FNCE 4070Financial Markets and Institutions

Lecture 9 Global Equity Markets

Trends in Global Equity and Bond Markets, 2001 - 2009

Trends in U.S. Equity and Corporate Bond Markets, 1983 - 2009

Contemporary Developments in Global Equity Markets

(1) Stock exchanges becoming public traded organizations Historically stock markets were private organizations. However, in February of 2001 Germany’s 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?s=NYX&ql=0 http://finance.yahoo.com/q?s=LSE.L&ql=0 http://finance.yahoo.com/q?s=DB1.DE http://finance.yahoo.com/q/bc?

t=1y&s=NYX&l=on&z=l&q=l&c=lse.l Implications of publically traded exchanges:

Inclusion in investor portfolios. Possibility of take-overs

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 Deutsche’s offer); however, the offer is rejected by NYSE Euronext as not “strategically attractive.”

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.

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 world’s stock markets see:

http://www.tdd.lt/slnews/Stock_Exchanges/Stock.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).

Ranking of Exchanges by Market Capitalization of Listed Companies

Ranking of Exchanges by IPOs

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.

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.

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

country’s 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

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/BrokerInvestor/drsearch.aspx

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.

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.

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)

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 1:2 (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

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.

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/

front_page.idms

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).

DR Trading Volume Billions of $s and Trillions of Shares, 2001 – 2011 (March)

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 company’s cost of capital through:

Improving liquidity, better corporate governance, and providing direct access to foreign capital markets.

See next slide.

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.

DR Benefits for CompaniesBenefits for Companies 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

Capital Raised, Billions of Dollars

25

ADRs Versus GDRs

Key: (1) Total Capital Raised in DR Form (Right Scale) (in USD billions).

(2) % Value of Capital Raised in DR Component (Left Scale)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

2H'00-1H'01

2H'01-1H'02

2H'02-1H'03

2H'03-1H'04

2H'04-1H'05

2H'05-1H'06

2H'06-1H'07

2H'07-1H'08

0

10

20

30

40

50

60

% ADRs % GDRs Total DRs Issued

• 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

Source: Citi DR Universal Issuance Guide

Examples of U.S. and Japanese Companies Cross Listed on the London Stock Exchange, April 2009U.S. 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/pricesnews/prices/International+companies/

Japanese Companies

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/pricesnews/prices/International+companies/

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 <1% 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/

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.

NYSE Foreign Company Listings: 1956 – 2008: Impact of SOX?Non-U.S. Companies % of Total

Millea’s 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.

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.

Why Have Foreign Companies Delisted from the Tokyo Stock Exchange?Benefits and Cost to List 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

Analysis of Benefits (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.

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.“ Citigroup’s 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.

Is the U.S. Equity Market’s 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, America’s 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.

NYSE Number of Foreign Companies: 1990 - 2008

Percent of Foreign IPOs in the U.S.

Is America’s 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.

Appendix 1

Stock Exchange Reports to Shareholders

Publically Traded Stock Exchanges: Annual Reports to Shareholders Tokyo Stock Exchange:

http://www.tse.or.jp/english/about/ir/financials/annual/annual_2007.pdf

London Stock Exchange: http://www.northcote.co.uk/company_links/alpha.asp?

SIT=1&ALR=L&SDL=NI01759

NYSE Euronext: http://ir.nyse.com/phoenix.zhtml?c=129145&p=irol-

reportsAnnual

Appendix 2

Studies Involving Cross Listings

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.