, but in spite of the market turmoil and the credit crunch he said the bank is pleased with the level of activity in the new programmes. 

"We estimate, based on our own numbers, that more than $1 billion of new investment have gone into the equity of companies around the world through new unsponsored ADRs [since October] and that is money that I think you can fairly safely say wouldn't have existed or come in but for these new programmes. Clearly, at a time like this, that is a fantastic story," he said.

BNY Mellon has been the most active DR bank with regard to this new trend, having set up a total of 668 unsponsored DR programmes, of which 291 are in Asia. Kearns said the bank initially focused on the 200 most wanted companies globally (as per a group of selected US investors) that didn't already have a US listing. It then targeted companies that are part of key indices around the world to enable fund managers to replicate these indices in DR form.

Citi and Deutsche Bank have also been busy tapping into this opportunity. Deutsche has created more than 400 new programmes so far, including more than 250 for Asian issuers, while Citi has set up about 220 new programmes, of which 140 are in Asia. J.P. Morgan has been less active with 30 new unsponsored programmes since October. All four banks say their starting point was to ask US investors and brokers which companies they would like to have access to in DR form and then worked backwards from there to see whether these companies qualified.

Many US funds have mandates that don't allow them to buy stocks listed outside the US, while others simply choose not to because of foreign exchange risks or expensive custody costs. This has created a steady demand for ADRs, which enable US investors to make these investments through a dollar-denominated instrument that trades in the US -- either on an exchange or over the counter.

Mass creation causes concern

Some companies are not all that happy about the latest developments though, and have taken action to stop the DR banks from offering their shares in the form of unsponsored DRs, which in turn has caused concern among some industry participants that this may not be in the best interest of the DR industry in general. One of them is Kenneth Tse, Asia-Pacific head of the depositary receipts group at J.P. Morgan, who noted that "some Level 1 programmes are already giving a bad reputation to ADRs because of a lack of liquidity" and widespread discontent related to unsponsored programmes could do a disservice to the market.