adr issue study icra.pdf

8/9/2019 ADR ISSUE STUDY ICRA.pdf

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I C R A B U L L E T I N

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A Study of International Listingby Firms of Indian Origin

SUDIPA MAJUMDAR*

AbstractA growing number of companies from emerging economies are cross-

listing their shares on international exchanges in their effort to access thedeveloped stock markets. This paper tries to look into the inter-sectoral andinter-temporal characteristics in prices of such stocks of Indian origin that arebeing dually traded on the American and Indian stock exchanges. The trendup to August 2006 shows the existence of positive premia levels of theAmerican Depository Receipts (ADRs) over the underlying domestic securities.In an effort to realign ADR prices and bring down premia levels, the ReserveBank of India introduced two-way fungibility in February 2002. However,ADR premia levels continued to increase during the period 2002 to 2004,with a decline only from 2005this downward trend seems to be unrelated tothe fungibility criterion since the two-way conversion did not open uparbitrage opportunities. We find that legislative changes in India had animpact on decisions of Indian companies to go in for international listings.However, once listed, the trading in ADRs by foreign investors was guided bymovements in the US stock market rather than capital market activities inIndia. We do not find any increases in domestic stock prices across firms aftertheir foreign listings, but the domestic stocks show an increase in tradingvolumes (liquidity gains) after their international listings.

I. IntroductionCompanies around the world, especially those in the develop-

ing nations, are increasingly tapping international equity markets, inan effort to enhance their global presence and to raise capital beyondthe borders of their home market. At the same time, investors aroundthe world are also looking beyond their national borders to takeadvantage of new opportunities for raising the risk-adjusted return onfunds through geographic diversification of their portfolios. This hasbeen a key factor for the success of Depository Receipts.

JPMorgan introduced the first American Depository Receipt(ADR) in 1927 to allow Americans invest in the British retailerSelfridges. Since then, the ADR market has evolved in sophistication

This paper tries to

look into the inter-

sectoral and inter-

temporal

characteristics in

prices of stocks of

Indian origin thatare being dually

traded on the

American and Indian

stock exchanges.

* Sudipa Majumdar is with the Monetary Research Project, ICRALimited.


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the trend in ADR premia levels during the 2001 to 2006 time period tostudy the effects, if any, of the introduction of re-conversion of ADRs inearly 2002. Moreover, we have also tried to explore the possible gainsin stock prices and in trading volumes, after the international listings of domestic stocks.

The structure of this paper is as follows. Section II gives theoverall background of the Depository Receipts market and the reasonsbehind the success of Depository Receipts around the globe, in terms of the benefits that accrue to the listing companies as well as the foreigninvestors. Section III provides a detailed background of the Indianexperience in the international stock markets. Section IV analyses themovements of stock prices and premia levels in the American and theIndian markets, and seeks to explain the trends in premia levels of Indian ADRs. This section also examines if the Indian companiesexperienced any significant increase in their domestic stock prices ortheir domestic trading volumes following their foreign listings. SectionV gives the summary of conclusions along with some directions of future research.

II. The Background(A) What are Depository Receipts?Depository receipts are negotiable certificates that represent

ownership of shares in companies of other countries. ADRs are typi-cally traded on US stock exchanges such as NYSE or NASDAQ.Depository receipts that are traded on stock exchanges at other parts of the globe are called Global Depository Receipts (GDRs); these arecommonly listed on European stock exchanges such as the Luxem-bourg/London Stock Exchanges or on Asian stock exchanges such as theDubai/Singapore Stock Exchanges. Both ADRs and GDRs are usuallydenominated in US dollars. 6 A depository receipt is created when acompany wishes to list its shares on a foreign stock exchange, afterfulfilling the requirements put forth by the foreign stock exchange aswell as the national Government and the domestic Central Bank. 7 Theregulatory procedure for issuing Depository Receipts has been ex-plained in Box 1 .

Once the Depository Receipt has been created, the tradingtakes place through the usual buying and selling transactions on theAmerican stock exchange. The procedures of intra-market and cross-border transactions have been depicted in Appendix 2 . An exposition of the background of depository receipts leads us to the question why acompany would opt for listing itself in a foreign market when it canraise capital in its own domestic market.

6 GDRs can also be denominated in Euros.7 The various types of Depository Receipts have been explained in

Appendix 1.

A depository receipt

is created when a

company wishes to

list its shares on a

foreign stock

exchange, after

fulfilling the

requirements put

forth by the foreign

stock exchange as

well as the national

Government and the

domestic Central

Bank.


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(B) Why Depository Receipts?Benefits of the Listing CompanyCompanies across the world are increasingly tapping interna-

tional markets and depository receipts have emerged as a favouredmethod of companies in developing countries to access internationalstock markets. Today the ADR is an instrument used widely by non-UScompanies to trade their shares conveniently and efficiently in the USequity markets.

During the 1990s, several studies sought to understand the netbenefits of the corporate decision to list shares on overseas exchanges.The decision to list shares abroad is expected to reduce the companyscost of raising capital by diversifying its exposure to different marketrisks and by reducing illiquidity of trading in its shares. These studiesemphasised the importance of the benefits of a lower cost of capital, anexpanded global shareholder base, greater liquidity 8 in the trading of

8 Liquidity refers to the volume of securities which can be bought/sold atone time without significantly affecting its price and the amount of time needed to

BOX 1: Regulatory Procedure for Issuing Depository Receipts

Step 1: Appointment of a financial adviser to manage the process, along with adepository bank* in the host market and a custodian bank in the country of the issuer.The adviser sets the number of shares to be represented by one depository receipt,known as the depository receipt ratio the ratio is set so that the price of a depositoryreceipt is comparable to that of similar securities in international markets.

Step 2: An American broker** purchases domestic shares from the Indian marketand delivers them to the local custodian bank of the depository banksay Bank ofNew York.

Step 3: The local Indian custodian bank verifies the delivery of the shares by inform-ing the Bank of New York that the shares can now be issued in the United States andthe Bank of New York delivers the ADRs to the broker who initially purchased them.Based on the determined ADR ratio, each ADR is issued as representing one or moreof the Indian local shares and the company determines the number of shares to besold in the international market and delivers the shares to the custodian bank.

Step 4: The custodian registers these shares in the name of the depository bank,which issues the appropriate number of depository receipts. These ADRs representthe local Indian shares held by the depository, and can be traded on the NYSE, likeother US securities. The holder of the depository receipt holds privileges like thosegranted to shareholders of ordinary shares, such as voting rights and cash divi-dends.#

* For an explanation of the role of the Depository Bank in the ADRmarket, see Appendix 3.

** Through an international office or a local brokerage house in India.# The rights of the ADR holder are stated on the ADR certificate.

Firms in emerging

nations seek to take

advantage of the

depth of the markets

in developed

countries and enter

the foreign capital

markets for raising

new capital. In

nations that have

high investment

barriers, the higher

price for market risk

would translate into

a higher cost ofcapital.


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shares, direct listing costs etc. Firms in emerging nations seek to takeadvantage of the depth of the markets in developed countries and enterthe foreign capital markets for raising new capital. In nations that havehigh investment barriers, the higher price for market risk wouldtranslate into a higher cost of capital. So, companies in less developedcountries have strong incentives to access capital markets of moredeveloped countries by dually listing their shares on those stock ex-changes to take advantage of the lower cost of capital.

In a focused study of cost-benefit trade-off, Mittoo (1992)obtained responses from 78 CEOs of Canadian firms that were listed onstock exchanges in the US/UK. She found that the reasons for managersto list their equities abroad included looking for increased ability toraise equity; growth of the shareholder base; increased visibility of thecompany; and the expected increase in trading liquidity. In fact, in hersurvey, the managers cited the increase in liquidity of underlying sharesto be a primary motivation for cross-listing on US exchanges.

