ADRs for Listed Asian and Chinese Companies: First Road to the U.S. Equity Markets (updated 6.2006)

03.25.2002

Introduction

What do S-Oil Corporation, Legend Holdings Limited, and Truly International Holdings Limited (diverse listed Asian 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 recent ADR programs our law firm worked on.

I. ADR Overview

The ADRs, invented in 1927, gave American investors their first 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 certificates 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).

Few unsponsored ADR programs are established anymore. 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-fledged 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 first 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 first 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-affiliated shareholders of an Asian listed company who hold unrestricted shares under U.S. law to enjoy some of the benefits 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 obtain an exemption from registration from the SEC under Rule 12g3-2b of the Securities Exchange Act of 1934 (the "Exchange Act"), negotiate and execute a deposit agreement, and submit a form F-6 (accompanied by relevant disclosures) to 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 benefit from certain name recognition and a heightened profile. 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 which created sponsored Level I ADRs now find 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 firms to make broad disclosures about their operations when registering publicly-traded shares and/or maintaining listings for such securities. Consequently, many listed foreign firms 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 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 significantly 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. Three documents must be filed with the SEC in order to comply with the sponsored Level I ADR regime: a deposit agreement, a form F-6, and a letter requesting exemption from registration under Section 12(g) of the 1934 Securities Exchange Act.

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 Exemption Request Letter: To obtain exemption from registration under the Exchange Act, a foreign issuer must submit a letter, through its U.S. counsel, to the SEC (pursuant to Rule 12g3-2(b) under the Exchange Act) requesting such an exemption. In addition, to satisfy SEC reporting requirements, an issuer must furnish to the SEC, when it submits the exemption letter and as long as the ADR program is in existence, the information already made public, distributed to its shareholders or filed with the exchanges where its securities are listed and made public by such exchange. A schedule of the issuer's home country disclosure requirements must accompany this filing. A final requirement is that all documents be written or summarized in English.
3. The Form F-6 Filing: This filing, 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.

B. Timing

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 benefits mentioned above.

IV. Future Prospects

The ADR is a mechanism with good potential for listed foreign companies. Developing an ADR program can benefit 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.

In the Recent Level I and Level II ADR Programs Represented
by Heller Ehrman White & MaAuliffe LLP for Asian and Chinese Issuers

(In Alphabetical Order)

1. Burwill Holdings Limited
2. Chen Hsong Holdings Limited
3. China Rich Holdings Ltd.
4. Companion Building Material (Holdings) Limited
5. Daiwa Associate Holdings Limited
6. Egana International (Holdings) Ltd.
7. Emperor (China Concept) Investments Ltd.
8. Emperor International Holdings Ltd.
9. Frankie Dominion International Limited
10. Glorious Sun Enterprises Ltd.
11. Golden Resources Development International
12. Greater China Technology Group Limited
13. Hanny Holdings Ltd.
14. HB International Holdings Ltd.
15. Heng Fung Holdings Company Limited
16. Hong Kong Daily News Holdings Ltd.
17. Jinhui Holdings Company Ltd.
18. Jinhui Shipping and Transportation Limited
19. K. Wah Construction Materials Ltd.
20. K. Wah International Holdings Ltd.
21. Kingboard Chemical Holdings Limited
22. King Pacific International Holdings Ltd.
23. Lai Sun Development Company Ltd.
24. Legend Holdings Limited
25. Magician Industries (Holdings) Limited
26. Moulin International Holdings Ltd.
27. Ngai Hing Hong Company Limited
28. Onfem Holdings Ltd.
29. Pacific Andes International Holdings Ltd.
30. Paul Y.-ITC Construction Holdings Limited
31. Recor Holdings Ltd.
32. S-Oil Corporation
33. Shanghai Wai Gaoqiao Free Trade Zone Development Co. Ltd.
34. Shenzhen Special Economic Zone Real Estate and Properties (Group) Co. Ltd.
35. Smartone Telecommunications Holdings Limited
36. Star Telecom International Holding Limited
37. Techtronics Industries Co. Ltd.
38. Theme International Holdings Ltd.
39. Tomorrow International Holdings Limited
40. Truly International Holdings Ltd.
41. Tung Fong Hung (Holdings) Limited
42. Vodatel Networks Holdings Limited
43. Yeebo (International Holdings) Ltd.

(In addition to the above, Heller Ehrman is assisting a number of Chinese issuers awaiting approval for establishing their level I ADR programs.)

By Simon Luk (Hong Kong)