FNCE 4070 Financial Markets and Institutions

1
FNCE 4070Financial Markets and Institutions

• Lecture 9
• Global Equity Markets

2
Trends in Global Equity and Bond Markets, 2001 -
2009
3
Trends in U.S. Equity and Corporate Bond
Markets, 1983 - 2009
4
Contemporary Developments in Global Equity Markets

• (1) Stock exchanges becoming public traded
  organizations
• Historically stock markets were private
  organizations.
• However, in February of 2001 Germanys stock
  exchange, the Deutsche Stock Exchange went
  public
• In July of 2001, both the London Stock Exchange
  and Euronext went public
• In 2006, the NYSE went public.
• Visit
• http//finance.yahoo.com/q?sNYXql0
• http//finance.yahoo.com/q?sLSE.Lql0
• http//finance.yahoo.com/q?sDB1.DE
• http//finance.yahoo.com/q/bc?t1ysNYXlonzl
  qlclse.l
• Implications of publically traded exchanges
• Inclusion in investor portfolios.
• Possibility of take-overs

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Global Equity Markets

• (2) Consolidations (mergers and acquisitions)
  among independent stock exchanges.
• On September 22, 2000, Euronext Stock Exchange
  was formed through the merger of the national
  stock exchanges of France, Belgium, and the
  Netherlands. In December 2001, Euronext acquired
  the shares of the London International Financial
  Futures and Options Exchange (LIFFE), in 2002 it
  acquired the Portuguese Stock Exchange.
• On April 4, 2007, the New York Stock Exchange and
  Euronext merged to form NYSE Euronext.
• In February 2011, NYSE Euronext and Deutsche
  Börse announce that they were engaged in
  "advanced merger talks.
• On April 1st, NASDAQ countered with a higher bid
  for NYSE Euronext (19 over Deutsches offer)
  however, the offer is rejected by NYSE Euronext
  as not strategically attractive.

6
Stock Exchange Consolidations

• In 2006 and 2007 NASDAQ twice attempted a hostile
  takeover of the London Stock Exchange.
• Both takeover attempts were rejected by LSE
  shareholders.
• In late 2010, Singapore offered to buy out the
  Australian Securities Exchange for 7.8 billion
• The offer was recently rejected by the Australian
  Government.
• In February 2011, the London Stock Exchange
  announced a merger with the Toronto Stock
  Exchange.
• Why are exchanges merging?
• (1) cost reductions (to the exchanges themselves
  through economies of scale).
• (2) to expand global capital raising benefits
  (IPOs) to corporations and
• (3) to provide liquidity (turnover) and global
  outreach benefits to investors.

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Global Equity Market Recent Trends

• (3) Increasing number of national stock markets
  around the world.
• John Thain, 2006, CEO, NYSE Most countries
  have an army, a flag, an airline, and a stock
  exchange.
• Today there are approximately 300 stock
  exchanges.
• Many emerging countries have their own stock
  markets.
• Part of their privatization process.
• For links to many of the worlds stock markets
  see http//www.tdd.lt/slnews/Stock_Exchanges/Stoc
  k.Exchanges.html
• (4) Declining share of U.S. equity market as
  stock markets in other countries have increased.
• U.S. share down to 31 in 2009 compared to 66
  in 1950.
• However, U.S. exchanges still dominate (see next
  slide).

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Ranking of Exchanges by Market Capitalization of
Listed Companies
9
Ranking of Exchanges by IPOs
10
Global Equity Markets

• (5) Companies are listing their common stock on
  foreign stock markets as well as their home stock
  market. Referred to as cross listing.
• Examples of cross listings
• Citigroup lists its stock on both the NYSE and
  the Tokyo Stock Exchange .
• Sony Corporation lists its shares on the Tokyo
  Stock Exchange, the NYSE and the London Stock
  Exchange.
• Cross listing can take the form of either a
  direct listing (i.e., actual shares) or a
  depository receipt program.
• Depository Receipt Programs
• American Depository Receipt (ADR) allows foreign
  companies to cross list on U.S. exchanges.
• Global Depository Receipt (GDR) allows foreign
  companies to cross list on foreign exchanges,
  other than U.S. exchanges.