In an early study, Choi and Stonehill (1982) found that, among Japanese and Korean firms, enhanced international corporate prestigeand visibility was the most common reason for an interest in listing ona foreign exchange. Sarkissan and Schill (2004) concluded that firmstend to target overseas listing in markets that are larger, highly capital-ised and have a more liberal tax environment. Miller (1999) docu-mented significantly large abnormal returns for issuers that listed ADRson major US exchanges. There is also a strand of literature that looksinto the value of firms following foreign listing. Some studies lookedinto the effect of liquidity on asset priceshigher liquidity results inlower transaction costs and lower cost of capital. Errunza and Losq(1985) showed how firms from emerging nations are able to reducetheir cost of capital and increase firm value by issuing equity onforeign markets. Another source of value for a foreign listing is basedon models of information asymmetry whereby firms seek to conveyinformation about their quality to the market. High-quality firms frommarkets with low disclosure standards gain by listing in markets thathave high disclosure requirementsforeign listing is a signal of higherquality, which then improves firm valuation. Jithendranathan et al(2000) listed out the possible reasons for cross-listing as availability of capital in large capital markets, lower costs of capital, enhancedliquidity and cost efficiency.

Investors Viewpoint Investors around the world are increasingly looking across

their national borders in an effort to geographically diversify theirportfolios by investing in international securities. Foreign investors buyshares of Indian companies in their effort to diversify their portfolio and

High-quality firms

from markets with

low disclosure

standards gain by

listing in markets

that have high

disclosure

requirements

foreign listing is a

signal of higher

quality, which then

improves firm

valuation.

complete a desired transaction. Therefore, asset liquidity reflects two dimensions of adesired transaction, namely speed (transaction time) and price (transaction cost).


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hence lower the risks in the equity market. A foreign investor may doso either through direct investment in the equity market of the emergingnation or through access to depository receipts of the firms on their ownstock exchange. Foreign investors find it very difficult to invest directlyinto equity markets of emerging nations like India. First of all, legaland institutional restrictions make it difficult for small and mediumforeign investors to invest directly in the Indian stock market. Theinvestor has to be a foreign institutional investor (FII) registered withthe SEBI in order to directly participate in the Indian equity market.Secondly, the foreign investors are also concerned about the poorregulatory mechanism and low liquidity of the market in emergingnations. Thirdly, direct investments in the equity market involvebrokerages and custody fees which are avoided in the case of deposi-tory receipts since the depository banks like Bank of New York arrangefor these services directly.

While the mechanics of cross-border investment flows are oftencomplex, ADRs offer a convenient avenue for adding global exposureto US portfolios. Through depository receipts, the foreign investors gainbenefits of diversification while trading in their market under their ownsettlement and clearance conditions. Given the legal and institutionalrequirements and restrictions, it is more convenient for small/mediumsize foreign investors and foreign individuals to invest in Indian deposi-tory receipts rather than in the Indian stock market. 9

The Developing CountriesIn reaction to the severe impacts of the financial crises in

different parts of the globe, the developing countries have severalconcerns about growing international integration and have placedstringent measures on activities of foreign investors. In particular, thereis a fear that foreign investors add volatility in asset prices in emergingmarkets through herding behaviour or contagion effects. 10 Therefore,for a developing country like India, it is more rational to allow andencourage domestic companies to issue depository receipts in foreigncountries rather than favour foreign investors to gain direct access tothe domestic equity market.

III. Foreign Listing by Indian CompaniesIndian companies began their foreign listings in the early 1990s

by issuing Depository Receipts. The Indian Government issued the

9 Hansda, S.K. and P. Ray, 2003. Stock Market Integration and DuallyListed Stocks: Indian ADR and Domestic Stock Prices, Economic and Political Weekly, Vol. XXXVIII, No. 8, pp. 743.

10 Herding refers to the phenomenon when investors follow each other ininvestment decisions, irrespective of whether the decision is warranted by changes ineconomic fundamentals. Contagion occurs when events in one emerging marketchange investors behaviour in other emerging markets, regardless of whether theeconomic fundamentals of the latter have been affected or not.

For a developing

country like India, it

is more rational to

allow and

encourage domestic

companies to issue

depository receipts

in foreign countries

rather than favour

foreign investors to

gain direct access to

the domestic equity

market.


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Foreign Currency Convertible Bonds and Ordinary Shares (ThroughDepository Receipt Mechanism) Scheme (1993), facilitating foreignlisting by Indian companies. It was stipulated that a company, desirousof raising funds through foreign listing, obtain prior permission of theDepartment of Economic Affairs, Ministry of Finance, Government of India. An issuing company seeking such permission was required tohave a consistent track record of good performance for a minimumperiod of three years. The ordinary shares issued against the GlobalDepository Receipts were to be treated as direct foreign investment inthe issuing company 11it was stipulated that the aggregate of theforeign investment made either directly or indirectly should not exceed51% of the issued and subscribed capital of the issuing company.

Indian companies began to issue ADRs since 1992 12 withReliance and Grasim Industries accessing the foreign equity market. Asubstantial volume of GDR/ADR issuance took place in the next coupleof years, till 1995 when large Indian companies like Bombay Dyeing,Arvind Mills, CESC, Finolex Cables, India Hotels, L&T, VideoconInternational, Crompton Greaves, Great Eastern Shipping, etc. beganforeign listings mainly through private placements. Foreign inflowsthrough depository receipts went up from US$240 million in 1992-93 toreach US$2,082 in 1994-95.

With Indian firms looking for their capital needs outside thedomestic country, the Indian government began to usher in widespreadreforms by opening up opportunities within the domestic stock market.A major improvement in the Indian stock market came in 1995 whenthe new electronic National Stock Exchange began operations wherebya new clearing corporation and a new depository were in place. Thisgenerated renewed interest and increased trading volumes in the Indianstock market in 1995-96, and consequently, we find a dip in the amountraised through depository receipts.

Moving ahead from the domestic stock exchange, the Govern-ment of India took another major step to permit financial servicescompanies like banks, non-bank finance companies and financialinstitutions, to access the foreign stock markets, which saw anotherround of new foreign listings. 1996-97 witnessed the foreign listing of State Bank of India (bank) and ICICI (finance), through private place-ments. The amounts raised by these two companies amounted toUS$600 million in 1996-97. As a further step, the mandatory three-yeargood performance track record was relaxed for financing investments ininfrastructure sectors, such as power generation, telecom, petroleumexploration and refining, ports, airports and roads, which encouragedforeign listings by BSES Ltd. (power), VSNL (telecom) and MTNL

11 For a detail on classification of Depository Receipts as FDI, seeAppendix 4 .

12 For a detailed exposition of the policy measures adopted by theGovernment from time to time, see Appendix 6 .

Indian companies

began to issue

ADRs since 1992

with Reliance and

Grasim Industries

accessing the

foreign equity

market. A

substantial volume

of GDR/ADR

issuance took place

in the next couple of

years.


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(telecom) in 1996 and 1997. In 1997-98 and 1998-99, the changingpolitical and economic conditions in India and in Asia brought downthe number of new issues in the foreign stock markets. Thus, 1997-98recorded the entry of only MTNL into the GDR market while 1998-99was marked by the issue of Infosys stocks as the first exchange tradedADR from India. Since 1999-00, the Ministry of Finance continued toliberalise the procedures and environment for the Indian corporatesector for acquiring capital from domestic and foreign sources, whichhas been reflected in the growing market for ADRs/GDRs. 2001-02 sawa dip in GDR issues, which was reflective of the global slowdown indeveloped markets, including the US, owing to a recession setting in theUS and the war in Iraq. By 2003, the overseas market began to look upafter the efforts to revive the US economy, and ADR/GDR issues byIndian companies also began to rise.

The process of global financial integration received a majorimpetus when two-way fungibility for Indian GDR/ADRs was intro-duced in 2002, whereby converted local shares could be reconvertedinto GDR/ADR subject to sectoral caps. Earlier, under the one-wayfungibility, once a company issued ADR/GDR, the holder could convertthe ADR/GDR into shares of the Indian Company, but it was notpossible to reconvert the equity shares into ADR/GDR. No re-issuanceof Depository receipts was permittedinvestors could only cancel thedepository receipts and avail of the underlying shares or take back theproceeds by selling the underlying shares. Hence over a period of time,the outstanding balance of depository receipts would decline, therebyreducing the liquidity of depository receipts for the internationalinvestors.

