The exciting new world of unsponsored ADRs

An exciting, although unfamiliar, source of investments has opened up for Indian companies. The Indian government, last year, liberalized regulations on depository receipt (DR) issuances, based on recommendations of the M.S. Sahoo committee. No sooner did the government notify the new regulations, in November 2014, that leading depository banks, The Bank of New York Mellon Corp. and JPMorgan Chase & Co., filed a slew of applications for issuing DRs against shares of Indian companies.

Together, the two banks have filed over 160 applications with the US Securities and Exchange Commission for issuing DRs against over a 100 Indian companies. Each of these applications is for unsponsored DRs, where the company or the issuer of the securities isn’t involved at all. This has understandably led to uneasiness among some Indian companies, which fail to understand how their shares can be listed in the US without their permission. (More on this later.)

There is the related worry if US capital market and accounting regulations will apply to these companies because of the involuntary listings. As far as reporting and legal requirements go, there are no incremental obligations on these Indian companies. In fact, no action whatsoever is required from these companies. It’s entirely the responsibility of the depository bank to ensure that minimum requirements are fulfilled—these include regular financial statements, annual reports and press releases in English on the company’s website. Evidently, depository banks file applications for companies that are already meeting these requirements.

The benefit for the Indian markets and its listed companies is that it gets access to capital which may otherwise be difficult. Some investors can’t access Indian stocks because of restrictions in their investment mandates (for example, some pension funds that have a mandate for buying only dollar-denominated securities). Then there are some investors who don’t want to go through the trouble of registering with Securities and Exchange Board of India (Sebi) to make investments. These investors can approach their broker to launch a DR programme with Indian stocks as underlying securities. The broker, in turn, will buy these assets from the Indian market and DRs can be issued against them by depository banks. These unsponsored DRs can be listed only in the over-the-counter market in the US. A cursory glance at the list of stocks for which the two banks have made applications reveals that while this form of capital may be new, it is essentially chasing the same set of stocks that are popular with foreign investors already present in India.

For perspective, the US Securities and Exchange Commission (SEC) had eased rules for unsponsored DRs in late 2008, and there has been a huge increase in issuances since then. Just before the rule change, there were about 170 unsponsored DR programmes in existence. As of December 2014, there are about 1,600, according to data published by BNY Mellon. Depository banks are awaiting some guidelines from Sebi before they can roll out their plans for the Indian DR programmes; once these guidelines are out, it looks like the Indian market will drive growth for the industry in 2015.

While growth of the segment has continued unabated, there have always been criticisms about the push from depository banks for unsolicited listings. Ironically, among the first was fellow bank JPMorgan Chase, which said in a white paper in December 2008, “The implementation of numerous unsponsored DR programs without, in many instances, the consent or knowledge of an issuer is neither collaborative nor transparent... As an issuer is not involved in the creation or the subsequent maintenance of an unsponsored DR program, it has limited influence on the treatment of DR holders. Moreover, more than one unsponsored program can be opened in a single issuer by competing depositary banks. Shareholder services vary between depositary banks, thus investor confusion could arise where multiple unsponsored programs exist for the same issuer.”

A January 2010 paper by Peter Iliev (Pennsylvania State University) et al documented positive wealth effects for depository banks and negative effects for many involuntary cross-listed foreign firms, such as those with high stock market liquidity and low information asymmetry.

According to Global Finance Magazine, some companies, such as the German multinational ThyssenKrupp AG, had attempted to fight back by posting disclaimers on its website stating that they do not want any unsupported ADR facilities and that they will accept no liability in connection with such programmes.

Indian companies that are overtly perturbed about an involuntary listing may well attempt some of these strategies. Or, they could do what ThyssenKrupp eventually did in November last year—launch a sponsored level I American Depository Receipt (ADR) programme. This way, it has control over the programme, without having to commit to any increase in disclosure or legal requirements.

In fact, a number of securities lawyers and depository banks themselves are advising companies to support a level I programme, which will lead to more predictable outcomes in areas such as investor relations. In an unsponsored programme, the investors are unknown to the issuer.

But having said all that, not many companies may want to proactively support an overseas listing, even if it doesn’t result in increased obligations. In such a scenario, there is no harm in enabling access for hitherto untapped investors through unsponsored programmes. While it may lead to uneasiness among some Indian companies, the causes for worry appear exaggerated.

Click here to download a list of Indian companies with SEC filings for depository receipts.

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