Lecture 15; Part 2: The International Equity Markets, Trends and Issues

1. Lecture 15; Part 2: The International Equity Markets, Trends and Issues NYSE 1926

2. Where are these Financial Markets? • Indicate Location for A through N K C H A L B N M D G J E I F

3. Opening Statement • For most of the post WW II years, U.S. equity markets had routinely attracted the lion’s share of global equity activity, especially from markets that were themselves considered relatively important (size, liquidity, regulation). • However, following the dramatic evolution in globalization since the early 1990s, an increasing number of alternative financial centers have developed and achieve the level of sophistication needed to attract global equity business.

4. 7 Equity Market Trends and Issues • (1) U.S. Share of Global Equity Markets has been Declining since the 1970s. • (2) Increasing Role of Foreign Stock Markets as a Source of Equity Financing. • (3) Increase in Foreign IPOs Combined with an Increasing Share Outside of the United States. • Foreign IPOs refer to the first sale of stock by a private company to the public outside their home countries. While IPOs are often issued by smaller, younger companies seeking capital to expand, they can also be done by large privately owned companies wishing to raise capital and looking to become publicly traded. IPOs are also referred to as a "public offering". • (4) Increase in Equity Cross-Listings. • Refers to the listing of a company's common shares on a different exchange than its primary and original stock exchange. The term often applies to the listing of foreign-based companies on national exchanges.

5. 7 Trends and Issues • (5) Demutualization of Stock Exchanges. • Refers to the transition of a stock market from a mutual association of exchange members to a limited liability, for-profit company accountable to shareholders. • (6) Increase in Mergers and Acquisitions among Stock Exchanges. • Consolidations among stock exchanges across national borders. • (7) Increase in Electronic Trading. • Refers to a method of trading which brings together buyers and sellers through electronic trading platforms in contrast to floor trading and phone trading.

6. Relative Importance of National Stock Markets: Historical Perspective • In 1899, London was the world’s leading financial center, with an estimated 30% of the global stock market. • The U.S. ranked second with just under 20% but was gaining momentum. Other European countries held significant market caps, namely France and Germany with 14% and 7%, respectively. (Note only 18 countries had “major” stock markets in 1899). • By 1970, the U.S. equity markets accounted for 2/3rds of the world’s total equity market.

7. (1) Rise of Foreign Stock Markets • Beginning in 1985, the market value of foreign stock markets combined exceeded the market value of the U.S. stock market. By 2004, the U.S. share had fallen to 44%, and currently it is just under 30% • Over this time we have seen an unparalleled rise in stock markets around the world. Today, almost every country possess a stock market, and some with multiple markets. • For example: Today India has 23 stock exchanges, trading over 12,000 companies (Sept, 2011).

8. Stock Market Capitalization, By Country, 2011

9. (2) U.S. Share of Equity Financing Has Declined

10. Equity Raised in U.S. and Non-U.S. Public Equity Markets, Billions of $s

11. (3) Global IPOs • “Global IPOs” are IPOs by foreign companies outside their home countries. The U.S. share of Global IPOs has declined since the mid 1990s. This trend is especially telling because foreign companies—more so than U.S. companies—must choose to come to the U.S. • Two measures of Global IPOs: • Narrowly defined: Only public offerings. • Broadly defined: Include both public and private offerings (in the U.S. through Rule 144A)

12. U.S. Share of Narrowly Defined IPOs

13. U.S. Share of Narrowly Defined IPOs: Data, 1996 - 2011

14. U.S. Share of Broadly Defined IPOs

15. U.S. Share of Broadly Defined IPOs: Data, 1996 - 2011

16. U.S. Share of Top 20 Global IPOs

17. U.S. IPOs in Foreign Markets • The willingness of U.S. companies to do their IPOs abroad is a strong indication of the attractiveness of foreign equity markets as a source of equity financing. • Historically, it was highly unusual for a U.S. company to do an IPO entirely outside of the United States, where demand for its shares was usually the highest. • The data, however, show the percentage of IPOs by U.S. companies—both by number and value—that were listed only on a non-U.S. exchange have increased since the mid-1990s.

18. IPOs by U.S. Companies Done Entirely Outside of the U.S.

19. U.S. IPOs Listed Only of Foreign Stock Exchange: Data, 1996 - 2011

20. Global IPOs Jan – Nov 28, 2011 Global IPOs by Volume Percent of Total ($125.8B) U.S.: 24.1% China: 23.5% Hong Kong: 14.0% U.K.: 12.8% Singapore: 5.6% Note: Total number of 2011 Global IPOs to date is 309. A Global IPOs is defined as at least $100 million.