The two-way fungibility guidelines of the RBI issued in Febru-ary 2002 enabled a non-resident investor to purchase local shares of anIndian company through an Indian stock broker and convert them intoADRs that were eligible to be traded on the American stock exchange. 13

However, the equity shares in India could be converted to ADRs only tothe extent of cancellation and conversion of ADRs in that company intoshares, known as the headroom. 14 The RBI guidelines stated that thetransactions will be demand-driven and would not require companyinvolvement or fresh permissions. All SEBI registered brokers would actas intermediaries in the two-way fungibility of ADRs.

The sudden skyrocketing of depository receipts in 2005-06came with the Monetary Policy of 2005-06 as there was a majorrevision to the guidelines on ADRs/GDRs for unlisted companies.

13 The concept and procedure of one-way and two-way fungibility hasbeen elaborated in Box 2.

14 Headroom= number of ADRs cancelled and converted into underlyingIndian equity shares.

= maximum number of ADRs that can be re-issued ondemand from foreign investors.

The process of

global financial

integration received

a major impetus

when two-way

fungibility for Indian

GDR/ADRs was

introduced in 2002,

whereby converted

local shares could

be reconverted into

GDR/ADR subject to

sectoral caps.


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BOX 2: One-way and Two-way Fungibility

In an efficient market, two assets with identical attributes must sell for the same price.On similar grounds, an identical asset trading in two different markets should alsotrade at the same price. If the prices differ, a profitable opportunity arises to sell theasset where it is overpriced and buy it back where it is under-priced. This gives riseto arbitrage opportunities. Countries like Germany and the UK do not have anybarrier to international flow of capital and ADRs can flow freely back and forthbetween the US market and the home market. For example, in Germany, an ADRholder can sell his ADR either in the ADR market or cancel the ADR and sell theunderlying share in the domestic market, depending on the prices prevailing in thetwo markets. When prices are higher in the German market, ADRs will be cancelledand underlying shares sold in the German market, thus decreasing the number ofADRs outstanding and increasing the number of shares traded in the German market.When prices are higher in the ADR market, new ADRs will be issued to benefit fromthe higher price thus increasing the number of ADRs outstanding and decreasing thenumber of shares traded in the German market. This is the basic concept and opera-

tion of a two-way ADR programme where there is unrestricted flow between the ADRmarket and underlying shares in the domestic market. Therefore, arbitrage activitiesare expected to keep the prices in the two markets from diverging by more thanarbitrage transaction costs.

There are restrictive ADR programmes where the number of ADRs from the initialoverseas offering poses a limit. So, ADRs can be cancelled and reissued, but only upto the initial offering size. Limited two-way programmes are found in the Korean,Taiwanese and Indian firms. Finally, the one-way programmes are the most restric-tive, where ADRs that are issued may be cancelled over time but subsequent re-issuance is not permitted.

India started their ADR programmes as one-way programmes and converted tolimited two-way programmes in 2002, whereby the re-issuance of ADRs once can-celled is restricted by the initial offering size. Subsequent sale of ADRs is not subjectto Indian capital gains taxes, but the dividends are taxed. Moreover, the depositorybank incurs foreign exchange transaction costs in conversions.

In India, with limited two-way fungibility, a foreign investor is now permitted to placean order with an Indian stock broker to buy local shares, with an intention to convertthem into depository receipts. The stock broker has to apply to the domestic custo-dian bank for verification and approval of the order. Once the approval is granted, thebroker purchases local shares on the Indian stock market and delivers the shares tothe domestic custodian for further credit to the overseas depository. The overseasdepository issues proportional Depository Receipts to the foreign investor. Thisconversion of the domestic share into ADR is subject to the extent of the originalissue of the ADRs. Consequently, the foreign investor can engage in secondarymarket trading on the American stock exchange or cancel the ADR.


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The focus of this study is to observe the price trend of eachdually listed stockwe, therefore, considered the time trend of fiveyears for each company after their foreign listing. Therefore, only thosefirms that were listed before December 2001 have been considered forthis analysis. Although this ideally refers to 10 Indian firms (refer toTable 1), our analysis has been restricted to eight companies, as wehave excluded Silverline Technologies and Rediff.com. Silverline islisted domestically but has not been traded on the National StockExchange since April 2003 and Rediff.com is not listed on any of thedomestic stock exchanges. Therefore, these two issues were not strictlycomparable to the others and were not included in the sample.

The ADR prices in US dollar terms were converted into IndianRupees by adjusting for the exchange rate for each particular day of trade. The ADR ratio of each stock was considered to estimate theequivalent, comparable ADR price. The equivalent prices were thencompared with the price of the underlying stock on the National StockExchange (NSE) .18 The closing price of ADR as well as the closingprice on the NSE for each day was taken for all calculations. In orderto find out the relationship between the prices of the dually listed

18 ADR prices were downloaded from http://finance.yahoo.com and NSEprices from www.nseindia.com

While Indian

companies have

issued ADRs since

the early 1990s,

most of these earlier

issues were

privately placed.

Exchange-traded

ADRs of Indian

origin have been a

relatively recent

phenomenon, being

issued during or

after 1999.

TABLE 1ADR issues by Indian Companies

Company Industry Issue Stock ADRExchange Ratio

1 Infosys Software March 1999 Nasdaq 2:1(1:1 from

July04)2 ICICI Bank Finance March 2000 NYSE 1:23 Silverline Software June 2000 NYSE 1:24 Rediff.com Software June 2000 Nasdaq 2:15 VSNL Telecom August 2000 NYSE 1:26 Wipro Software October 2000 NYSE 1:17 Dr Reddys Healthcare April 2001 NYSE 1:18 Satyam Software May 2001 NYSE 1:29 HDFC Bank Finance July 2001 NYSE 1:3

10 MTNL Telecom September 2001 NYSE 1:211 Tata Motors Engineering September 2004 NYSE 1:1

12 Patni Computers Software December 2005 NYSE 1:213 WNS Holdings Support Services July 2006 NYSE 1:1

Note : ADR Ratio, known as the depository receipt ratio, denotes the numberof shares to be represented by one depository receipt. The ratio is set sothat the price of a depository receipt is comparable to that of similarsecurities in international markets.

Source: Company Websites, Bank of New York (www.adrbny.com).


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stocks, the ADR equivalent prices of each stock to the closing prices of the same underlying securities on the National Stock Exchange werecompared. The price data for each of the eight companies which werelisted dually on NASDAQ or NYSE as well as NSE were considered.The price data are from 1 st January 2001 for those companies that werelisted on American stock exchange before that date. For those compa-nies that got their foreign listing after 1 st January 2001 (but during2001), the prices have been taken from the first day of the foreigntrading on the American stock exchange. The cut-off date for ouranalysis is 31 st August 2006.

As a first step, the scatter of the ADR equivalent prices and theNSE closing prices of the same stocks were plotted for each of the eightcompanies that have been taken in this sample (see Graph 1). Thescatter clearly showed a strong positive correlation between the pricesof the dually listed Indian stocks. 19

In order to find out the magnitude of the relationship, thecorrelation coefficient between the ADR price and the NSE price wascalculated for each stock (See Table 2). The correlation coefficient wasfound to be very high, around 0.9, for the ADR price and the corre-sponding domestic share price. The sectoral break-up revealed that thesynchronisation between the foreign and the domestic market wasstrongest for the finance companies that were considered for analysis,namely ICICI Bank and HDFC Bank. 20 All the other companies, withthe exception of Infosys and MTNL, showed correlation coefficients of more than 0.96.

19 Hansda and Ray (2003) found that the high correlation coefficientbetween domestic stock exchange (Bombay/National Stock Exchange) and theforeign stock exchange (Nasdaq/NYSE) remains unaltered irrespective of whetherone considers contemporaneous data or one day lagged data; also with variouscombinations of closing or opening prices.

20 Hansda and Ray (2003) found a low correlation for the foreign anddomestic share prices of HDFC Bank and VSNL, considering the price data for theperiod from the listing of each stock up to February 2002.