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Depository Receipt Programs

• At the most fundamental level, a Depositary
  Receipt represents ownership of equity shares in
  a foreign company. These receipts are issued
  against ordinary shares held in custody in the
  issuer's home market.
• Each depositary share issued represents a certain
  number of underlying shares held in custody in
  the issuer's home market. Ratios will vary based
  upon the share price of the underlying shares
  and, in the case of an ADR, the US share price of
  other companies in that industry.
• DRs can be listed on a major exchange (e.g.,
  NYSE, AMEX, NASDAQ in the U.S. London,
  Luxembourg, or Singapore outside of the U.S.).
  DRs may also trade in the over-the-counter (OTC)
  markets, or be privately-placed.
• The currency risk associated with investments in
  foreign companies is not eliminated since DR
  denominations match the currency of the market in
  which they trade.

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Cross Listing through Depository Receipts

• Creating a Depository Receipt Program
• Step 1 The underlying shares of a foreign
  company (e.g., a Japanese company) are acquired
  by a custodian bank in that foreign country.
• Sponsored receipts shares provided by company.
• Unsponsored receipts shares purchased by
  custodian bank.
• Step 2 A depository bank in the home country
  (e.g., the United States) then issues a
  depositary receipt which represents a claim
  against the underlying shares held in the local
  market (e.g., in Japan)
• Often times the custodian bank will be a branch
  of the depository bank.
• In the U.S. the major depository banks (April
  2009 data) are Bank of New York (1,732 programs)
  Citibank (322) and JP Morgan (250)
• Step 3 Once issued, these certificates can trade
  in the home countrys financial market (e.g., in
  the United States)
• In the U.S., on the NYSE, American stock exchange
  or NASDAQ.
• The Depositary Receipt certificate also states
  the responsibilities of the depositary bank with
  respect to actions such as payment of dividends,
  voting at shareholder meetings, and handling of
  rights offerings

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World Wide Depository Receipt Programs, April 21,
2009

• Total 3,180
• Trading in U.S markets 2,123 (66.8)
• Trading in London 192
• Trading in Luxembourg 166
• Issued on behalf of companies from
• Japan 290
• India 273
• U.K. 229
• China 171
• Brazil 133
• Sponsored 2096
• Unsponsored 1084
• Source (JP Morgan) http//www.adr.com/BrokerInve
  stor/drsearch.aspx

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American Depository Receipts

• ADRs first traded in the U.S. in 1927, when JP
  Morgan listed the U.K. company, Selfridge's.
• Initially seen as a means of reducing the risk
  associated with holding shares overseas and also
  reducing the trading (clearing) times for
  American investors.
• Depositary receipt volume currently account for
  about 15 of the U.S. equity market.
• Today companies from around 80 countries have ADR
  programs in the United States.
• In order of number of ADR companies by country
  Japan (276), UK (207), Australia (174), China
  (159), India (145).
• Depository banks earn fees from
• The documentation required by home country
  exchanges and regulators (sponsored DR).
• Commissions when the ADR is first sold to
  investors.
• Fees on currency conversion of dividends into
  U.S. dollars.

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American Depository Receipts

• American Depository Receipts (ADRs)
  Certificates that represent ownership of shares
  of foreign companies trading in the United
  States.
• ADRs can be listed on any U.S. exchange, such as
  the NYSE, the American Stock Exchange, and
  NASDAQ. They can also be privately placed as Rule
  144A securities.
• ADRs trade in the United States just like shares
  of domestic companies, with each ADR representing
  some multiple of the underlying foreign shares.
• This multiple arrangement allows ADRs to trade in
  a price range appropriate for the U.S. equity
  market.
• ADRs trade in U.S. dollars and pay dividends in
  U.S. dollars, however, they do not eliminate the
  currency risk associated with an investment in a
  non-U.S. company.
• Reason Underlying shares are trading on foreign
  stock markets in their local currency.

