Depositary receipts set to shine in era of mega trades

Published: February 2, 2018

Depositary receipts are facing a swell of potentially jumbo sized transactions from markets that are only just now opening to international investors, with regulators and bankers alike trying to decipher the best way to capture the rush of activity.

Companies raised around US$5.5bn in capital via depositary receipts (DR) by the end of the third quarter of 2017 according to Deutsche Bank, and multiple bankers expect this figure to climb to US$10bn by the end of the year. This will be higher than the more than US$8bn that was raised in 2016, according to BNY Mellon figures.

However, the domicile of companies looking to use depositary receipts is changing.

“New markets are coming online and the depositary receipt product can be one of the main considerations,” Scott Pollak, managing director, global product and capital market solutions head, depositary receipt services at Citi told EMEA Finance. “There are markets that are yet to open up to the product and that’s exciting for us.”{mprestriction ids=“*”}

The big market that looks to be offering the clearest new opportunities for the product is Saudi Arabia. The oil rich Kingdom has leapt onto the international financial stage in the last 12 months to patch up the gaps in its economy after the price of oil plunged to around US$55 a barrel.

The Saudi sovereign has raised more than US$30bn from the bond market after debuting in October 2016, and for the last year the state has been exploring the best way to launch an initial public offering for the jewel in the sovereign’s crown, the state owned oil company Saudi Aramco.

This will almost certainly require DRs to achieve, given that the sovereign is considering an initial public offering on an international bourse. London is in the running in a trade that will be a boon for the UK capital, which has been through a quiet patch for IPOs in recent years.

“The IPO market for London global depositary receipts (GDRs) has been quiet largely because London is the historic home for emerging market issuers, led by Russians,” Anthony Moro, head of EMEA depositary receipts at BNY Mellon, told EMEA Finance. “London, however, is only a small slice of the depositary receipt IPO market.”


London calling
Nonetheless, the City is working to secure Saudi business at all levels. The UK’s regulator, the Financial Conduct Authority (FCA), has a proposal to create a new premium listing category to use rather than the existing standard category for sovereign controlled companies. Premium listings are subject to the UK’s highest standards of regulation, which are above the European Union’s minimum. The premium stamp acts as a confidence builder for investors.

“If the regulatory environment is appropriate,” said Moro, “issuers will come to market and it’s important to understand that regulators are consistently assessing their markets.”

The FCAs proposal suggests allowing sovereign controlled companies list on the London Stock Exchange in a special category that would not consider the sovereign shareholder to be a related party for the purposes of UK listing rules, and to waive the rules for controlling shareholders if that shareholder is a sovereign.

“Sovereign owners are different from private sector individuals or companies – both in their motivations and in their nature,” said Andrew Bailey, FCA chief executive officer. “Investors have long recognised this and capital markets are well adapted to assess the treatment of other investors by sovereign countries.”

When the FCA announced the proposals in July, investors were quick to raise their concerns that the regulator was willing to change its own rules to attract business from one company.

“Regulatory protections for investors lie at the core of the listing regime,” said Bailey at the FCA. “However, it is important that these protections remain well-targeted. Refining the listing regime in this way would make UK markets more accessible whilst ensuring that the protections afforded by our premium listing regime are focused and proportionate.”

The proposal will also allow depositary receipts to list on London’s premium market for the first time. A policy statement from the FCA is due in the last quarter of 2017.

“There is a widely rumoured sovereign IPO from the Middle East looking to come to the market,” said Moro at BNY Mellon. “And the FCA’s proposed rules, combined with the widely accepted cross-border depositary receipt structure, would structurally allow that deal to happen on the LSE.”

Recent history suggests that getting it right from a regulatory standpoint could be a huge win for the London Stock Exchange. In 2014, Chinese e-commerce company Alibaba used DRs to raise US$25bn in New York in the largest IPO ever. Aramco’s IPO is expected to rival Alibaba in size, with Saudi officials valuing the company at US$2 trillion, potentially making it the biggest public company in the world.

Of course, Saudi Aramco is just one company and DR bankers are working hard to encourage other private names to go public.

“A lot of it is educating the advisor communities, lawyers as well,” said Zafar Aziz, director, head of DR investor relations advisory group at Deutsche Bank. “If they know it’s a tried and tested route to raise capital, they will likely consider trying it.”


Pent up demand
2016 was lacklustre in EMEA, with few London IPOs, for example. However, the muted market led to increased demand this year.

“Last year there were lots of disruptors in the market place, but this meant there was lot of pent up demand this year,” said Pollak at Citi, who puts capital raising in the EMEA region at US$1.1bn for the first half of 2017. 

