Question

1. You are a director of finance of a well-known reputable corporation and in recent years the business has experienced tremendous success. During a board meeting the need to expand internationally was debated although the limited avenues to raise equity and debt domestically may jeopardise such expansion ambitions. One of the choices is to try to raise funds internationally and one of the options would be to list the company on the American market. After talks with the advisory service of a global investment bank an issue of American depositary receipts (ADRs) was suggested. Based on the advice given by the investment banker you are asked to brief the board how ADRs work, what levels of issues can you choose, and the limitations imposed by regulation.

Word Count (500 words)              

Answer 1

An American depository receipt (ADR) is a US dollar- denominated security that trades like a common share on US exchanges. They enable foreign companies to raise capital from US investors.

For example, The ordinary shares (common stock) of M/s XYZ, a UK company, trade on the London Stock Exchange. The company’s stock trades on the NASDAQ exchange in the United States in the form of an American Depositary Receipt (ADR). ABC Bank, a financial institution that holds the ordinary shares in custody and issues ADRs of XYZ against the ordinary shares of XYZ held in custody. The ADRs of XYZ are available for US and international investors. The ADRs are quoted in US dollars, and each one is equivalent to 'x' number of ordinary shares. Unusually, the financial institution does not retain the voting rights associated with the shares, and ADR shareholders (Shareholders of XYZ) can instruct ABC Bank on the exercise of voting rights relative to the number of ordinary shares represented by their holding of ADRs.

There are four primary types of ADRs, based on the extent to which a foreign company has access to US Markets. They have different levels of corporate governance and filing requirements.

· A Level I ADR is used when the issuer is not initially seeking to raise capital in the U.S. markets or does not wish to, or can't, list its ADRs on an exchange. A Level I ADR program offers an easy and relatively inexpensive way for an issuer to gauge interest in its securities and begin building a presence in the U.S. securities markets. Level I ADRs are traded in the over-the-counter (OTC) market.

· In a Level II ADR program, the ADRs are listed on the U.S. securities exchange or quoted on Nasdaq, thereby offering higher visibility in the U.S. market, more active trading, and greater liquidity. However, the company cannot raise fresh capital but can develop & broaden US investor base with existing shares. Level II ADR programs must comply with the full registration and reporting requirements of the SEC's Exchange Act.

· Level III, an issuer floats a public offering of ADRs in the U.S. and lists the ADRs on one of the U.S. exchanges or Nasdaq. The benefits of a Level III program are that it allows the issuer to raise capital and leads to much greater visibility in the U.S. market. They are subject to full reporting with the SEC.

· A SEC Rule 144A ADR allows foreign companies to raise capital by privately placing these DRs with qualified institutional investors. They can be traded as private offerings, resales, or trading through automated linkages such as PORTAL. SEC registration is not required unlike other 3 levels.