What do S-Oil Corporation, Lenovo Group Limited, and Beijing Beida Jade Bird Universal Sci- Tech Company Limited, diverse listed Asian and Chinese companies in very different businesses, have in common? All of these companies have created sponsored Level I American Depositary Receipt, “ADR”, programs to facilitate the trading of their listed shares in the United States. Continuing a trend begun in the late 1980s, many new Depositary Receipt, “DR”, programs were created by Asian and Chinese issuers in the past few years. Attached to this article is a list of some ADR programs the author worked on.
I. ADR Overview
The ADRs, invented in 1927, gave American investors their fi rst opportunity to purchase foreign stock without concern for settlement delays and other vagaries associated with overseas securities transactions. ADRs are increasingly recognized as solid investment mechanisms by U.S. investors seeking to purchase the securities of foreign issuers.
Asia based ADRs, negotiable certifi cates issued by U.S. depositary banks, represent shares of listed Asian companies deposited with custodial banks in Asia. Individual receipts can represent a single foreign share, multiple shares, or a fraction of a share. ADRs or more properly, the underlying American Depositary Shares, “ADSs”, must be registered with the United States Securities and Exchange Commission, the “SEC”, and can trade in the U.S. over-the-counter, the “OTC”, market or, depending on the level of compliance with U.S. disclosure and registration requirements, on a national exchange.
There are two main types of ADR facilities: the sponsored ADR, of which there are three tiers, Levels I, II, and III, all created pursuant to a deposit agreement between a depository bank and the issuer of an underlying security, and the unsponsored ADR facility, created by a depository acting on its own or at the prompting of potential investors.
Not too many unsponsored ADR programs are established as they are considered less favorable to issuers and investors, partly due to the lack of control by issuers. Sponsored ADR programs with full U.S. trading privileges consist of Level II programs, which involve full U.S. registration but no new securities issued by the issuer, and Level III programs, which involve a securities issuance by the issuer and are, in fact, full-fl edged U.S. public offerings. Level I programs, by contrast, do not permit the issuer to sell shares in the U.S. nor do they permit trading on U.S. securities exchanges. They do, however, permit trading “over-the-counter,” and since they are much less expensive to establish than Level II or Level III programs, they are usually the fi rst choice of a foreign company without any substantial U.S. presence.
II. ADRs in Hong Kong
In 1978, The Hong Kong and Shanghai Banking Corporation became the fi rst Hong Kong-based entity to issue ADRs. Since then, many other Asian companies have established ADR programs, the majority having done so within the past few years. The following factors have contributed to the popularity of ADR programs with Asian companies.
1. Ease of Creation. Asia and China listed companies wishing to enter the US equity markets can do so quite easily by creating a sponsored Level I ADR program. Such a program allows non-affi liated shareholders of an Asian listed company who hold unrestricted shares under U.S. law to enjoy some of the benefi ts of public trading of their securities in the U.S. without requiring the company to change its reporting procedures. The Level I compliance process is rather simple. To create a Level I program, an Asian issuer needs to submit a form F-6, accompanied by relevant disclosures, to the SEC. As a result of the recent amendments to Rule 12g3-2(b) of the Securities Exchange Act of 1934, the “Exchange Act”, the Rule 12g3-2(b) exemption is now self-executing and it is no longer necessary to apply for an exemption from registration from the SEC under rule 12g3-2(b) of the Exchange Act. A foreign private issuer is now eligible to claim the Rule 12g3-2(b) exemption as amended as long as it meets the following three conditions:-
- The issuer currently maintains a listing of the subject class of securities on one or more exchanges in its “primary trading market”;
- The issuer is not required to fi le or furnish reports under the Exchange Act Section 13(a) or 15(d); and
- The issuer has published in English specifi ed non- US disclosure documents, from the fi rst day of its most recently completed fi scal year on its internet website or through an electronic information delivery system generally available to the public in its “primary trading market”, unless claiming the exemption upon or following its recent Exchange Act deregistration; and the issuer must continue to publish such information promptly after it is made public in order to remain in compliance with the exemption.