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Examples of ADRs Multiples of Underlying Shares

• COMPANY ADR SHARE RATIO SECTOR (COUNTRY)
• Nissan Motor 1 2 Automobiles (Japan)
• Bridgestone Corp 1 2 Tires (Japan)
• Daiwa Securities 1 10 Financial Services
  (Japan)
• Komatsu 1 4 Machinery (Japan)
• GlaxcoSmithKline 1 2 Pharmaceuticals (U.K.)
• Vodafone 1 10 Telecommunications (U.K.)
• HSBC 1 5 Banking (U.K.)
• Benetton 1 2 Clothing (Italy)
• China Mobile 1 5 Telecommunications (China)
• China Life 1 15 Life Insurance (China)
• TELMEX 1 20 Telecommunications (Mexico)
• Cemex 1 10 Cement (Mexico)
• Telkom 1 4 Communications (South Africa)
• Anglogold 1 1 Gold Mining (South Africa)

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The Price of an ADR

• The price of an ADR corresponds to the price of
  the foreign stock in its home market, adjusted to
  the ratio of the ADRs to foreign company shares.
• The ADR price also reflects the exchange rate
  between the two markets.
• Assume
• ADR ratio of 12 (each ADR represents 2 shares of
  the underlying stock)
• Stock trades in local market at 1,000 yen and the
  exchange rate is 95 yen to the dollar.
• The ADR would trade at (1,000 x 2)/95 21.05

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What Causes the Price of an ADR to Change?

• (1) Changes in the home currency price of the
  foreign company.
• Price risk resulting from changes in the outlook
  for the company.
• (2) Changes in the overall stock market of the
  ADR country.
• Systematic risk.
• (3) Changes in the exchange rate between the U.S.
  dollar and the currency associated with the
  underlying asset.
• Exchange rate risk resulting from unfavorable
  changes in currency values.

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Depository Receipt Web-Site

• Three useful web sites for DR programs are
• Bank of New York
• http//www.adrbnymellon.com/
• JP Morgan
• http//www.adr.com/
• Citibank
• http//www.citiadr.idmanagedsolutions.com/www/fron
  t_page.idms

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DR Benefits for Investors

• Easy to purchase and sell.
• DR trade and settles in the same manner as any
  other security available in the investor's home
  market.
• Facilitates global and sector diversification by
  providing access to new companies in foreign
  markets.
• Enables comparison with other investments due to
  accessible price (and other financial)
  information.
• Pays dividends and delivers corporate action
  notifications in the investor's home currency and
  language.
• And if publicly-listed
• Conforms to home market disclosure and accounting
  requirements.
• Publically traded ADRs must satisfy listing
  requirements for U.S. exchanges and must comply
  with U.S. GAAP and other disclosure and reporting
  requirements (e.g., Sarbanes Oxley).

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DR Trading Volume Billions of s and Trillions of
Shares, 2001 2011 (March)
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Why Do Companies Cross List?

• Impact on share price
• Firms with shares trading in small, less liquid
  markets may see price benefits from cross listing
  in larger secondary markets overseas.
• Increasing the firms visibility to potential
  customers, suppliers and creditors (e.g., banks)
• Increase sales and expand funding opportunities.
• Raising new capital
• Cross listing as part of an IPO in the foreign
  market.
• Starbucks and Sazaby joint venture expansion in
  Japan funded with a 90 billion yen (about 850
  million) IPO (in 2001).
• Cost of capital benefits
• Cross listing can lower a companys cost of
  capital through
• Improving liquidity, better corporate governance,
  and providing direct access to foreign capital
  markets.
• See next slide.

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Impact on Cost of Capital (Data 1970 -1996)

• Country and Region Australia Canada U.K.
  Europe Asia
• Cost of Capital
• Before Listing 13.74 8.17 15.56 8.80 16.15
• After Listing 12.15 7.49 12.91 8.47 14.08
  
• Change -123 -68 -264 -33
  -207
• Change in basis points.
• Source Andrew Karolyi, Financial Markets and
  Institutions, 1998.

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DR Benefits for Companies

• Benefits for Companies

• Capital Raised, Billions of Dollars

• Creates, broadens or diversifies investor base to
  include investors in other capital markets.
• Enhances visibility and global presence among
  investors, consumers and customers.
• Increases liquidity by tapping new investors.
• Offers a new venue for raising equity capital.
• Overseas IPOs

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ADRs Versus GDRs

• Why has this trend occurred?
• The general rise in depth and value of non-U.S.
  Equity markets since 2001
• Sarbanes-Oxley Act (2002)
• More cumbersome and less cost-effective
  regulatory requirements for listed companies have
  discouraged ADR issuance.
• GDRs have presented a more efficient and less
  expensive alternative to U.S.-listed DR programs

Key (1) Total Capital Raised in DR Form
(Right Scale) (in USD
billions). (2) Value of Capital Raised in
DR Component (Left Scale)
Source Citi DR Universal Issuance Guide
26
Examples of U.S. and Japanese Companies Cross
Listed on the London Stock Exchange, April 2009

