SEC Rule Change Spawns ADR Boom
Traders Magazine, February 2009
About 750 new American Depositary Receipts have been created in the wake of a rule change last fall by the Securities and Exchange Commission. This has led some in the industry to anticipate a trading boom.
All of the new ADRs are "unsponsored" programs. That means the issuers of the underlying shares were not involved in establishing the ADR programs. In a sponsored arrangement, the issuer selects the depositary bank and controls the terms and conditions of the ADR program. There are about 1,800 ADRs in the U.S., according to Bank of New York Mellon.
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R. Cromwell Coulson, CEO of Pink OTC Markets, believes the SEC's rule change will boost volume in ADRs. "We expect that dollar volume to grow significantly," Coulson said. "I wouldn't be stunned if our dollar volume in ADRs is 10 times higher in three years."
Last year, almost $100 billion, or two-thirds of Pink OTC's dollar volume traded, was in ADRs, Coulson said. About 500 ADRs trade on the Pinks, up from 425 before the SEC's rule change took effect on Oct. 10. U.S. exchanges, which account for most ADR trading, transacted $3.7 trillion last year, according to a year-end BNY Mellon report.
Unsponsored ADRs and "Level 1" sponsored ADRs trade in the gray market and Pinks, although efforts are under way to move more trading to the Pinks. Those issuers are exempt from registering their securities with the SEC and have minimal disclosure requirements. Level 2 and 3 sponsored ADRs are SEC-registered securities whose issuers must meet higher disclosure standards and must reconcile their financial statements to U.S. GAAP. These ADRs are listed and traded on exchanges (Level 3 also allows an issuer to raise capital). Until October, about 80 percent of ADRs were sponsored, BNY Mellon said.
Bernardo Mariano, an analyst at Equity Research Desk, an investment advisory firm in Greenwich, Conn., doesn't think the new unsponsored ADRs will build a lot of liquidity. "These are tailor-made ADRs for special needs," Mariano said. "There will be more trading, but not significantly more trading."
Mariano added that a limited number of investors buy securities traded on the Pinks or gray market. Coulson disputed that, pointing out that many institutions trade OTC ADRs, and that retail investors can also trade these and other OTC names through big brokers and online brokerages. The OTC market today is significantly different from the OTC market of a half-dozen years ago, he said.
The October rule change involves Rule 12g3-2(b) under the Securities Exchange Act of 1934. Before October, foreign firms wishing to create ADRs that would trade OTC had to formally apply for an exemption and submit periodic financial statements to the Commission.
Now, foreign companies don't have to fill out any forms. But the rule change is much more significant. Depositary banks can now create unsponsored ADRs without asking the issuer to apply for the exemption. As long as the required disclosure materials are published in English on the issuer's web site, the depositary bank can go ahead with a presumptive exemption in hand. The issuer does not have to sign off on these arrangements.
BNY Mellon, one of the largest depositary banks and a big ADR player, has issued more than 500 new unsponsored ADRs since the SEC's amendment went into effect, according to Jason Paltrowitz, a vice president at the bank. About 150 of them have been duplicated by other banks. Unsponsored ADRs, Paltrowitz said, can be created on the same underlying stock, although all trading takes place with one ticker symbol and one CUSIP. The other big depositary banks in the ADR landscape are Deutsche Bank, Citibank and J.P. Morgan.
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