An Asian issuer that meets the three conditions of Rule 12g3- 2(b) as amended can automatically claim the exemption without having to submit a written application to or otherwise notifying the SEC.
2. Market Visibility. Many Asian companies have very small American shareholder followings. Creating an ADR program serves as a means of introducing the United States public to a particular Asian company and its securities. By establishing a presence in the U.S., an Asian company could benefi t from certain name recognition and a heightened profi le. In addition, after the creation of an ADR program, an Asian company can attempt to enhance its visibility in the U.S. marketplace by establishing relationships with analysts, fund managers, brokers, and U.S. based ADR holders.
3. Expansion of Shareholder Base. The potential enlarged investor market afforded to Asian companies with ADR programs allows them to increase their shareholder base. A number of companies that created sponsored Level I ADRs now fi nd that approximately 5-15% of their shareholders are ADR owners. A broader potential shareholder base may lead to higher trading volumes in an Asian company’s securities and possibly a stabilization of or an increase in its share price.
4. Non-Applicability of Certain U.S. Securities Laws. The U.S. has the world’s most comprehensive securities regime. These laws and regulations, administered by the SEC, generally require fi rms to make broad disclosures about their operations when registering publicly-traded shares and/or maintaining listings for such securities. Consequently, many listed foreign fi rms are reluctant to issue shares in the American capital markets. Level I ADR programs, however, allow listed foreign companies to facilitate some U.S. trading in their securities while disclosing only that information about financial and operational matters that is required to be disclosed in its country of incorporation or where its securities are traded.
5. Access to Certain U.S. Institutional Investors. Institutional investors, such as pension funds, insurance companies and mutual funds, hold some of America’s largest securities portfolios. These investors are expanding their foreign equity holdings. International securities are attractive to these investors, who increasingly seek to diversify their portfolios to minimize risks and maximize their potential growth by tapping opportunities throughout the globe. A recent study showed that two-third of U.S. institutions owning foreign equities exclusively held ADRs. Moreover, U.S. law places limitations on the ability of some institutional investors to purchase certain foreign securities. Indeed, a number of U.S. institutions are required to use ADRs for their investments in securities issued outside of the U.S. Thus, a listed foreign company can reach powerful American institutional buyers by creating an ADR program.
6. Platform for Future U.S. Listing and Capital Formation. Lastly, an ADR program can be used as a springboard both for listing on an American exchange, through a sponsored Level II ADR program, and/or raising capital in the U.S. markets, through a sponsored Level III ADR program or sales pursuant to 3 Article Rule 144A under the Securities Act of 1933, the “1933 Act”, a device which under certain circumstances facilitates the private placement of securities in the U.S. Although companies initially can opt to create Level II or Level III programs, the overwhelming majority have preferred to test the market with the creation of Level I ADRs. Companies make this election because Level II and III programs cost signifi cantly more, require continuous reporting under U.S. securities laws, compel the issuer to make comprehensive disclosures to the SEC and oblige that the issuer keep records in compliance with U.S. generally accepted accounting principles. At present, there are a few Asian corporations which have listed on a U.S. exchange and/or made a US public offering.
III. Creating an ADR Program
A. Necessary Documentation
The process involved in creating a Level I ADR program is relatively simple. It does not require any disclosure by the issuing Asian company other than those already required under the home country’s securities laws. A form F-6, to which a deposit agreement is attached as an exhibit, must be fi led with the SEC in order to comply with the sponsored Level I ADR regime.
1. The Deposit Agreement: This agreement, negotiated between a depository bank and a foreign issuer, governs their relationship and details the terms and conditions of the proposed ADR program. The agreement should cover all aspects of the planned ADR program, and include detailed provisions addressing the rights and responsibilities of each party. Under the terms of a typical deposit agreement, the issuer agrees to pay certain costs incurred by the depository in maintaining the ADR program, while the depository agrees to serve as a facilitator for the issuance of the ADRs and as an intermediary between the issuer and purchasers of the ADRs representing the underlying shares.
