The Hindu Business Line : ADR premium over underlying shares re-emerged in 2006: Study

Kolkata May 11 The RBI's efforts to realign ADR prices and bring down premia levels through introduction of a limited two-way fungibility in February 2002 have not achieved the targeted results as the premiums over the underlying shares continued to move up till 2004 and re-emerged in 2006.

A decline in premiums in 2005, however, seem unrelated to the fungibility criterion, noted Ms Sudipa Majumdar of the monetary research project of ICRA in a study on the US listings by the India Inc.

In this recent ICRA research, based on the contemporary capital market developments, Ms Majumdar noted that the trend up to August 2006 suggested "existence of positive premia levels" of the ADRs over the underlying domestic securities.

2005, an Exception

The 2005 experience was an exception, ICRA researcher suggested.

The decline in premia was evident only in 2005, but this convergence in prices was not associated with the fungibility facility as the ADR premia level showed positive relation with the S&P 500 index, she argued.

Also, the returns on ADRs were related positively to the returns on the US market index, while the relation with the Indian index was unclear and inconclusive, the research paper said.

As the stocks continued to trade at higher prices in the US than the domestic market "re-conversion was not possible" and the two-way conversion did not actually open up arbitrage opportunities, Ms Majumdar concluded.

Indian companies started running their exchange traded ADRs as one-way programmes in 1999 with listing of Infosys on the Nasdaq. Incidentally, the RBI's move had placed Indian ADRs in the same league with Korean and Taiwanese securities with restrictive ADR programmes.

The conversion to limited two-way programmes meant the re-issuance of ADRs once cancelled is restricted by the initial offering size. Subsequent sale of ADRs is not subject to capital gains taxes here, but the dividends are. Moreover, the depository bank incurs foreign exchange transaction costs in conversions.

An FII in India is currently allowed to place an order with an Indian broker to buy local shares, with an intention to convert them into DRs. The broker has to obtain approval for the order after a verification process with the domestic custodian bank.

Identical asset trading in two different markets should theoretically trade at the same price. If the prices differ, a profitable opportunity arises to sell asset where it is overpriced and buy it back where it is under-priced. This gives rise to arbitrage opportunities.

Higher liquidity

The ICRA research did not find any conclusive effect of foreign listing on domestic shares prices, but there was a definite increase in trading volumes in the home market during the 100 trading days after their foreign listing. This was a confirmation, ICRA study observed, that overseas listing helped to increase liquidity.

Another interesting ICRA finding was that in the post-ADR 100-day period, increase in volume on the Dalal Street appeared to have had a magnifying effect on traded quantity of the stock on Wall Street.

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