Recent Citibank research on the American Depositary Receipt market provided strong evidence that US investor sentiment towards Asian ADRs, particularly emerging Asia ADRs, is extremely positive. Citibank's David Russell explains some of the reasons for this trend and the benefits that establishing listed ADR programmes could have for Asian corporates.
FA: Do you think there has been a shift in foreign investor sentiment towards emerging Asia ADRs, and if so, why?
In the last year or so we have seen a lot of issuance from the Asian American Depository Receipt (ADR) market, largely targeting US investors. US investment in foreign equities is increasing every year and around 50% of that total is done in the form of ADRs. If you look back to 10 years ago, that number would have been nearer to 20%.
A lot of the activity comes from the blue chip stocks like Taiwan Semiconductor Manufacturing Company (TSMC) which have attracted retail US investors as well as the institutional investor base. The fact that the investor base has got broader means you've got more funds heading from the US towards these markets.
Nonetheless, activity is still fairly limited to the blue chip stocks rather than across the board activity.
Do Asian ADRs offer better value to US investors?
A good way to look at the attractiveness of ADRs to US investors is to split the markets up by the free Asian markets and the restricted markets. To invest in Taiwan or Korea, for example, there are certain processes you have to go through before you can invest directly. For those markets, ADRs are very neat for foreign investors because its a way they can buy exposures into those huge markets without going through the approval process, and for issuers to tap these investors.
For the free Asian markets such as Singapore, foreign investors buy these ADRs for the ease and simplicity of trading in the US. They are also comfortable with the disclosure and transparency required under US Securities and Exchange Commission (SEC) regulations and thus find it easy to compare ADRs with a global peer group.
How do you gauge the success of an ADR?
The success of an ADR is in the trading - whether or not people are interested in buying or selling it. Investors wish to buy liquid stocks, analysts cover liquid stocks and issuers can raise capital through a well-traded stock listing. If you take the Korea Telecom (KT) ADR as an example, KT did its IPO in 1999 and the second tranche was done around June last year so it is a fairly big ADR now. But how does it trade? In the last 30 days, the average has been $32 million per day on the ADR and $34 million on the underlying stock, proving that the ADR has not drained liquidity from the local market and that it is trading very actively in both markets.
ADRs are coming into their own now because you are getting US listed ADRs attracting a certain type of investor, the local stock attracting another type of investor and liquidity moving freely between the two. That is how it has worked for some time with the blue chips in Europe, but it is only in the last couple of years that we've started to see the same thing in Asia, with names like KT, TSMC, United Microelectronics Corporation and SK Telecom. There are about 10 names in this sort of category.
Aside from the obvious capital raising nature of ADRs, are there other ways in which they benefit Asian issuers?
A US listed ADR programme has substantial other benefits to the issuer. First of all it shows that they are transparent in their disclosure and preparing SEC filings under US GAAP. Investors can easily get access to their accounts and it is very straightforward for US investors to buy them. To all intents and purposes they look exactly like a US equity.
For example: A local Korean stock will have its own peculiar quirks to its filings and Korean accounting standards are different to US GAAP - so it's more difficult to compare it cross-border. That can have a knock-on benefit to some of those foreign investors buying underlying stock because they are happier with the filings and this opens up the market for those who buy ADRs but wouldn't normally buy the underlying stock.
Does the same thing happen in the unrestricted markets?
If you look at Chartered Semiconductor in Singapore, the average trading of local stock is $22 million per day while the Nasdaq listed ADR does about $17 million a day. You have got two genuine pools of liquidity flowing between one and the other.
This is the same sort of thing that KT is achieving but some of the reasons are different. Perhaps less of the investors in Chartered's ADR are there because of the restrictions in buying the underlying stock as Singapore is a free market. Investors buy the Chartered ADR because it is viewed as a comparable stock to global semiconductor companies. A US analyst will put the ADR into a pool with 20 other stocks and its attractiveness will be measured against that peer group by investors. And crucially, it hasn't drained liquidity from the local stock - it has actually helped local liquidity.
There are only two listed ADRs from Singapore but I think it's logical to see more companies taking advantage of the success that Chartered has achieved with its US listing.
How long can the upward trends of US investors buying Asian ADRs continue?
The trends have been consistent and I don't see any indication of a tailing off - in fact it is the opposite, especially in North Asia. In the South East Asian markets like Thailand, Indonesia and the Philippines - there are only a handful of listed ADRs, and these stock markets as a regional percentage have reduced in relative importance as investors have focused on North Asia.
This phenomenon has however also led to greater interest in ADRs from South East Asian markets. Foreign investors who may want to look at these countries occasionally as part of a regional portfolio are attracted to the ADR as a simple way to gain exposure without dealing with all the local market trading mechanics. This can be time consuming and complicated - especially if you only wish to buy one or two stocks! It may be that the ADR markets in this part of Asia will develop as Latin America has, where the top blue chips with US-listed ADRs have attracted strong and consistent US investment.