“That’s 133% up year-on-year,” said Pollak. “The encouraging sign is that the market remains robust and the pipeline materialises.”

In total, 13 EMEA companies completed DR capital raisings in the first half of 2017, a 160% increase from the same period the previous year and accounting for more than half of the 24 companies to raise capital via DR globally between January and June 2017, according to Citi figures.

Pharmaceutical sector DRs were the most actively traded in EMEA in 2016, with US$290.3bn of DRs in the sector changing hands, according to BNY Mellon. Israel’s Teva made up a large portion of that, with US$88bn traded in 2016. 

And it was the pharma sector that provided the EMEA region’s largest DR IPOs in the first half of 2017, according to Citi, with the Netherland’s Argenx raising US$115mn and the UK’s Verona Pharma US$88mn the fifth and sixth largest IPOs globally in the time frame.

The UK market was the busiest for the US$1.3 trillion of DRs traded in 2016, accounting for US$421bn. The next busiest single market was the Netherlands, which saw US$148.2bn traded. 

Institutional investors held US$850bn of DRs at the end of June 2017, with mutual funds accounting for about 81% of the DR value held, according to Citi.

For the first half of 2017, 44% of total traded value and 46% of total trading volume was completed in EMEA - though overall volumes are down 10% year-on-year.

Nonetheless, all the bankers spoken to for this article agreed that China, not EMEA, was the major hotspot for DR business in the near future.

“The market has dropped in EMEA and has risen in Asia, China in particular,” said Aziz at Deutsche Bank.

While the value traded in Asia Pacific was lower than EMEA last year at US$1.2trn, according to BNY Mellon, the vast bulk of that, some US$825.6bn, was in China. Alibaba made up US$315bn of the total.

“The DR market is very active but has shifted East because there is a big supply in Asia from sectors such as online education, e-commerce and fintech,” said Aziz at Deutsche Bank.

Other busy sectors bankers highlighted include biotech and logistics.


Driving acquisitions
Another avenue DR bankers have been pursuing is encouraging companies to raise capital via DRs for event driven uses, such as acquisitions. 

This was seen when UK technology company Micro Focus International financed the merger of its wholly owned subsidiary with US firm Seattle SpinCo in early September. Deutsche Bank was hired as the depositary bank for the ADR programme following the transaction.

“The recent transaction […] shows that DRs can be used as an acquisition currency,” said Aziz. “If a company wishes to acquire a US company, then using the DR route is a well-trodden path.”

The US DR market has been bolstered substantially by the passing of the Jumpstart Our Business Startups Act, known colloquially as the Jobs Act, in 2012, which lets smaller companies jump through fewer regulatory hoops to access securities markets.

“We are seeing a lot of American depositary receipt offerings,” said Moro at BNY Mellon. “The US markets are keeping us busy, particularly with several capital raises under the Jobs Act. The Jobs Act has brought many issuers to come to the market by reducing the regulatory burden for certain companies.”

All of the banks interviewed for this article have added a litany of companies as clients to their ADR business this year. In September and early October alone, BNY Mellon convinced Germany’s BASF and the UK’s Orange to use it for ADR programmes, Citi added the UK’s Nightstar Therapeutics and NuCana for ADR programmes and Deutsche Bank was appointed ADR depositary bank for the UK’s Micro Focus and China’s Secoo Holding.


Central bank anxiety
While the market is rosy for DRs for now, the same iceberg floats on the horizon for DRs as it does many other financial products – a tightening of monetary policy from the world’s central banks. 

“A gradual repricing of rates should not prove disruptive for risk assets,” said Deutsche Bank in a DR research note, “as it reflects a strong macro backdrop.”

However, the key word there is “gradual”. Sharply rising inflation could cause central banks to act more aggressively than the market expects.

These worries were in sharp focus in mid-October in the UK, when the previous month’s consumer price index was shown to have reached 3%, a level not seen since April 2012 and just shy of the 3.1% threshold that would require the governor of the Bank of England to write to the chancellor to explain why inflation is so far from the central bank’s 2% target.

“The UK’s relative economic strength post Brexit has now waned as consumers begin to feel the impact of rising inflation,” said Emmanuel Lumineau, chief executive officer of investment platform BrickVest. “Higher interest rates should be coming for the first time in more than a decade.”

The fall in the value of the pound since 2016’s Brexit vote was given as a main reason, as the cost of imported goods has shot up. 

“A sharp rise in rates, precipitated by a more meaningful pickup in inflation which reveals that central banks may be behind the curve, could be highly disruptive to asset pricing generally,” said Deutsche Bank. “2013’s taper tantrum provides an example, with US rates rising 140bp in eight months and wiping billions off risk asset valuations.” {/mprestriction}