What is an American Depository Receipt (ADR)?

An American Depositary Receipt (ADR) is a share of stock of an investment in shares of a non-US corporation. The shares of the non-US corporation trade on a non-US exchange, while the ADRs, perhaps somewhat obviously, trade on a US exchange. This mechanism makes it straightforward for a US investor to invest in a foreign issue. ADRs were first introduced in 1927.

Issuer: Non-U.S. corporations use depositary receipts to raise capital, establish brand equity in the U.S. and improve share valuation.
Investors: U.S. investors can use depositary receipts as a convenient means to achieve portfolio diversification through global investment.
Banks: Two banks are generally involved in maintaining an ADR on a US exchange: an investment bank and a depositary bank. The investment bank purchases the foreign shares and offers them for sale in the US. The depositary bank handles the issuance and cancellation of ADRs certificates backed by ordinary shares based on investor orders, as well as other services provided to an issuer of ADRS, but is not involved in selling the ADRs.

How does an ADR work?

  • To establish an ADR, an investment bank/custodian bank arranges to buy the shares on the local market and issue the ADRs on the US markets.
  • For example, Bank of New York Mellon (BoNY Mellon) might purchase 25 million shares of a non-US stock of PT Telekomunikasi Indonesia, Tbk (TELKOM). TELKOM trades on the Indonesia Stock Exchange, where BoNY Mellon bought them. BoNY Mellon would then register with the SEC and offer for sale shares of TELKOM ADRs.
  • TELKOM ADRs are valued in dollars, and BoNY Mellon could apply to the NYSE to list them. In effect, they are repackaged TELKOM shares, backed by TELKOM shares owned by BoNY Mellon, and they would then trade like any other stock on the NYSE.
  • BoNY Mellon would take a management fee for their efforts, and the number of TELKOM shares represented by TELKOM ADRs would effectively decrease, so the price would go down a slight amount; or TELKOM itself might pay BoNY Mellon their fee in return for helping to establish a US market for TELKOM. Naturally, currency fluctuations will affect the US Dollar price of the ADR.

Depositary Receipt Settlement

Example: U.S. Investor purchases DRs on the New York Stock Exchange
1. Investor contacts U.S. broker with instructions to purchase DRs
2. Broker purchases existing DRs on NYSE Or, U.S. broker contacts local broker to purchase equivalent number of shares in the local market
3. Local broker purchases shares in the local stock market
4. Shares are deposited with The Bank of New York’s Mellon local custodian
5. Local custodian credits The Bank of New York’s Mellon account and instructs The Bank of New York Mellon to issue DRs
6. The Bank of New York Mellon delivers DRs to U.S. broker account via DTCC
7. DTC credits DRs to U.S. broker’s account on behalf of the investor

What are the Technical Aspects of ADR?

Dividen: Dividends paid by TELKOM are received by BoNY Mellon and distributed proportionally to TELKOM ADR holders. If TELKOM withholds (foreign) tax on the dividends before this distribution, then BoNY Mellon will withhold a proportional amount before distributing the dividend to ADR holders, and will report on a Form 1099-Div both the gross dividend and the amount of foreign tax withheld.

Proxy: Most of the time the foreign nation permits US holders (BoNY Mellon in this case) to vote their shares on all or most issues, and ADR holders will receive ballots which will be received by BoNY Mellon and voted in proportion to ADR Shareholder's vote. I don't know if BoNY Mellon has the option of voting shares which ADR holders failed to vote.

Ratio: The depositary bank sets the ratio of US ADRs per home country share. This ratio can be anywhere, and can be less than or greater than 1. Basically, it is an attempt to get the ADR within a price that Americans are comfortable with, so upon issue, I would assume that most ADRs range between $15 and $75 per share. If in the home country, the shares are worth considerably less, than each ADR would represent several real shares. If, in the home country, shares were trading for the equivalent of several hundred dollars, each ADR would be only a fraction of a normal share.

Price: Now, concerning who sets the price: yes, it floats on supply and demand. However, if the US price gets too far off from the price in the home country (Accounting for the currency exchange rate and the ratio of ADRs to home

TELKOM’s Depository Receipts in ADR are used to facilitate cross border trading and to raise capital in global equity offerings to US and Non-US Investors

  • Empirical evidence is presented that DR Program add value and improve liquidity to benefit both issuers and investors.
  • DR’s additionally provide from issuers to the US capital markets a strong signal of willing disclosure, greater transparency and superior governance.
  • DR Program provides the US capital market with a strong signal of superior governance, resulting in an enhanced reputation with investors.

What is the Structure and Processes of US Proxy Voting

  • TELKOM (“issuer”) notify Bank of New York Mellon (”Depository”) of an upcoming shareholder meeting.
            -   Inform date of meeting
            -   Request distribution of material and the solicitation of a vote.
            -   Set a US Recording Date to determine those ADR holders who are entitled to submit voting instruction for the meeting.
  • Bank of New York Mellon ascertains the details of those holders by referring to the names registered as DR holders on its book (mostly nominee holder not the beneficial).  

Large proportion of DR holders hold in “Street”

  • The holder listed in the book of Bank of New York Mellon is a “nominee holder” and not the “beneficial owner”.
  • The largest holding of DR’s on the books of the Bank of New York is registered in the name of Cede & Co (“CEDE”).
  • CEDE is the nominee of the Depository Trust and Clearing Corporation (“DTCC”).
  • DTCC is the US clearing agency that provides settlement and clearing services for its participant banks and brokers.

Bank of New York Mellon notifies CEDE of the upcoming meeting and receive from CEDE a record of the participant banks and brokers with position in TELKOM’s

Depository Receipt Proxy Solicitation

  • Upon being notified by Bank of New York Mellon of an upcoming shareholder meeting, DTCC issues an “omnibus proxy” to its participant banks and brokers.
  • Participant banks and brokers notify the beneficial owner of the DR’s that they can exercise their voting power.
  • In order to mail the requisite proxy materials to their clients, virtually all of the banks and broker holdings in street name through CEDE use power of attorney to appoint Automatic Data Processing Inc (“ADP”) as their agent.
  • ADP distributes proxy materials (by using CUSIP number to identify the securities that is eligible to vote at the meeting.

Accumulation of Responses and Tabulation of Vote

  • ADP provides various procedures for the holders to furnish voting instruction (mail, telephone or internet).
  • ADP accumulates the responses and tabulates the votes.
  • When the process is complete, ADP issues an “ADP client proxy” reflecting the total vote in the name of its client banks and brokers.
  • ADP client proxy is delivered to the Bank of New York.
  • The Bank of New York Mellon reconciles the number of voting instruction for each bank and broker client of ADP, with the CEDE omnibus proxy (record date) position for such bank and brokers. 

DR Representative in Meeting

  • Number of DR’s represented by the ADP client proxy, together with the number of DR’s represented by voting instructions received from registered holders are converted by BoNY into ordinary shares to be voted at the TELKOM Shareholder Meeting.
  • Conversion is done by using the appropriate DR to ordinary share ratio 1:40. 

 Posted on September 16, 2009