My own view is that many of the blue chip corporates in South East Asia would benefit substantially from a US listed ADR programme. By complying with SEC regulations and US GAAP, foreign investors perception of corporate governance and transparency would increase quite substantially. There have been academic studies conducted as to the actual benefits in terms of stock price ?uplift' effect and lowering cost of capital. As you might expect, these benefits tend to increase in an inverse relationship with the credit rating of the underlying market.
Where do you see the activity coming from?
New York listed ADRs are limited at the moment to the top tier blue chips. Korea and Taiwan are also very active markets for Global Depositary Receipts (GDR). These do not require full registration.
In general though, we feel that if our clients can comply with the requirements to do a listed ADR, then we think there are more benefits to them if they do so.
What about costs?
The cost is higher for an ADR but the benefits are substantially higher because you attract a wider investor base. The main issue is not cost, but generally whether a company wants to comply with US GAAP accounting and there is some additional workload in terms of disclosure. For various reasons, some companies do not want to provide full disclosure at the moment, sometimes because of the substantial differences between local market GAAP and US GAAP.
A further cost is that of servicing US investors in terms of the IR function. The US is a very demanding market and it requires strong commitment from management to service US investors to make a success of the ADR programme.
What about your focus for this year?
One aspect new in the region is the rise in interest in Japan to list ADRs. There are a few in existence already - Sony, Toyota, Hitachi for example - but in the last year there's been a greater desire. This is often not driven by a desire to raise capital, which is unusual, but a desire by corporate Japan to show that they are of true international standing in terms of accounting and corporate governance. There are a number of Japanese issuers that are lining up to do this.
Where will the activity come from in China?
The China landscape is dominated by the mega deals, the privatizations of the likes of Bank of China, which we have been mandated to arrange the ADR for, China Telecom, and China Netcom. These will be HK listed and NY listed.
You are also seeing the emergence of private sector issuers. Up until now the ADRs from China have been privatizations of state-owned entities, but you will start to see some exciting private sector issuers. Foreign investors generally are very keen to get their hands on, or invest in private sector Chinese corporates, which often have that added dynamism.
A lot of what we've seen from China have been issuers where part of the growth comes from restructuring of existing state bureaucracy. As with privatizations everywhere else in the world - there is often room to improve efficiency and costs.
Private sector China companies may be exciting to investors. I think we will see one or two deals this year and I guess what happens thereafter will depend on how the market responds to those deals.
Are there any other exciting trends in the region?
When you look at Taiwan, there are a lot of corporates who have issued through the GDR market that are now considering ADRs, basically because they've seen the success of the ADRs that have been done. TSMC has been a stunning success - it is the fourth biggest ADR worldwide by volume and is in the top 10 by trading value.
Another trend is the way companies have come on in terms of investor relations (IR) in the last couple of years. 10 years ago some of the best Asian corporates may have had one person working part-time, but someone like TSMC will now have an IR function of a standard equivalent to, or better than some US companies. Issuers are starting to see the value of having a high standard of IR. That doesn't just mean that they are quick to send out a copy of the annual report, it means properly thinking about how to target new investors. TSMC will look at who is investing in their peer group worldwide and look at who may hold stock in one company but not TSMC and then target them.
IR advice is something we at Citibank are heavily involved in with our ADR clients. The success of their ADR program often hinges of the success of the IR function. Citigroup's own IR function is we believe very close to 'world best practice'. We practice what we preach and share this knowledge and experience with our ADR clients.
So the market is not saturated with Asian ADRs?
Foreigners want to buy Asian stock and that will continue to be the case. All the ADR does is allow them another channel in which they can invest. It makes it easier for foreign investors to buy into Asia. As more and more of these investors come to realize that diversification of their portfolios is essential, then they'll want to buy into Asian corporates.
This will widen up further the potential market as big as the entire list of blue chip stocks in Asia. I don't see any reason why any of the major blue chip Asian corporate should not do an ADR program.
What's your view on Level 1 ADRs vs. listed level 3 ADRs?
A lot of Asian issuers have got Level 1 ADRs, which are traded over the counter in the US. These are relatively straightforward to set up. You can do this in a matter of weeks; the filings are minimal; you don't need to comply with US GAAP or SEC regulations.
Unfortunately they have not been very successful and it is our policy not to promote Level 1 ADRs unless the issuer has a strategic intent to look at some point at a US listing. To some extent the Level 1 ADRs have tarnished the product in Asia.
Why haven't level 1 ADRs been successful?
There is still a perception in the US that an OTC traded stock is risky. That's fair enough because you do not have a price on a US exchange, you don't have easy access to accounts etc. Even though the underlying issuer could be of a very high credit standing or a giant company, US investors will still see the risks of companies that should be attracting a lot of interest.
This has also created a negative image in some issuers' minds about the merits of ADRs, but a level 1 ADR and a listed ADR are chalk and cheese.
I think it is up to the depositary banks to explain the advantages of doing listed ADRs. Luckily now we have many concrete examples in Asia of successful US-listed ADRs. Level 1 ADRs probably account for 90% of the market in Asia. A lot of the time they're done quickly without much strategic thought and if you took the top five corporates from any country in Asia, I think this type of US-listed ADR could add a lot of value.