2. The Form F-6 Filing: This fi ling, a simple registration statement for the ADR, is made pursuant to provisions of the 1933 Act. It incorporates by reference various provisions of the deposit agreement. Typically, the F-6 for a sponsored Level I ADR is executed by the depository bank, but must also be signed by a majority of the issuer’s board of directors, who undertake, if necessary, to make limited future disclosures.
Although the registration process for most securities issued in the U.S. is quite lengthy, a Level I ADR program can be created with relative expedience. Completion of the entire process generally can be accomplished in as few as three to six months. This allows any Asian or Chinese company seeking to enter the U.S. market to do so quickly and to take advantage of the benefi ts mentioned above.
IV. Future Prospects
The ADR is a mechanism with good potential for listed foreign companies. Developing an ADR program can benefi t an issuer and can lead to the creation of a number of opportunities for entering the U.S. equity markets. Asian and Chinese companies have established more new sponsored ADRs than the companies of any other country. Because so many listed Asian and Chinese companies have already created ADR programs, the future prospects for other Asian and Chinese companies seeking to enter the ADR markets look attractive. Furthermore, the recent amendments to the Rule 12g3-2(b) exemption enacted by the SEC should encourage the creation of many new sponsored and unsponsored ADR programs.
Examples of Level I and Level II Asian and Chinese ADR issuers represented by the author
(In Alphabetical Order)
- Artel Solutions Group Holdings Limited
- Beijing Beida Jade Bird Universal Sci-Tech Company Limited
- Burwill Holdings Limited
- Chen Hsong Holdings Limited
- China Rich Holdings Ltd.
- ChinaCast Communication Holdings Ltd.
- Chitaly Holdings Ltd.
- Companion Building Material (Holdings) Limited
- Daiwa Associate Holdings Limited
- Digiwave technologies Inc.
- Egana International (Holdings) Ltd.
- Emperor (China Concept) Investments Ltd.
- Emperor International Holdings Ltd.
- Frankie Dominion International Limited
- Fufeng Group Ltd.
- Glorious Sun Enterprises Ltd.
- Golden Resources Development International
- Greater China Technology Group Limited
- Hanny Holdings Ltd.
- HB International Holdings Ltd.
- Heng Fung Holdings Company Limited
- Heng Xin China Holdings Ltd.
- Hong Kong Daily News Holdings Ltd.
- Jinhui Holdings Company Ltd.
- Jinhui Shipping and Transportation Limited
- K. Wah Construction Materials Ltd.
- K. Wah International Holdings Ltd.
- Kenfair International (Holdings) Ltd.
- Kingboard Chemical Holdings Limited
- King Pacific International Holdings Ltd.
- Lai Sun Development Company Ltd.
- Legend Holdings Limited
- Magician Industries (Holdings) Limited
- Moulin International Holdings Ltd.
- Ngai Hing Hong Company Limited
- Onfem Holdings Ltd.
- Pacific Andes International Holdi
- Pan Sino International Holding Limited
- Paul Y.-ITC Construction Holdings Limited
- Recor Holdings Ltd.
- S-Oil Corporation
- Shandong Luoxin Pharmacy Stock Co. Ltd.
- Shanghai Wai Gaoqiao Free Trade Zone Development Co. Ltd.
- Shenzhen Special Economic Zone Real Estate and Properties (Group) Co. Ltd.
- Smartone Telecommunications Holdings Limited
- Star Telecom International Holding Limited
- Techtronics Industries Co. Ltd.
- Theme International Holdings Ltd.
- Thiz Technology Group Ltd.
- Tomorrow International Holdings Limited
- Truly International Holdings Ltd.
- Tung Fong Hung (Holdings) Limited
- Universal Holdings Ltd.
- Vodatel Networks Holdings Limited
- Yeebo (International Holdings) Ltd.
(In addition to the above, Winston & Strawn LLP is assisting a number of Chinese issuers to establish their level I ADR programs.)