TABLE 2Correlation Coefficient between ADR Closing Price and NSE Closing Price

Sector ADR Stock Correlation Coefficient

IT Wipro 0.961Satyam Computers 0.965Infosys 0.922

Finance ICICI Bank 0.993HDFC Bank 0.990

Others MTNL 0.872VSNL 0.997Dr Reddys Laboratories 0.977

The scatter of the

ADR equivalent

prices and the NSE

closing prices of the

same stocks were

plotted for each of

the eight companies

that have been taken

in this sample. The

scatter clearly

showed a strong

positive correlation

between the prices

of the dually listed

Indian stocks.


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A closer look at the scatter diagram in Graph 1 showed thatthe majority of the points on the scatter are to the right of the 45 degreeline. Each scatter point to the right of the 45 degree line indicates thatthe equivalent ADR price for that trading day was higher than theprevailing price of the same stock on the domestic NSE. This throwslight on the existence of premia in the ADR markets over the domesticprices.

A detailed exposition of the premia levels has been carried outin the next section.

Each scatter point to

the right of the 45

degree line indicates

that the equivalent

ADR price for that

trading day was

higher than the

prevailing price of

the same stock on

the domestic NSE.

GRAPH 1Scatter of ADR Equivalent Prices and NSE Closing Prices

. . . continued on following page


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B. ADR Premia Levels over the Underlying Domestic Stock PricesThe prices of the same stock in two markets are expected not to

differ widely when there are arbitrage possibilities, whereby investorswould simultaneously purchase and sell equivalent securities in twodifferent markets in order to profit from discrepancies in their pricerelationship. Although ADRs are a derivative of the underlying equity,there exists a significant difference in the ADR prices compared withthe price of underlying equitythis is known as the ADR premium.Arbitrage opportunities help to diminish the discrepancies in prices,reducing the premium levels.

Depository Receipts are expected to trade within transactioncost bands of the currency-adjusted price of equivalent domestic shares.Gagnon and Karolyi (2004), in a study of almost 600 pairs of cross-listed shares from 39 countries, found the prices of depository receiptsto be within a 15-20 per cent (+/-) band of the equivalent home-marketshare prices. However, there were some glaring exceptions to thisowing to a wide range of institutional/market frictions such as regula-tory restrictions, currency controls, foreign ownership limits andrestrictions on convertibility that existed in certain countries. One suchexception was India.

The Indian government had restrictions on the conversion andre-conversion of ADRstill 2002, India followed the one-way ADRprogrammes, where ADRs once issued could be cancelled and con-verted into the underlying Indian shares (after a delay of 45 days fromthe closing date of the issue) but subsequent re-issuance of ADRs wasnot permitted and this posed restrictions on arbitrage opportunities. So,even when identical stocks in the domestic market and ADRs traded atdifferent prices, the prevailing trading restrictions resulted in highpremia in the ADR market 21the higher ADR prices have been ex-plained by higher liquidity in the US stock market and the associatedcosts for transactions.

Jithendranathan et al (2000) explained that in India, localinvestors are allowed to hold only the securities that are listed on theIndian stock exchanges while US investors may hold Indian securitieslisted on the American stock exchanges as well as purchase othersecurities listed in other foreign stock markets. Therefore the valuationfor the same stock was different for a foreign investor and a domesticinvestor. With such market segmentation, US investors priced the ADRsdifferently from the underlying securities, leading to the price differen-tials for the same securities. Similar market segmentation models weretested by Hietala (1989) for the ADRs issued in Finlandhe concludedthat since the foreign and domestic investors were choosing the same

21 As has been seen by Hansda and Ray (2003) and Chakrabarti (2003).

Although ADRs are

a derivative of the

underlying equity,

there exists a

significant

difference in the

ADR prices

compared with the

price of underlying

equitythis is

known as the ADR

premium.


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securities from a different choice set, 22 this may lead to a different riskestimate and the price of a security may differ from the adjustedequivalent price of the depository receipt of the same stock.

Differences in trading hours cause a lead-lag relationship ininformation transmission between the ADR and the local markets.There is a distinct difference in the timings of trade in the two stockmarketsin India trading starts at 10am and ends at 4pm while thetrading session in US spans from IST 8pm to IST 2:30am the followingday. So, trading in the Indian market is over before trading commencesin the US market on the same day, which can give rise to differences inADR prices and the Indian prices for the same stock.

In 2002, the Reserve Bank of India issued detailed operatingguidelines for implementing two-way fungibility in Indian ADRs. Arestrictive form of two-way ADR programmes was introduced wherebyADRs were allowed to be cancelled and reissued, but only up to theinitial offering size. Two-way fungibility was expected to open uppossibilities of arbitrage so that the market forces would trigger arealignment of prices and minimise the divergent premium levelsprevailing between ADR/GDR prices and the domestic stock prices.

In an attempt to find out whether any such realignment of theprices has occurred after the two-way-fungibility this study has tracedthe ADR premia of the companies in the sample from the date of theirforeign listing. After estimating the equivalent, comparable ADRprices, as has been already explained, these prices were then comparedwith the price of the underlying stock on the National Stock Exchange(NSE)23 in order to calculate the ADR premium for each day. The dailypremia figures were used to compute the various averages, as havebeen detailed in Table 3.

ADRs of Indian companies enjoyed considerable premium overtheir underlying stocks, indicating effective market segmentationbetween the US and Indian markets. Chakrabarty (2003) noted thisphenomenon for his data set covering the time period March 1999 to

January 2003. Hansda and Ray (2003) also found high premia levelsfor their sample spanning March 1999 to February 2002. We havetaken the same sample of companies, but the time span for the presentstudy has been stretched to cover the time period up to August 2006 inan effort to explore the effect of two-way fungibility of ADRs sinceFebruary 2002 which was expected to bring down premia levelsaphenomenon that has not been explored yet.

The inter-sectoral average premia levels indicate that theInformation Technology (IT) companies have enjoyed the highest

22 Set A has all domestic securities available to domestic investors; Set Bhas all depository receipts of securities in Set A available to foreign investors; Set Ccomprises all other global stocks available to foreign investors.

23 ADR prices were downloaded from http://finance.yahoo.com and NSEprices from www.nseindia.com

Two-way fungibility

was expected to

open up

possibilities of

arbitrage so that

the market forces

would trigger a

realignment of

prices and minimise

premium levels

prevailing between

ADR/GDR prices

and the domestic

stock prices.


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premia levels (an average of 28%). Infosys has been the clear winner,reaching its peak of more than 60% premium level in 2002. 24 Satyamand Wipro started with low premium levels, and enjoyed a positivetrend up to 2004. After the introduction of two-way fungibility inFebruary 2002, the premia levels of Wipro and Satyam continued torise for another two years, with premia levels going beyond 40% in2004, which was in contrast to the expectations. The decline in premiafor Wipro and Satyam is evident in 2005 and 2006. The Otherscategory comprises telecom (MTNL and VSNL) and the healthcare (DrReddys Laboratories) sectors. This category registered the lowestaverage premia levels, registering a sectoral average of 3.5% over the2001-06 period. MTNL showed some spurt in premia in 2004 and2005; otherwise, the average annual premium of the companies hasbeen negligible. The finance companies enjoyed modest averagepremium of ADR prices over the domestic stock prices during thisperiod and the ADR premia levels within the financial sector continuedto increase after the introduction of the two-way conversion of ADRssimilar to the IT sector companies. ICICI Bank experienced a declinetheir ADR premia from 2004 while the ADR premia of HDFC Bankstarted coming down from 2005, much after the introduction of the two-way fungibility.

Two-way fungibility was introduced with the expectation thatthe resulting arbitrage opportunity would help to converge the ADRprices and the domestic prices of the same shares trading in the twocountries. However, despite the two-way fungibility, the conversion andre-conversion of ADRs into the underlying security involves timethetime period involved between a US investor buying an ADR on the

TABLE 3ADR Premia (in %)

ADR Stock 2001 2002 2003 2004 2005 2006 Average Sector(up to Aug) Average

Wipro 2.2 3.1 11.6 42.2 31.1 18.5 18.1 ITSatyam 15.5 9.5 23.9 44.9 21.3 10.5 20.9 27.8

Infosys 57.4 61.4 49.7 48.5 36.3 13.5 44.5ICICI Bank 2.7 13.2 16.0 14.9 11.4 9.3 11.2 FinanceHDFC Bank 5.4 7.5 13.8 20.6 11.6 6.6 10.9 11.1

MTNL 5.66 1.1 0.4 21.1 15.5 2.7 7.7 OthersVSNL -0.65 0.01 0.14 0.46 -0.67 0.36 -0.06 3.5Dr Reddys Labs 6.7 1.5 0.7 3.2 1.5 2.56 2.7

Note : Premia levels were calculated as the percentage excess of price of theADR over the price of the underlying stock in the Indian market, afteradjusting the ADR prices for exchange rate and the ADR ratio.

