How Can American Depository Receipts (ADRs) be Created? | USA

The following article will guide you about how can american depository receipts (ADRs) be created.

ADR is an instrument similar to GDR and is issued in the capital markets of USA alone. Generally, far more stringent rules and regulations prevail for bringing out an ADR issue.

An American Depository Receipt is a receipt or a certificate issued by a US bank, representing title to a specified number of shares of a non-US-company. The US bank is a depository in this case. ADR is the evidence of ownership of underlying shares. ADRs are freely traded in the USA, without actual delivery of underlying non-US-shares.

ADRs can be created in two ways:

1. Unsponsored ADRs:

One way to create ADR is by an arrangement which is not initiated by the company concerned, but is generally set up by one or more US brokers, when it is observed that a large number of American investors are interested in dealing in the shares of a non-US-company. The brokers then ask a US depository bank to create ADRs.

The depository has to register the ADRs with the Securities and Exchange Commission (SEC), which is the main securities regulator in USA. However, as the ADRs are not initiated by the company concerned, the depository may not be able to fulfill the reporting requirements of the SEC. Therefore, the depository asks exemption from these.

The depository bank receives the compensation or the income from issuance of certificates and from cancellation fees. It also deducts fees from dividend payments. The company, whose shares are linked to this kind of ADRs, is not required to pay any costs to the depository.

The trading of ADRs takes place in some of the stock exchanges in USA such as NASDAQ or NY stock exchange.

2. Sponsored ADRs:

In this case the issuing company actively promotes the company’s ADRs in the USA, choosing a single depository bank, which assumes sole responsibility for administration and dividend payment. In this case, the administrative costs involved in issuing the ADRs are borne by the issuing company. The proceeds of the ADR issue are also received by the company.

The registration of ADRs with SEC (Securities Exchange Commission) is not compulsory. The company needs to submit its annual reports to SEC.

Unregistered ADRs are not eligible for listing on any of the American stock exchanges. However, trading in such ADRs may take place on the NASDAQ’s bulletin board.

If the ADRs are to be registered with SEC, the financial statements of the company need to be prepared in accordance with US Generally Accepted Accounting Principles (US GAAP) and fulfill listing requirements of at least one of the US stock exchanges.

The size of ADR can expand or reduce depending upon demand, as depository banks can issue or withdraw corresponding shares in the local market. Generally, raising forex funds through ADR/GDR route is preferred to external commercial borrowing route. Commercial borrowing adds to the country’s external debt burden, which is not the case with ADR/GDRs.

3. Global Depository Receipts (GDRs):

A GDR is a dollar denominated instrument, tradable on a stock exchange in Europe or private placement in USA, representing one or more shares of the issuing company. The shares are acquired by a bank in Europe, which then issues its own “receipts” or “certificates” to the investors. This bank is called a “depository” and such certificates are called “Global Depository Receipts,” in short, GDRs. These GDRs can be traded on the European exchange.

A holder of a GDR can at any time convert it into the shares that it represents. However, till conversion, the GDRs do not carry any voting rights. The company, which has issued GDRs, has no commitment to pay any amount in foreign exchange, and thus has no exposure in foreign exchange.

As a result, it has no foreign exchange risk. The dividend paid by the company is in local currency. The holder of the GDR has to get the amount converted in US dollars at the prevailing exchange rate. As the GDR represents shares, there is no redemption involved. The company doesn’t have to make any payment either in foreign exchange or in local currency for the repayment of GDRs.

This arrangement thus, works to the advantage of the company has also is convenient for the holder of the GDRs, as it can be traded on a foreign stock exchange where they are listed. Alternatively, the holder can convert the GDR into its underlying shares, sell these on the local stock exchange, and then convert the proceeds into US dollars at the prevailing exchange rate.

The main features of GDRs are as under:

1. GDR has a distinct identity from the underlying shares.

2. GDRs do not appear in the books of the issuing company. However, the underlying shares appear in its books.

3. The issuing company collects the GDR proceeds in foreign currency. It may then use these proceeds for meeting the foreign exchange component of its project cost, repayment of foreign loans, or for its domestic expenditure.

4. A GDR holder has the option to convert the GDR and hold the underlying equity shares.

5. GDRs are normally listed on Luxembourg exchange and traded at two other places besides the place of listing-OTC market in London and private placement market in USA.

6. GDR does not entitle the holder any voting rights. However, the holder gets the voting rights, when he prefers to convert GDRs into underlying shares.

7. GDR is an instrument governed by international law.

8. Pricing of GDR would generally be in line with the pricing of underlying shares. However, based on international market conditions and perceptions about domestic currency, the GDR may be at discount or at premium compared to domestic share prices.

9. The GDR market is a global one. It is therefore exposed to international influences, like prices of other securities in the financial market or interest rates in the US market. Currency markets also have impact on GDR prices.

4. Foreign Currency Convertible Bands (FCCB):

Foreign currency bonds market is an important source of raising funds. The issuers, at times issue convertible bonds, which are equity related, and are convertible in part or full, into equity of the issuing company at a later date, say a few years from the date of issue. It can be said that the bonds have warrants attached to it, which entitles the holder to get equity shares in the company, say at an agreed price, or ratio.

FCCBs, in similar nature, are fully or partly convertible bonds, which give right to the holder to convert the amount into equity shares, at a pre-agreed price. Here, keeping in view the right being given for acquiring equity, the interest rate is very fine, as compared to a pure debt bond.

FCCBs also have optional conversion into shares, at the option of the bond holder.

The bondholder would exercise the right to convert the bond into shares, when the market price of the equity shares, is higher than the exercise price, otherwise, the bondholder would like to get back the money from the issuer.

Indian companies are allowed to issue FCCBs, in terms of RBI guidelines.