• U.S. Companies

• Japanese Companies

• Boeing (1990 - 2008)
• Bank of America (1975 - 1996)
• Caterpillar
• Colgate Palmolive
• Ford (1988 - 1995)
• GE (1987 - 1995)
• General Motors (1974 - 1992)
• IBM (1974 - 2005)
• JPMorgan Chase (2001)
• Sara Lee
• Verizon
• Note Those in blue are also cross listed on the
  Tokyo Stock Exchange(and year listed on the TSE)
• Note Those in red were once listed on the TSE
  (with year of listing - delisting)
• Source http//www.londonstockexchange.com/en-gb/p
  ricesnews/prices/Internationalcompanies/

• Honda (NYSE)
• Mitsubishi (OTC)
• Nippon Telephone (NYSE)
• Sony (NYSE)
• Toshiba
• Toyota (NYSE)
• Note Those in blue are also cross listed on an
  exchange in the U.S. (with exchange)
• Source http//www.londonstockexchange.com/en-gb/p
  ricesnews/prices/Internationalcompanies/

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Number of Domestic and Foreign Listed Companies
on Stock Exchanges, November 2008

• Exchange Total Domestic Foreign Foreign
• NYSE 3014 2593 421 14
• NASDAQ 2945 2608 337 11
• American 498 397 101 20
• London 3137 2448 689 22
• Tokyo 2392 2371 21 .8
• Osaka 469 468 1 lt1
• Euronext 1012 1012 0 0
• Frankfurt 835 744 91 11
• Shanghai 863 863 0 0
• Singapore 769 453 311 40
• Total 46678 43611 3067 7
• 51 registered stock exchanges reporting to the
  World Federation of Exchange Source
  http//www.world-exchanges.org/

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Sarbanes Oxley Act of 2002 and Its Impact on
Global Financial Markets

• The Sarbanes-Oxley Act of 2002 is a United States
  federal law enacted on July 30, 2002 in response
  to a number of major U.S. corporate and
  accounting scandals (e.g., Enron)
• Opponents claim that because of its cost
  (estimated at 2 to 3 million annually) and
  heavy regulatory slant, it has reduced America's
  international competitive edge against foreign
  financial service providers (especially when it
  comes to IPOs).
• As one example, it requires that the company's
  "principal officers" (typically the Chief
  Executive Officer and Chief Financial Officer)
  certify and approve the integrity of their
  company financial reports.
• However, the act does not apply to privately held
  companies in the United States.

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NYSE Foreign Company Listings 1956 2008
Impact of SOX?

• Non-U.S. Companies

• of Total

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Milleas Delisting from NASDAQ

• July 5, 2007 (Reuters)
• Japanese insurer Millea Holdings Inc. announced
  it will voluntarily have its shares delisted from
  the U.S. Nasdaq market and stop reporting its
  earnings under U.S. accounting rules to save
  costs.
• Millea said it no longer made sense to pay to
  keep its listing and report under U.S. accounting
  standards given that trading of its shares on
  Nasdaq accounted for only 2 percent of its total
  trading volume over the past 12 months.
• The company said its American Depositary Shares
  (ADS) would be delisted from Nasdaq on July 26,
  2007
• Millea will continue reporting earnings under
  Japanese standards and plans to keep its listings
  on the Tokyo Stock Exchange and the Osaka
  Securities Exchange.
• According to Reuters, several foreign companies
  have recently delisted their shares from U.S.
  exchanges due to the high cost of maintaining a
  listing and complying with the Sarbanes-Oxley
  Act.

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The Tokyo Stock Exchange

• History of Foreign Listings

• End of the Year Data

• The Tokyo Stock Exchange first permitted foreign
  companies to list in 1973.
• 6 companies (5 U.S. companies) listed that year.
• Foreign company listings peaked in December 1991
  at 127 (with U.S. companies at 78)
• By April 2011, the number of foreign companies
  listed had fallen to 12 (with U.S. companies at
  8).
• Last foreign company listing was Citigroup on Nov
  5, 2007.

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Why Have Foreign Companies Delisted from the
Tokyo Stock Exchange?