24 Average premium level of Infosys had reached more than 100% in 2000.

The inter-sectoral

average premia

levels indicate that

IT companies have

enjoyed the highest

premia levels (an

average of 28%).

Infosys has been the

clear winner,

reaching its peak of

more than 60%

premium level in

2002.


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NYSE and then selling it on the Indian National Stock Exchange wouldbe approximately 45 days 25 from the date of his cancellation of theADR. More importantly, the limited form of two-way fungibilityimplied that Indian equity cannot be converted into ADR unless ADRshave been cancelled (that is, headroom is available) and the re-issuanceis limited to the extent of cancellation for that particular stock.

With the Indian ADRs trading at premium levels, foreigninvestors holding ADRs do not have any incentive to cancel them andconvert into Indian equities, implying the absence of headroom for thestocks. On the other hand, when the price of ADR is higher, foreigninvestors would want to purchase shares in India and sell them in theUS marketin the absence of headroom, such re-conversion of Indianequities into ADR is not possible. The resulting absence of arbitrageopportunity explains the persistence of premia levels in the ADR pricesover the underlying Indian equity prices, even after the introduction of two-way fungibility.

C. Relation of ADRs with Stock MarketsWe then considered the relation, if any, between ADR premia

levels and the prices of the equities on the stock markets where theywere being actively traded. We took the daily premium level of eachdually listed company from the date of its foreign listing up to August2006 and conducted a simple regression analysis with the daily closingprice of the S&P 500 index (for the US stock exchange) and the S&PCNX Nifty (for the National Stock Exchange of India). The resultshave been presented in Table 4.

25 According to Jithendranathan et al. (2000).

TABLE 4Relation of ADR Premia Levels with S&P 500 Index and S&P CNX Nifty

ADR Premia Levels S&P CNX Nifty S&P 500 Index(Indian Stock Exchange) (US Stock Exchange)

Wipro 0.010* (0.0008) 0.031* (0.005)Satyam 0.001 (0.0005) 0.014* (0.003)Infosys -0.020* (0.001) 0.050* (0.005)ICICI Bank -0.001* (0.0005) 0.028* (0.002)HDFC Bank -0.0003 (0.0003) 0.010* (0.002)MTNL 0.003* (0.0004) 0.030* (0.002)VSNL 0.0001 (0.0002) 0.001 (0.001)Dr Reddys Labs -0.00055 (0.0003) 0.006* (0.001)

Average -0.0017* (0.0003) 0.04* (0.002)

Note : Regressions on daily premia level for each dually listed stock with dailyclosing price of S&P 500 index (for US stock exchange) and S&P CNXNifty (for NSE, India). The figures represent regression coefficients.Figures in parentheses denote standard errors. Asterisks denote that thecoefficients are statistically significant at 5% level.

With the Indian

ADRs trading at

premium levels,

foreign investors

holding ADRs do

not have any

incentive to cancel

them and convert

into Indian equities,

implying the

absence of

headroom for the

stocks.


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The relationship of ADR premia levels with the S&P CNXNifty of the Indian stock exchange is very weak and inconclusivethecoefficients are positive for four stocks (statistically significant for twoout of four); negative for four stocks (statistically significant for two outof four). On the other hand, the ADR premia levels of each and everycompany in our sample show a positive relation with the S&P 500Index of the US stock exchange and are also statistically significant forseven out of eight companies (with the exception of VSNL). At theoverall level for all the eight dually listed companies taken together,the relationship of the ADR premia levels with the S&P 500 Index isstronger and significant.

Next, we studied the returns on ADRs and their relation withthe returns of the US stock exchange (S&P 500 index returns); theIndian stock market returns (S&P CNX Nifty returns) and the returnson the underlying domestic equity shares. Returns are computed bytaking the percentage changes of the closing index levels and closingstock prices on successive trading days.

TABLE 5Relation of ADR Returns with Stock Markets and Domestic Stock Price

ADR Returns S&P CNX S&P 500 Underlying Nifty Returns Index Returns Domestic(Indian Stock (US Stock Equity share

Exchange) Exchange) Returns(1) (2) (3)

Wipro -0.28* (0.06) 0.88* (0.06) 0.79* (0.02)Satyam 0.05 (0.06) 0.99* (0.06) 0.63* (0.03)Infosys -0.24* (0.08) 0.34* (0.10) 0.19* (0.03)ICICI Bank 0.32* (0.06) 0.58* (0.07) 0.46* (0.03)HDFC Bank 0.32* (0.05) 0.45* (0.06) 0.29* (0.03)MTNL 0.05 (0.06) 0.46* (0.07) 0.62* (0.03)VSNL 0.15* (0.05) 0.17* (0.06) 0.44* (0.02)Dr Reddys Labs 0.07 (0.05) 0.45* (0.06) 0.66* (0.03)

Note : Regressions on ADR returns for each dually listed stock with returns of the Indian stock exchange, US stock exchange and returns on theunderlying domestic equity shares. Returns are computed by taking thepercentage changes of the closing index levels and closing stock prices onsuccessive trading days.The figures represent regression coefficients.Figures in parentheses denote standard errors. Asterisks denote that thecoefficients are statistically significant at 5% level.

The relation between the ADR returns and domestic StockExchange returns (column (1)) is, once again, inconclusivethe coeffi-cients are significant for five stocks, of which two are negative andthree are positive. In contrast, the relation of ADRs returns with thereturns on the S&P 500 index of the US stock exchange (column (2)) ispositive and significant for all the companies. As expected, there also

The relation

between the ADR

returns and

domestic Stock

Exchange returns is

inconclusive. The

relation with the

returns on the US

stock exchange is

positive and

significant for all the

companies.


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Four out of the eight dually listed companies in our sampleshowed an increase in domestic share prices immediately after theirforeign listing. The domestic share price of ICICI Bank almost doubledduring the 100days after their ADR issue while Dr Reddys, Infosys andMTNL enjoyed moderate increases of around 12-15% from their USlisting. On the other hand, the remaining four of the eight companiesshowed declines in their prices following the issue of the ADRs (statisti-cally significant at 5% level).

Previous studies have also compared the pre-listing to the post-listing share prices in an effort to find out the possible gains in domesticstock market prices following the foreign listing. The results have beeninconclusive and the reasons have remained largely unexplored andunexplained. One might think that the effect on domestic share pricescould well be related to the ongoing activities in the domestic stockmarket at the time of the ADR issuethat is, the movements in pricesmight depend on the timing of the foreign listing rather than the eventof the listing itself. However, this remains to be seen in the case of theIndian ADRs.

E. Changes in Trading VolumesThis section studies the liquidity changes that are expected to

accompany a new cross-border listing. Karolyi (1998) concluded thatcross-border listings were found to enhance the liquidity of trading instocks in the home market, especially for stocks of companies inemerging nations which were listing in the United States. Liquidityeffects have been measured in the literature in terms of an increase in

TABLE 6Effect on Average Domestic Stock Prices Before and After ADR Listing

Stock Prior Mean Post Mean % Change t-Test for Twoin prices Sample Means

ICICI Bank 108 213 98.1 15.6*Dr Reddys 1295 1498 15.7 7.4*

Infosys 2976 3359 12.8 3.7*MTNL 124 139 11.8 10.1*

HDFC Bank 230 224 -2.5 3.5*Wipro 2669 2522 -5.5 2.9*Satyam 301 171 -43.1 15.9*VSNL 1234 531 -56.9 16.6*

Note : Prior Mean: Average Stock Price on NSE for 100 trading days beforeforeign listingPost Mean: Average Stock Price on NSE for 100 trading days afterforeign listingt-Test for Two Sample Means: t-statistic indicating whether the mean of

daily domestic stock price before and after ADR listing is significantlydifferent at 5% level, from the mean of daily domestic stock prices afterADR listing. Asterisk denotes significance (5% level) of the t-statistic.

