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Depositary Receipt Programs Comments

John Gazy   |   February 28, 2008
I bet most of you have heard of PetroChina, ICICI Bankor Nokia. Indeed, these companies are currently very much spoken of in the financial media world. Many analysts recommend investing in their stocks. Despite the fact that they are non-US companies, investors may purchase them on the US stock markets through American Depositary Receipts.

First depositary receipts were invented in 1927 to facilitate foreign investments for US investors. Since then, depositary receipts have won public recognition and developed into a flexible tool helping issuer to attract foreign investments.

Depositary receipts are negotiable certificates that represent ownership in the shares of a foreign company. They are issued by depositary banks and enable investors to purchase and trade in foreign securities without undertaking cross-border transactions. Usually a depositary receipt represents a company's publicly traded equity or debt. It can represent a fraction of a share, a single share, or multiple shares of foreign stock, which are deposited in a local custodian bank.

There are three major kinds of depositary receipts:

- American Depositary Receipts (ADRs) - traded on the US stock exchanges;
- European Depositary Receipts (EDRs) - provide an access to European markets, mostly the London and Luxembourg Stock Exchanges.
- Global Depositary Receipts (GDRs) - securities available in one or more markets outside the company�s home country. They are usually issued under the US legislation: under the terms of Rule 144A and SEC Regulation S.
To establish a depositary program, an issuer should engage a team of counselors to take part in this activity. Usually the team consists of investment banks� representatives, attorneys and auditors. The issuer should also choose a depositary bank and finalize a depositary deal. The depositary bank then issues Depositary Receipts and chooses a custodian bank where the basic securities will be kept. Depositary receipts are delivered to an initiating broker, who then delivers them to investors.

Custodian banks should regularly report about available deposited shares. Through depositary banks brokers also pay for depositary receipts� transactions.

An issuer may choose different types of programs depending on the company�s goals. They are sponsored, unsponsored and private placement Depositary Receipts. Unsponsored Depositary Receipts are issued by one or more depositaries in response to market demand, but without a formal agreement with the company. They are often issued by more than one depositary and traded on the over-the-counter (OTC) market. Private placement DRs can be spread only within the restricted number of investors.

Sponsored depositary receipts are divided into three levels. A sponsored Level I Depositary Receipt program is the simplest method for companies to access the US and non-US capital markets. Shares can be traded on the Pink Sheets and the OTC BB only. The company does not have to comply with the US Generally Accepted Accounting Principles (GAAP) or full Securities and Exchange Commission (SEC) disclosure. A sponsored Level I Depositary Receipt program enables foreign companies to enlarge its stock without changing its current reporting process. A sponsored Level I Depositary Receipt involves the filing of the Form F-6 registration statement but allows for exception under Rule 12g3-2(b) from full SEC reporting requirements.

Companies that wish to list their securities on the large US exchanges (NYSE, ���� or NASDAQ) use sponsored Level II Depositary Receipts. Issuers must comply with the SEC�s full registration and reporting requirements. In addition to filing an F-6 registration, issuers are required to file the SEC Form 20-F. Furthermore, issuers must comply with NYSE, AMEX or NASDAQ listing requirements.

Companies that wish to raise capital use the highest Level III Depositary Receipts. Setting up a Level 3 program means that a foreign company takes part of its shares from its home market and deposits them to be traded in the US. In this case, the company is required to file F-1 in addition to F-6, which is the format for an Offering Prospectus for the shares. It also must file the Form 20-F annually and adhere to GAAP standards. In addition, any material information given to shareholders in the home market must be filed with the SEC through the Form 8K.

Private Placement (144A) Depositary Receipt. According to the SEC Rule 144A, companies may raise foreign capital through a private placement of sponsored Depositary Receipts avoiding SEC registration. In this case a company can place Depositary Receipts with large institutional investors in the United States and to non-US investors in reliance on Regulation S.

According to the New York Mellon bank, companies from 33 countries launched 60 new DR programs last year. It is the highest level of establishing new programs in seven years. For the third straight year, more than half of all new DR programs were private placement global depositary receipts (GDRs) issued under the Rule 144A and/or Regulation S.

In 2007, 39 issuers listed new ADRs on one of the major U.S. exchanges (NYSE, NASDAQ or Amex), up from 21 in 2006.

Companies from the BRIC countries were the most active in 2007, establishing 93 new programs, more than 58% of the year�s global total. India continued a four-year trend as the DR market�s most active country. In 2007, issuers from India tied those from China by establishing 28 new DR programs.

Depositary Receipts are becoming more and more popular with both issuers and investors. Most investors recognize the benefits of global diversification from geographical and economical point of views. Companies are interested in access to the most developed stock markets. Depositary Receipt programs allow issuers to attract diversified investors and enhanced visibility and image for the company�s products.
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