Sarbanes-Oxley may be a cloud hanging over a lot of foreign issuers on US exchanges, but Asia seems hardly to have noticed. Sox certainly didn’t deter the ten Chinese tech stocks that listed American depositary receipts (ADRs) on Nasdaq in the year to September, or the dozen or so still in the pipeline. Section 404 didn’t scare off one of the largest ever venture cap-backed IPOs, Shanghai chip maker SMIC, which last year dual-listed in Hong Kong and on the NYSE, raising $1.8 bn and surpassing even Google. Nor did the type of shareholder litigation faced by China Life and China Mobile stop China’s own version of Google, Baidu, from climbing more than 350 percent on its first day of Nasdaq trading in August.
And no amount of SEC fine print could slow Taiwan’s Chunghwa Telecom, which in August raised $2.56 bn in a secondary offering on the NYSE – the largest ever ADR capital raising from Asia and the second largest from anywhere.
‘Sox actually helped us,’ says Fufu Shen, head of IR at Chunghwa Telecom. ‘We were preparing for years before we listed on the NYSE, so the new requirements developed gradually. I know there are lots of Sox constraints, but the review we conducted gives investors more confidence.’
Christopher Sturdy, managing director and head of the Bank of New York’s depositary receipt division, says US investor interest in Asian stocks has been growing for years, with a substantial inflow of capital continuing through 2005.
‘One reason Asian issuers can’t ignore US investors is that US investors are actively looking for Asian issuers,’ he explains. In part this trend is a result of the quest for growth. ‘US investors may feel they’re overweight in slower-growth European companies and want to get into higher-growth companies in Asia,’ Sturdy continues. ‘Sometimes we can actually see the movement – a fund gets out of a European ADR and the money goes straight into an Asian one.’
Why ADRs?
Some pundits – among them IR magazine – have long sounded the death knell for ADRs as domestic markets have opened up to US investors. The Hong Kong market, for example, is easy and cheap to access, while a growing number of qualified foreign institutional investors (QFIIs) can access China’s A-share market. So why don’t Asian issuers sit tight and let US investors come to them?
Regional domestic markets have also seen large offerings in 2005, and they will continue to do so. ‘But that doesn’t mean issuers will ignore overseas pools of capital,’ notes David Russell, Asia-Pacific director at Citibank Depositary Receipt Services. ‘A Taiwan tech company may be able to raise all its capital locally, but if it has customers, suppliers and employees in the US, why not raise money there?’
Besides, not all US investors are able or willing to trade on Asian exchanges. ‘There are literally hundreds of sector-style fund managers that do not have QFII status,’ says Kenneth Tse, head of Asia-Pacific ADRs at JPMorgan Chase. ‘Even within large global fund families, there are individual funds that are not allowed by their charters to buy non-US listed shares, and buying ADRs is the most economical route for them to get international equities exposure. Even for foreign investors that can buy Asian shares in the local markets without foreign ownership restrictions, many still prefer to trade on the US stock exchanges and in their own time zone.’
Consider two key types of investor that rely on ADRs, and not just the classic example of US pension funds, which can hold only US-listed securities. Separately managed accounts (also known as ‘wrap’ accounts) and hedge funds have been growing in leaps and bounds, and in both cases fund managers prefer US-listed securities over domestically listed ordinary shares. ‘They have to use DRs to be cost-effective,’ Sturdy points out.
Rush to Nasdaq
Certainly, new NYSE-listed ADRs have been thin on the ground over the last year, continuing a slowdown triggered by delayed though still looming Sox deadlines, but Nasdaq listings have been coming thick and fast. And secondary capital raising has been healthy: Asia-Pacific, excluding Japan, raised $10.8 bn in DR form up to September, compared with $6.7 bn in the whole of 2004, according to Citibank.
Chris Kearns, the Bank of New York’s regional director for North Asia DRs, explains the healthy flow of Asian tech companies. ‘Many of the new listings over the past 18 months have been relatively small entrepreneurial tech companies funded by predominantly US venture-cap firms, and part of the exit strategy is a Nasdaq listing,’ he says. ‘After all, US investors still value tech companies more highly than their counterparts around the world, and the venture-cap firms want the quickest, cleanest way out.’