Four out of the eight

dually listed

companies in our

sample showed an

increase in domestic

share prices

immediately after

their foreign listing.

On the other hand,

the remaining four

showed declines in

their prices

following the issue

of the ADRs

(statisticallysignificant at 5%

level).


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the trading volume or by a reduction in the bid-ask spread. Hargis andRamanlal (1998) developed a theoretical model and found that interna-tional cross-listing resulted in an increase in volume traded in thedomestic markets. Jayakumar (2002) studied the Chilean stock marketwhere there was no explicit trend in domestic trading volumes by thecross-listed firms and in the aftermath of cross-listing while Domowitzet al (1998) found a fall in trading volumes in the domestic marketfollowing cross-listing for his sample of Mexican foreign-listed compa-nies. Domowitz (1998) and Jayakumar (2002) also studied the order-flow migration in order to find out if the cross-listing resulted in anytransfer of trading activity from the domestic to the foreign stockmarkets. 26 In line with Domowitz and Jayakumar, we now carry outthe same analysis for the trading volumes of our sample of eight Indiancompanies that had undertaken listing on the US stock exchanges. Thedaily domestic trading volume around the ADR introduction of eachstock was considered.

Table 7 provides the results from a t-test of difference of meansof pre-ADR listing and post-ADR listing daily domestic trading volumefor each individual stock series. In order to find out the immediateimpact of the foreign listing, 100 trading days in the sample prior tothe ADR listing date and 100 trading days after the ADR listing datewere taken for the difference of means test.

26 Order Flow migration seeks to study whether there is any transfer of trading activity, after the cross-listing of a stock, from the local stock market to theinternational exchange.

TABLE 7Average Trading Volumes Before and After ADR Listing (100 trading days)

Stock Prior Post Difference t-Test Statistic

Infosys 58,128 110,887 7.27*Dr Reddys 108,227 141,787 2.36*VSNL 33,198 151,952 8.65*Wipro 448,369 700,850 7.91*MTNL 397,177 809,366 4.10*

Satyam 15,960,780 9,426,792 8.58*ICICI Bank 266,963 134,961 4.87*HDFC Bank 103,465 87,361 1.45Combined 2,172,038 1,448,789 3.09*Excl. Satyam 202,218 309,075 5.32*

Note : Prior : Average Trading Volume on NSE for 100 trading days beforeforeign listing.Post : Average Trading Volume on NSE for 100 trading days after foreignlisting.Difference t-Test : t-statistic indicating whether the mean of daily domestictrading volume before and after ADR listing is significantly different at5% level, from the mean of daily domestic trading volume after ADRlisting. Asterisk denotes significance (5% level) of the t-statistic.

In line with

Domowitz and

Jayakumar, we carry

out the analysis for

the trading volumes

of our sample of

eight Indian

companies that had

undertaken listing

on the US stock

exchanges.


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For five out of the eight stock series in the sample, the averagedaily trading volume on the National Stock Exchange was found to behigher after ADR listing and the difference t-test indicates that thetrading volume increase is statistically significant (at 5% level) foreach of the five stocks. For the remaining three companies, the averagetrading volume in the domestic market declined after the foreignlistingthis included the finance sector companies (ICICI Bank, HDFCBank) and Satyamand the difference was not significant for HDFCBank. When we examined the average combined (total of all the eightcompanies) daily domestic trading volumes, the post-ADR volume waslower than the pre-ADR volumes but the relationship was reversed (andsignificant) when we found the combined average of seven companiesexcluding Satyam. So, if we exclude the outlier (Satyam) we mayconclude that there has been an increase in trading volumes in thedomestic market for the majority of stocks, during the 100 trading daysfollowing their foreign listing, which confirms that foreign listing of adomestic stock does help to increase liquidity of the stocks.

We then looked into the order-flow migration, where tradingvolumes on the American stock exchanges were considered (NASDAQand NYSE, as applicable). Using the same sample stock as in Table 6,the proportion of total trading taking place in the ADR market wasincluded in the analysis along with the domestic trading volumes. Theresults are provided in Table 8.

It is evident from the results that the trading volume during the100 trading days following the foreign listing was dominated by theADR marketfor six out of the eight companies, the average dailyADR trading volume exceeded 50% of the total trading that took placein the foreign and domestic market taken together. The trading follow-

TABLE 8Order-Flow Migration

Stock Post Volume ADR Volume % ADR

Infosys 110,887 448,500 80Dr Reddys 141,787 450,172 76HDFC Bank 87,361 241,689 74ICICI Bank 134,961 367,302 73

VSNL 151,952 303,904 67Wipro 700,850 698,040 50

MTNL 809,366 129,848 14Satyam 9,426,792 374,956 4

Note : Post Volume : Average daily Trading Volume on NSE for 100 tradingdays after foreign listing.ADR Volume : Average daily Trading Volume on US stock exchange for100 trading days after listing. ADR daily trading volume was adjustedusing ADR ratios to make it comparable to local trading volumes.% ADR : % of total trading in the ADR market = 100* (ADR/ (ADR +Post).

There has been an

increase in trading

volumes in the

domestic market for

the majority of

stocks, during the

100 trading days

following their

foreign listing.


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For the five companies where the average daily trading volumeon the National Stock Exchange was found to be significantly higherafter ADR listing, in the case of Infosys, Dr Reddys, VSNL and Wiprothe gain in trading volumes in the domestic market was overshadowedby the enhanced trades in the ADR market during the 100 trading daysfollowing the foreign listing. The finance sector companies (ICICI Bankand HDFC Bank) showed a clear migration of trading activity wherethere was a fall in trading volumes in the domestic market whilevolumes in the ADR market comprised more than 70% of their totaltrades during the initial 100 days following their foreign listings. ForMTNL, the company gained from increased trading volumes in thedomestic market but trading on the ADR market during the first 100trading days remained modest. Satyam was the only company that didnot experience any flurry of trading activity following its foreign listingsince trading volumes on the domestic stock exchange witnessed asignificant fall and activity in the ADR market also remained low key.

V. Summary of Findings Exchange-traded ADRs of Indian shares originated in 1999,

with the listing of Infosys on the US stock market. The Indian

TABLE 9Summary of Trading Activities in 100 trading days following Foreign Listing

Stock Increase in Domestic Dominance of ADRTrading volume in total trading

Infosys

Dr Reddys

VSNL

Wipro MTNL

HDFC Bank

ICICI Bank

Satyam

ing foreign listing was dominated by the domestic stock market forMTNL and Satyam. 27 Therefore, there was an increase in domestictrading volumes soon after the cross-listing by the Indian firms. Interest-ingly, along with the gain in trading volumes in the domestic stockmarket, the amount of trading occurring in the ADR market during thistime was even larger, indicating a definite gain for the company interms of trading activity following their foreign listing. The summaryof our findings is given in Table 9.

27 Our result is in line with the Chilean experience where Jayakumar(2002) found that trading was dominated by the ADR market for 12 out of 14Chilean stock series.

Interestingly, along

with the gain in

trading volumes in

the domestic stock

market, the amount

of trading occurring

in the ADR market

during this time was

even larger,

indicating a definite

gain for the

company in terms of

trading activity

following foreign

listing.


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government continued with widespread reforms of the financialsector by liberalising the procedures and environment for issueof depository receipts, which has been reflected in the growingmarket for ADRs/GDRs.

The Indian ADRs have been trading at high premia over theunderlying domestic stocks, with Information Technologycompanies at the highest premia levels. The premia levels of VSNL and Dr Reddys Labs have been negligible.

Two-way fungibility was introduced in India in February 2002,to allow re-conversion of ADRsa foreign investor who heldADRs could sell the underlying shares in the market and thecompany was then allowed to issue fresh ADRs to the extent of the shares cancelled (known as headroom). The re-conversionwas aimed at minimising the divergent ADR premium levelsover their domestic stocks. However, premia levels continuedto soar in 2002, 2003 and for most companies even in 2004.This was because the stocks continued to trade at premia levelsin the US market, indicating absence of headroomtherefore,re-conversion was not possible and arbitrage opportunitiesremained restricted even after introduction of two-wayfungibility.