• Benefits and Cost to List

• Analysis of Benefits

• Potential Benefits
• Investor participation through trading volumes.
• Wealth gains to home country shareholders
  (through increasing liquidity)
• Cost
• Tokyo Stock Exchange Listing fee from 250,000
  to 300,000 and annual costs around 150,000

• (1) Wealth Effects 1994 study (Fry, Lee and
  Choi) found no significant wealth effects for
  U.S. companies listing on the TSE from 1973 to
  1989.
• (2) Trading Volume
• Apple was listed on the TSE exchange on September
  18th, 1990.
• Trading volume on TSE was averaging 1,340 shares
  per day (in 2004).
• Apple delisted on December 25, 2004.

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Citigroup Lists on the Tokyo Stock Exchange

• November 05, 2007
• Citigroup announced that the company's shares
  were being cross listed on the Tokyo Stock
  Exchange (TSE) as "Citi.
• Citigroups announcement included the following
• "Today's TSE listing is a milestone for Citi in
  Japan. In this year alone, we have formed a
  comprehensive strategic alliance with Nikko
  Cordial Corporation, localized our banking
  operations, and now listed on the TSE. In all
  these ways, we have advanced the Citi franchise
  in Japan and positioned it for accelerated
  growth. Our TSE listing is a natural next step in
  Citi's long-term commitment to Japan, which is an
  important part of our global growth strategy.
  Citi is committed to providing our clients in
  Japan with an unrivalled breadth of products and
  services. Citi is also firmly rooted in Japan and
  will strive to contribute to the Japanese economy
  and financial markets.
• Citi's common stock is also listed on the New
  York Stock Exchange and cross listed on the
  Mexican Stock Exchange.

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Is the U.S. Equity Markets Competitive IPO and
Listing Position Declining?

• Some say yes, point to data which show a decline
  in U.S. equity market involvement in
• (1) Foreign stocks listed in the U.S.
• U.S. equity markets have seen a decline in the
  number of foreign companies listings.
• (2) Growth in GDR programs world wide.
• GDRs are certificate issued in more than one
  country for shares in a foreign company (London
  is a large trading market)
• (3) IPO distribution
• In 1999, the American markets accounted for 57
  of world wide IPOs. By 2006, Americas share had
  fallen to 18 to 7 in 2007 and 2 through the
  2Q2008.
• From 2002 through 2007, 80 of the foreign firms
  that did IPOs in the U.S. did so through Rule
  144a private offerings (which escapes Sarbanes
  Oxley).
• See slides which follow for specifics on these
  three factors.

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NYSE Number of Foreign Companies 1990 - 2008
36
Percent of Foreign IPOs in the U.S.
37
Is Americas Competitive Position Really
Declining?

• Some argue no and suggest that the data simply
  suggests that foreign markets have become larger,
  thus encouraging companies to seek IPOs in their
  home markets.
• In addition, trading across borders has become
  easier, thus reducing the usefulness of a
  non-home country listing.
• In essence, the changing U.S. position simply
  represents the changing nature of global
  financial markets.

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Appendix 1

• Stock Exchange Reports to Shareholders

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Publically Traded Stock Exchanges Annual Reports
to Shareholders

• Tokyo Stock Exchange
• http//www.tse.or.jp/english/about/ir/financials/a
  nnual/annual_2007.pdf
• London Stock Exchange
• http//www.northcote.co.uk/company_links/alpha.asp
  ?SIT1ALRLSDLNI01759
• NYSE Euronext
• http//ir.nyse.com/phoenix.zhtml?c129145pirol-r
  eportsAnnual

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Appendix 2

• Studies Involving Cross Listings

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Case Study Wealth Gains from Cross Listing in
Japan

• Study by Fry, Lee and Choi (March 1994, Review of
  Quantitative Finance and Accounting)
• They found that shareholders of U.S. firms that
  listed stock on the Tokyo Stock Exchange from
  1973 to 1989 experienced no significant longer
  term wealth gains. The pattern of the market's
  reaction to a Tokyo listing tracked closely the
  reactions to a domestic listing, where gains
  prior to listing are later erased.
• The findings indicate no advantages to a listing
  for a U.S. firm with a prior business presence in
  Japan.
• The findings are consistent with the integration
  of international capital markets.
• If markets are completely integrated,
  cross-listing a firm's stock in other markets
  should have no impact on stock prices, since
  investors could presumably undertake financial
  market transactions in any market.