DRs Or Local Market Access?

Terry Flanagan

Depository receipts spike in popularity among buy-side traders, so what does that mean for local providers?.

It doesn’t come as a surprise that market participants are looking to gain access to the emerging and frontier markets. Better growth prospects and rising currency appreciation are just a few reasons for increasing investors’ attention. Yet, facilitating trades that will allow U.S. traders to access these non-developed markets is a process that’s constantly being revamped.

At the end of 2011, over $14 Billion was raised by corporate issuers using depositary receipts (DRs). DR Trading volume hit a recent high, according to J.P. Morgan.

“The year-on-year growth in DR trading volume and value shows the continued popularity of depositary receipts with issuers and investors even during challenging times within the global capital markets,” said Dennis Bon, global head of J.P. Morgan’s DR business.”

Local depositary receipts are expected to rise in trading volume in the “BRIC” countries, Brazil, Russia, India, and China—the emerging mecca. The region continued to dominate capital raising, accounting for more than 76% of IPO (initial public offering) capital raised and 70% of follow-on capital. As a result, DR trading volume hit a new record within these markets, increasing 16% in the first 11 months of 2011, compared with the same period in 2010. In 2011, 91 issuers from 27 countries created new sponsored DR programs.

Bon expects frontier markets, such as Nigeria and Mongolia will spearhead DR trading growth in 2012.

What does that mean for local market access providers in these respective DR-friendly markets? They may need to add significant value to entice buy-side traders spend the extra cost of trading locally.

“Investors are accustomed to the American depositary receipts program,” says Nuno Da Silva, head of Latin America depositary receipts at BNY Mellon. “Latin American ADRs often have higher trading volume than the local shares.”

Brazil leads the path for top ADRs listed on the New York Stock Exchange, with oil titans Vale and Petrobras leading the way. Eighty percent of ADR trading is done via Brazilian companies, with Mexico coming in second at 14%.

“We’re currently not investing with local market providers down in Brazil because we’re in the same time zone and I can just buy an ADR on one of the big companies,” said a buy-side source.

Others might feel differently, such as Michael J. Levas, director of trading for Olympian Capital. “We’re not currently working with local brokers, but we’re trying to establish connections with the local desks down there,” he said.

Perhaps an important point to consider is that DR vs. trading locally is not an “either/or proposition,” according to Bon of J.P. Morgan.

“With the growth in trading volumes, returns and wealth in many emerging markets, being able to trade in these markets is fundamental to any global investing strategy. All large firms have both the interest and need to transact in locals,” he told Markets Media. “Different funds at these firms have different objectives, investment horizons and constraints in which they must trade…firms still have mandates that require holding U.S. securities.”

Generally speaking, as local regulators open doors to investors and local markets are becoming more sophisticated, the investment pie or opportunities to invest, have grown globally, Bon noted.

The BMF Bovespa, Brazil’s largest and consolidated equity and futures exchange experienced the largest boost on trading volume–$15 billion—shares traded, last August, at the height of the U.S. market volatility.

While foreign investors can access Latin America for cheap through DRs, there are some local brokers that are focused on the region’s burgeoning domestic appetite for investing.

“There are small local brokers, strong in retail and without international ambitions,” said Philippe Carré, global head of connectivity for SunGard Capital Markets, in FTSE Global Markets.

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