Fundamentals of Financial Instruments. Sunil K. Parameswaran

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СКАЧАТЬ on the part of investors, have led to rapid integration of equity markets in recent years. Some of the major deregulatory measures in the past two decades are the following:

       On 1st May 1975, the United States abolished fixed brokerage commissions.

       In 1985 the Tokyo Stock Exchange started admitting foreign brokerage firms as members.

       In 1986 the London Stock Exchange (LSE) eliminated fixed brokerage commissions and began admitting foreign brokerage houses as full members. This event is known as the “big bang” in financial circles. These changes were designed to give London an open and competitive international market. Until the end of World War II, London was the center of global financial activity. For obvious reasons, the center of postwar economic activities moved across the Atlantic to New York. London is, however, critical for global financial activities, for it lies in an ideal time zone. The city is located in between the capital markets of North America and those of Singapore and Tokyo. Consequently, it is the middle link for what is effectively a 24-hour market.

       In 1987, financial institutions in London were permitted to participate in both commercial and investment banking.

       In 1999 the Glass-Steagall Act, which sought to segregate commercial and investment banking activities in the United States, was repealed. The Act was a product of the Great Depression and sought to insulate commercial banks from the vagaries of the stock market. Once this Act was enacted, institutions were given a clear choice. Either they could accept deposits and make loans, or they could provide underwriting and broker-dealer services. Thus, US institutions in the business of deposit taking and loan making were precluded from trading and market making in securities. For instance, Morgan Stanley was formed as a splinter from JP Morgan. While JP Morgan continued as a commercial bank, Morgan Stanley went into the areas of securities dealing and investment banking. In 1999 the Financial Services Modernization Act, known as the Gramm-Leach-Bliley Act, did away with this restriction and paved the way for giant financial conglomerates who could undertake both investment banking as well as commercial banking activities.

DUAL LISTING

      Dual or multiple listing allows the shares of a company to be traded on the exchanges of many different countries. Foreign equity is traded in global markets, in the form of Depository Receipts (DRs). On the US exchanges, they are traded in the form of American Depository Receipts (ADRs). Such securities are special shares of foreign equity that are priced in US dollars. The issuance of such assets facilitates the ownership of foreign equity by American residents. An ADR is essentially a receipt issued by a depository bank in the United States that is backed by foreign shares that are deposited with a custodian bank in the country of issue of the original shares. ADRs are quoted and traded in US dollars just like domestic US shares.

      The mechanism of issuing ADRs is as follows. A US depository bank will acquire shares of the foreign company in its domestic market. These shares will then be deposited with a local custodian bank in the foreign country. The US depository bank will then issue ADRs to the investors in the United States, where each ADR will correspond to a specified number of foreign shares.

      Shareholders receive dividends in US dollars. The depository takes on the task of collecting dividends in the foreign currency, converting the dividends to dollars, and making payments.

      An ADR may represent either a fraction or a multiple of the underlying shares, packaged in such a way that it will trade at the appropriate price range in the United States. This can be illustrated with the help of an example.

      EXAMPLE 1.5

      Take the case of a company based in India that is being traded at INR 60.00 per share, at a time when the exchange rate is INR 75 per US dollar. If an ADR were set to be equal to one Indian share, it will trade for approximately 80 cents in the United States. In order to ensure that the ADRs trade at a more respectable price, one ADR may be made equivalent to 10 domestic shares, thereby ensuring that it trades at approximately $8.00.

      On the other hand a share may be trading at a very high price in its home country. For instance, if a share is trading at INR 37,500 in India, it will trade at approximately $500 in the United States, assuming a 1:1 issue ratio and an exchange rate of INR 75 per dollar. In such circumstances one ADR may be set equal to 0.05 Indian shares, thereby ensuring that it trades at approximately $25 in the United States.

The ADR market is growing from the standpoints of both supply as well as demand. Foreign companies are being increasingly attracted to the US market for it is the largest in the world and is arguably the most efficient. Unlike other nations, the United States presents fewer barriers to entry. Compared to other countries the United States has more High-Net-Worth Individuals (HNWIs) who are not only better endowed financially, but are more aware of the benefits of international diversification and willing to take the attendant risks.

      Although an American investor can always acquire a share that is traded on a foreign stock exchange, it is a lot simpler in practice to invest in an ADR. There is no need to locate a foreign broker or be conversant with the systems and practices of a foreign stock exchange and its related institutions. Besides, acquiring a foreign security will expose the investor to exchange rate risk. In most countries reporting standards are not as stringent as those prevalent in the United States. Consequently, companies abroad are able to get away with less disclosure, which may not be adequate for an American. A practical difficulty from the standpoint of trading foreign shares is that such transactions can be undertaken only when the overseas market is open, and the timings of these trading venues usually do not overlap with American market hours.

      One of the advantages of ADRs is that an ADR may offer greater liquidity in the United States than the underlying shares do in their domestic market. Moreover, certain US pension funds and investment managers have a strong preference for ADRs because they are legally required to invest in ADRs while investing in non-US securities. Many institutional investors prefer investing in securities that are listed for trading in the US market rather than investing directly in foreign equity markets.

      In order to list its shares on the exchange of a developed country, the issuing company must meet the securities market regulations of the foreign country as well as those of the stock exchange on which the shares are to be listed. This very often requires the company to comply with stringent disclosure norms. For instance, in order to list on the New York Stock Exchange (NYSE), it is necessary to comply with US GAAP (generally accepted accounting principles). For companies based in developing countries, such compliance has ensured more transparency in their operations, leading to the benefit of not just global investors, but also the domestic shareholders. However, after issues like the ENRON collapse, it is arguable as to whether the disclosure norms in the United States are as commendable and effective as once believed. Besides, many other countries have considerably beefed up their security-related regulations to a large extent, as a response to financial scams and scandals.

Foreign listing provides a multinational corporation (MNC) with indirect advertising for its product brands in the foreign market. It also raises the profile of the company in international capital markets, making it easier for it to raise finances in the future, and provides greater mileage for its international marketing efforts. Take the case of an Indian company which is seeking to raise a bank loan in London. It will have greater credibility in the eyes of the international lending community if it were to be listed on an exchange in the developed world. Besides, when a firm's equity is held by shareholders across the globe, the risk of a hostile takeover of the firm may reduce somewhat.

There could be instances where foreign investors put a higher premium on the issue than do domestic investors. This could be the case, for instance, if the foreign market were to have greater experience in dealing with a particular industry. As Geddes points out, СКАЧАТЬ