The decline in premia became evident only in 2005, but thisconvergence in prices was not associated with the two-wayfungibility facility. Firstly, the ADR premia level showedpositive relation with the S&P 500 Index of the US stockexchange. Secondly, the returns on ADRs were related posi-tively to returns on the US stock market index while therelation with the Indian stock exchange remained inconclusive.We found that premia levels have been persistently high for ITand Finance sector companies, which had strong positiverelationship between ADR returns and returns on the US stockexchange. Therefore, the ADR premia moved in line with theUS stock marketforeign investors who traded in ADRs wereconcerned with activities in the US rather than the legislativechanges or the stock price movements in India.

There was no conclusive effect of foreign listing on domesticshare prices of the dually listed stocks. But there was a definiteincrease in trading volumes in the domestic market during the100 trading days following their foreign listing, confirmingthat foreign listing helped to increase liquidity. Moreover, forthe companies where average daily trading volume on theNational Stock Exchange was found to be significantly higherafter ADR listing, there were further gains in trading volumesin the ADR market during the 100 trading days following theforeign listing.

The decline in

premia became

evident only in

2005, but this

convergence in

prices was not

associated with the

two-way fungibility

facility.

There was a definite

increase in trading

volumes in the

domestic marketfollowing foreign

listing, confirming

gains in liquidity.


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Appendix 1: Types of Depository ReceiptsUnsponsored Depository Receipts are issued in response to

market demand, but without a formal agreement with the company.Unsponsored ADR programmes can be created by multiple depositoriesfor the same firm and the investors bear a large portion of the deposito-rys administrative expenses. Today, unsponsored Depository Receiptsare considered obsolete and are rarely established due to lack of controlover the facility and potential hidden costs.

Sponsored Depository Receipts are issued at different levelsavailable in various trading markets. A sponsored programme isissued by an exclusive depository selected by the company through adeposit agreement or a service contract. Sponsored DepositoryReceipts offer control over the facility, the flexibility to list on USor European stock exchange and the ability to raise capital. Thefirm, and not the investors, bears the administrative costs of thedepositories.

Sponsored Level I Depository Receipts programme is thesimplest method for companies to access the US and non-US capitalmarkets, to use existing shares to broaden the shareholder base, withoutraising new funds. A Level I programme does not require full Securitiesand Exchange Commission (SEC) registration and the company doesnot have to report its accounts under US Generally Accepted Account-ing Principles (GAAP) or provide full SEC disclosure. A SponsoredLevel I Depository Receipt programme allows companies to enjoy thebenefits of a publicly traded security without changing its currentreporting process.

Sponsored Level II and Sponsored Level III DepositoryReceipts are used by companies that wish to list their DepositoryReceipts on a US stock exchange (NASDAQ, American or New York),raise capital or make an acquisition using securities. Level II and LevelIII Depository Receipt programmes require SEC registration andadherence to requirements for US GAAP. Level II Depository Receiptsare exchange-listed securities but do not involve raising new capital.Level III programmes typically generate the most investor interestwhere new capital is raised.

Privately Placed and Offshore (SEC Rule 144A / Regula-tion S) Depository Receipts are ADRs that are privately placed withQualified Institutional Buyers (QIBs) in the Rule 144A market, withoutany SEC registration. The Regulation S programme allows raisingcapital through placement of Depository Receipts offshore to non-USinvestors.

Appendix 2: Intra-Market vs. Cross-Border TransactionsSuppose an investor who is holding Depository Receipts wishes

to sell them. The investor has to first notify his broker.The broker can either sell the Depository Receipts in the US


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market through an intra-market transaction where the DepositoryReceipts are sold to subsequent US investors by transferring them fromthe existing holder (who is now the seller) to the new holder (who is thebuyer). Intra-market trading accounts for approximately 95% of allDepository Receipt trading.

The investor can also sell the shares back into the home marketthrough a cross-border transaction . In this case, the US broker surren-ders the Depository Receipts to the depository bank, so as to deliver theshares to a buyer in the home market. The depository bank cancels theDepository Receipt and instructs the custodian to release the underlyingshares and delivers them to the local broker. The Indian broker pays forthem in equivalent Rupees that are converted into dollars by the USbroker.

Appendix 3: Role of the Depository BankThe Depository Bank is the American institution that issues the

ADRs in USA.Domestic shares are first delivered to the local custodian bank

of the depository bank for the initial verification and delivery of thedepository receipts to be issued in the US equity market.

The depository bank holds the securities in custody in thecountry of origin and converts all dividends and other payments intoUS dollars to certificate holders in the USA. In turn, the US investorsbear all currency risks and pay fees to the depository bank.

The depository bank has responsibilities relating to shareholderrights (such as payment of dividends and voting at shareholder meet-ings), which are stated in the depository receipt certificate, and mustalso maintain a share register of depository receipt owners. Intra-market trading accounts for almost all the trading in depositoryreceipts; the most important role of a depository bank is to maintainsophisticated stock transfer systems and operating capabilities.

Appendix 4: Report of the Committee on Compilation ofForeign Direct Investment in India, October 2002According to the International Monetary Fund (IMF) definition

contained in the Balance of Payments Manual, Fifth Edition (BPM-5),Foreign Direct Investment has three components, viz., equity capital,reinvested earnings and other direct capital.

In an effort to align the Indian FDI reporting system with theinternational norms, the Government of India, in May 2002, constituteda Committee comprising officials from the Department of IndustrialPolicy and Promotion (DIPP) and the Government of India (GoI).

The Committee noted that FDI inflow should get reflected inincrease in foreign equity holding in an existing firm. Moreover,according to the Organisation for Economic Cooperation and Develop-ment (OECD) norms, any foreign investment beyond the threshold limit


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of 10 per cent should be treated as part of foreign direct investmentinflows, even if it comes through the portfolio route. Since ADRs/GDRsdo not attract 10 per cent ceiling and also permit automatic acquisitionof shares on retirement of GDRs/ ADRs, it was recommended thatdepository receipts be treated as Foreign Direct Investment.

Based on the recommendation of the Committee, the Govern-ment of India classifies ADRs/GDRs as Foreign Direct Investment andall laws and procedures relating to FDIs are applicable to ADRs/GDRsas well.

Appendix 5: Policy Changes and Amount Raisedby Indian Companies through Depository Receipts

Year Policy Changes GDR Listings which raised GDRs/ADRsmore than US$20 million (US$ million)

1992-93 Indian companies allowed Grasim, Reliance 240

to raise capital abroad.1993-94 ArvindMills, BombayDyeing, GEShippg, 1520

Hindalco, Indal, IndianRayon, IndoGulf,ITC, Mahindra, Nippon, Reliance(2 nd),SPIC, Sterling, TataElec, TISCO, UnitedPhos, Videocon, Wockhardt.

1994-95 AshokLeyland, BajajAuto, BallarpurInds, 2082CenturyText, CESC, Reddys, EIH, EIDParry, Finolex, GNFC, GV Films, Grasim(2nd), Hindalco (2 nd), Hind Dev, IndiaCements, IPCL, JKCorp, JCT, L&T,NEPC, Oriental, Ranbaxy, Raymond,SIEL, SIV, Sterlite, Telco, Usha

1995-96 Flex Inds, GujaratAmbuja, Himachal 683Futuristic, Indian Hotels, Indo Rama,Ispat, L&T(2 nd), Reliance Energy, SAIL

1996-97 Financial sector companies could issue BharatHotels, BSESLtd, Crompton 1366GDRs. Track record requirement was Greaves, ICICI, Jagatjit, KesoramInd,relaxed for financing investments in Pentamedia, Telco(2 nd), VSNL, Stateinfrastructure sectors. Bank of India

1997-98 MTNL 6451998-99 Infosys (ADR) 2701999-00 Software companies could issue ADR/ GAIL, ICICI Bank (ADR), ReliancePetro, 768

GDRs without reference to RBI up to Satyam, Dishnet, Sify, SSI

US$100 million. End-use restrictions onissue proceeds were removed.