‘We gave serious consideration to all our options, including a dual listing,’ says Donglei Zhou, director of IR at Shanghai-based online gaming company Shanda Interactive Entertainment, which was one of the two best performing US IPOs in 2004 (the other was China’s 51job). ‘Most of our peers in the Chinese internet space were trading on Nasdaq at the time, and US investors are just more familiar with the concept. In fact they’re more appreciative of technology companies overall, whereas in Asia investors still tend to give tech companies a lower valuation compared with the traditional sector companies that dominate the Hong Kong market.’
For Shanghai’s Focus Media Holding, which raised $172 mn on Nasdaq in July, an ADR does more than just attract investors: it also attracts advertisers to its network of TV screens in offices and other commercial sites across China.
‘One reason we listed on Nasdaq was to raise our international profile and support our business,’ says Jie Chen, investor relations manager at Focus. ‘Companies are somehow suffering from credibility problems in China, but our successful US listing shows that our financials are audited and we have strong corporate governance. That will also help attract more international advertisers to our network.’
Larger Asian companies, swelled by continuing economic growth, also need to be compared with their counterparts traded in the US. ‘These companies are leaders globally, not just in Asia,’ says Tse. ‘It makes sense for these stocks to trade alongside their peers on the US stock exchanges.’
There are other good reasons why issuers from some Asian countries will continue to use DRs. ‘Underwriting rules in some domestic markets are still tipped against mega-offerings,’ explains Russell. ‘Hong Kong, for example, has reasonably standard international underwriting rules but in Korea, Taiwan and India, local underwriting rules can restrict the allocation of stock to foreign institutional investors. DRs can help issuers from these countries target institutional investors with large chunks of stock.’
Sox challenge
Still, Sox has been an obstacle if not a roadblock. The US-listed DR market saw only eight new programs in the first half of 2005 compared with 22 new global depositary receipts (GDRs) listed on the London and Luxembourg exchanges. ‘It’s one of our busiest years ever for GDRs,’ Russell says. ‘But without a doubt, big-ticket US-listed ADRs have had a number of setbacks, largely due to Sox. The China pipeline has been particularly affected.’
Russell admits to hearing some concerns about the costs involved in complying with Sox, but he hasn’t heard of any major problems among existing issuers. ‘Remember, many Asian DR issuers were recently privatized, and there is no more traumatic event in the life of a company,’ he says. ‘It’s the same for firms from other emerging markets: having just started complying with US Gaap fairly recently, they’re saying, OK, we’ll comply with Sox, too. European firms seem focused on Sox, but for Asian companies it’s not a big concern.’
While complaints about Sox from European ADR issuers have been rife, Asian companies, like their Latin American counterparts, have been stoically accepting. ‘There has been much greater acquiescence in Asia than in Europe or the US,’ Sturdy says. ‘Clearly some companies want to avoid US regulations and costs. But others want to demonstrate they can keep up with the highest and most rigorous standards.’
He also expects Sox difficulties to diminish, partly through experience and, perhaps more significantly, because of better Public Company Accounting Oversight Board (PCAOB) guidance for auditing firms, released in May 2005. The second round of Section 404 compliance could cost 40 percent less for some US companies, for example, according to a March 2005 survey by Financial Executives International (FEI).
‘We were aware of Sox and the possible costs when we went for our US listing,’ Chen says. ‘We have built an internal auditing team and appropriate corporate governance system to comply with SEC regulations.’
For that matter, Sox-like regulations – particularly the EU directives – are spreading round the world. ‘GDR issuers will have to meet additional requirements to maintain a listing on an EU stock exchange,’ Tse says. ‘Meanwhile, the adoption of international financial reporting standards (IFRS) by an increasing number of countries means reconciliation to US Gaap should, over time, become less onerous. That’s a positive factor for the ADR market.’
‘Other regulators are raising the bar,’ agrees Sturdy. ‘New ADRs will pick up.’ He predicts that China and India will continue to contribute new ADRs and Korean issuance will pick up as its economy recovers. Japan, he says, is a hotbed of possibilities. Japanese companies have seen US investment growing ‘exponentially’ and they recognize the need for more presence in the US. Kearns adds that the pipeline of new NYSE-listed ADRs from Asia, largely dry for the past year, will resume with programs for Chinese companies in more traditional sectors such as retail, oil and gas, industrials and banking.
As Russell says, don’t write off ADRs yet. Or as Shen puts it: ‘An ADR is something that most global companies aim for. Quite simply, it’s an honor to be listed in the US.’