2000-01 Permission of ADR/GDRs under auto- Aptech, Gesco, Rediff (ADR), Silverline 831matic mechanism for specified sectors. (ADR), VSNL (ADR), Wipro (ADR)IT companies could issue ADR/GDRlinked stock options to employees.

2001-02 Sponsor of ADR/GDR issues against Dr Reddys (ADR), HDFC Bank (ADR), 477shares held by shareholders; overseas MTNL (ADR), Pentasoft, Satyam (ADR),business acquisition through ADR/GDR Teamasiastock swap under automatic route.



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Appendix 6: Details of Policy Changes in India relatingto Depository Receipts1992-93Indian companies were allowed to raise capital abroad

through the issue of ordinary shares against Global DepositoryReceipts (GDRs)or certificates created outside India and issued to non-resident investors. The Indian company desirous of raising foreignfunds through GDR was required to obtain prior permission of theDepartment of Economic Affairs, Ministry of Finance, Governmentof India. The company was required to have a consistent trackrecord of good performance (financial or otherwise) for a minimumperiod of three years, on the basis of which an approval would beissued to the company by the Department of Economic Affairs,Ministry of Finance. On completion of finalisation of issue structurein consultation with the Lead Manager to the issue, the issuingcompany had to obtain the final approval from the Department of Economic Affairs.

1996-97 Banks, Financial Institutions and Non-Banking Finance Com-

panies registered with the RBI were permitted to access GDR markets.GDR issue proceeds were permitted to be deployed for investments injoint ventures and wholly-owned subsidiaries in India by parent compa-nies, in addition to end uses earlier allowed. Use of GDR proceeds forinvestments in stock markets and real estate were banned. There wasno limit on the number of Euro issues a company or group may float.

Year Policy Changes GDR Listings which raised GDRs/ADRsmore than US$20 million (US$ million)

2002-03 Guidelines issues for Two-way Aftek, HimachalFuturistic(2 nd), Mascon, 600fungibili ty of GDRs and ADRs. Morepen, Patni, Reliance Ports, Reliance

Utilities, Uniphos2003-04 ACC, BallarpurInds(2 nd), CranesSoftware, 459

CrestComm, Maars, Mawana, Silverline,

Tata Tea, UnitedPhos(2nd

)2004-05 Rules were simplified to allow spon- CenturionBank, Elder, Essar Oil, Essar 613

soring, listing on overseas exchanges, Projects, Gammon, IndiaBulls, LIC Housing,retention of proceeds abroad and free MicroInks, Tata Motors (ADR), Ultratech,conversions and repatriability. UTI Bank

2005-06 Foreign Currency Convertible Bonds AlpsInds, ApolloHosp, Ballarpur Sugar, 2552and Ordinary Shares (Through BharatForge, Cipla, Emco, EssarShipping,Depository Receipt Mechanism) Eveready, FederalBank, HindCnst, ILFS,Scheme, 1993 was amended and IndiaCements(2 nd), IndiaBulls(2 nd), Jindal,simplified. JK Paper, Lloyd, Lyka, McDowell, MicroTech,

Patni (ADR), SREI, Usha(2 nd), Videocon (2 nd)

Source: Data from Reserve Bank of India Bulletin; Policy Changes from Ministry of Finance website, ADR/GDR

listings from Bank of New York website.


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The three-year track record requirement of good performance by theissuing company was relaxed for financing investments in infrastructuresectors, such as power generation, telecom, petroleum exploration andrefining, ports, airports and roads.

1999-2000The Reserve Bank of India granted general permissions to

Indian companies to make an international offering of Rupeedenominated equity shares by way of issue of ADRs/GDRs. Thenecessary permissions under FERA-1973 for issue and export of ADRs/ GDRs by the Indian company and acquisition of ADRs/GDRs byforeign investors were also granted. The track record scrutinyprocess and two-stage approval by the Ministry of Finance for ADR/ GDR issues were not required anymore. Issuing companies wereallowed to enter into agreements in respect of or ancillary to theoffer including but not limited to the Subscription Agreements andDeposit Agreement and to provide the necessary warranties andindemnities in accordance with international practices. The Ministryof Finance permitted Indian software companies which were listed onforeign exchanges and have already floated ADR/GDR issues, toacquire foreign software companies and issue ADR/GDR withoutreference to the Government of India or RBI up to the value limit of US$100 million. Unlisted companies were permitted to float Euroissues under certain conditions. All end-use restrictions on GDR/ADRissue proceeds were removed, except restrictions on investment instock markets and real estate. The 90-day validity period for finalapprovals of GDR/ADR issues was withdrawn, imparting greaterflexibility to issuing companies regarding the timing of issues. Indiancompanies were permitted to issue GDRs/ADRs in the case of Bonus orRights issue of shares, or on genuine business reorganisations dulyapproved by the High Court. However, the companies were requiredto get approval from the Department of Economic Affairs for the issueof GDRs/ADRs.

2000-01Overseas business acquisitions through the ADR/GDR route

were permitted under the automatic/simplified approval mechanism forIndian companies engaged in (1) Information technology and Entertain-ment software; (2) Pharmaceuticals; (3) Biotechnology; and (4) Anyother sector as notified by the Government from time to time. Indiancompanies, engaged in IT software and IT services, were permitted toissue ADR/GDR linked stock options to permanent employees (includ-ing Indian and overseas working directors) of its subsidiary companiesincorporated in India or outside and engaged in IT software and ITservices.


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2001-02Operational guidelines for facility for limited two-way fungi-

bility for Indian ADRs/GDRs announced by the Finance Minister in theUnion Budget 2001-02 were under finalisation in consultation with theRBI and the SEBI. Indian companies were permitted to list on foreignstock exchanges by sponsoring ADR/GDR issues with overseas deposi-tory against shares held by its shareholders subject to prescribedconditions. Indian companies were allowed to utilise up to 100 per centof proceeds of ADRs/GDRs for overseas investments instead of theexisting ceiling of 50 per cent allowed so far. Any Indian company,irrespective of its line of activity and which has already made an ADR/ GDR issue, was allowed to acquire shares of foreign companies en-gaged in the same core activity, up to an amount of US$ 100 million,or an amount equivalent to 10 times its export earnings in the preced-ing financial year, whichever is higher, by way of swap of fresh issuesof ADRs/ GDRs on back to back basis subject to compliance withcertain conditions. Earlier this facility was available only to Indiancompanies in certain sectors.

2002-03Guidelines for two-way fungibility were finalisedre-conver-

sion of ADR/GDRs was made possible, to the extent of ADR/GDRwhich have been converted into equity shares and sold in the localmarket. No specific permission of the RBI was required for the re-conversion. The RBI guidelines stated that the transactions would bedemand-driven and would not require company involvement or freshpermissions. The custodian would monitor the re-issuance of ADRs/ GDRs within the sectoral cap fixed by the Government. Each purchasetransaction would be against delivery and payment received in foreignexchange through banking channels. For this purpose, all SEBI regis-tered brokers were permitted to act as intermediaries in the two-wayfungibility of ADRs/GDRs.

2003-04Resident shareholders of Indian companies who offer their

shares for conversion to ADRs/GDRs, were allowed to receive thesale proceeds in foreign currency subject to the condition that theconversion to such ADRs/GDRs should have the approval of ForeignInvestment Promotion Board. The sale proceeds so received byresidents were permitted to be credited to their Exchange EarnersForeign Currency/Resident Foreign Currency (Domestic) accounts orto their Rupee accounts in India at their option. Disinvestmentproceeds under the scheme, receivable by residents, who have sincebecome non-residents, would also be eligible for credit to their foreigncurrency accounts abroad or any of their accounts in India at theiroption.


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2005-06In order to bring the ADR/GDR guidelines in alignment with

the guidelines on domestic capital issues framed by SEBI, the Govern-ment of India amended the Foreign Currency Convertible Bonds andOrdinary Shares (Through Depository Receipt Mechanism) Scheme,1993. Accordingly, both listed and unlisted companies in India wererequired to comply with the amended guidelines for issue of ADRs/ GDRs.

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