21. (4) Cross Listing of Equity Shares • Cross listing refers to the listing of a company's common shares on a different exchange other than its primary and original stock exchange. In global finance, the term applies to the listing of foreign-based companies on national exchanges other than (and in addition to) its home exchange. • Example of cross listings: • Citigroup currently lists its stock on both the NYSE and the Tokyo Stock Exchange . • Sony Corporation currently lists its shares on the Tokyo Stock Exchange, the NYSE and the London Stock Exchange. • As of March, the number of cross-border listed stocks totaled 3,163 (this represented approximately 7% of the 45,731 companies trading on the world’s 52 major stock exchanges. Source: Federation of Stock Exchanges Monthly Reports).

22. Cross Listings on Stock Exchanges, March 2011

23. Cross Listings for Selected Exchanges

24. 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; thus positive impact on value of the firm. • Increasing the firms visibility to potential customers, suppliers and creditors (e.g., banks and bond markets): • Thus, increase sales and expand funding opportunities. • Raising equity capital: • Cross listing as part of an IPO or secondary offering in the foreign market. • Cost of capital benefits: • Cross listing may lower a company’s cost of capital through: • Improving liquidity, better corporate governance, and providing direct access to foreign capital markets. See next slide.

25. Impact of Cross Listing on Cost of Capital (Data: 1970 -1996) Source: Andrew Karolyi, Financial Markets and Institutions, 1998.

26. Sarbanes Oxley Act of 2002 and Its Impact on Cross Listing in U.S. • 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 relative to foreign financial centers (especially when it comes to IPOs or even cross-listings). • As one example, the act 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.

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

28. Cross Listing on 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 November 2011, the number of foreign companies listed had fallen to 11 (with U.S. companies at 8). • http://www.tse.or.jp/english/listing/foreign/b7gje60000003wsy-att/Listed-delisted-foreign-companies.pdf • Last foreign company listing was Citigroup on Nov 5, 2007.

29. Why Have Foreign Companies Delisted from the Tokyo Stock Exchange? Benefits and Cost to List Analysis of Benefits/Costs (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) Researchers concluded that there were no advantages to a listing for a U.S. firm with a prior business presence in Japan. (3) Additionally, TSE listing costs and annual costs were not justified by relatively low volumes for U.S. companies. Apple was listed on the TSE exchange on September 18, 1990. Trading volume on TSE was averaging 1,340 shares per day (in 2004). Apple delisted on December 25, 2004. • 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

30. Methods of Cross Listing • Cross listing can take the form of either a direct share listing or a depository receipt program. • 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. • Depository Receipt Programs • American Depository Receipt (ADR): arrangement by which foreign companies cross list on U.S. exchanges. • Global Depository Receipt (GDR): arrangement by which foreign companies (including U.S. companies) cross list on foreign exchanges, other than U.S. exchanges.

31. Depository Receipts • A depositary receipt is a claim against specified number of underlying common stock shares. • The DR ratio to the underlying share will vary based upon the local market share price and, in the case of an ADR, the US share price of other companies in similar industries. • DRs can be listed (and traded) on a major exchanges: • For example: NYSE, AMEX, NASDAQ in the U.S. and London, Luxembourg, or Singapore outside of the U.S.. • DRs may also trade in the over-the-counter (OTC) markets, or be privately-placed.

32. Growth in GDRs Versus ADRs Key: (1) Total Capital Raised in DR Form (Right Scale) (in USD billions). (2) % Value of Capital Raised in DR Component (Left Scale) • 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

33. American Depository Receipts • The first ADRs issued and traded in the U.S. occurred in 1927 when JPMorgan listed the retail U.K. company, Selfridge's. • ADRs were initially seen as a means of reducing the risk associated with holding shares overseas and reducing the trading (clearing) times for American investors. • Today companies from around 80 countries have ADR programs in the United States. • Currently, ADR Depositary receipt volume accounts for about 15% of the U.S. equity market.

34. American Depository Receipts • American Depository Receipts (ADRs): Certificates that represent ownership of shares of foreign companies. • ADRs can be listed on any U.S. exchange, such as the NYSE, the American Stock Exchange, or 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. • ADR programs are managed by commercial banks on behalf of foreign companies. • In the U.S. the major depository banks (April 2009 data) are Bank of New York (1,732 programs) Citibank (322 programs) and JP Morgan (250 programs)

35. The Price of an ADR • The price of an ADR trading on a U.S. stock market corresponds to the local currency price of the foreign stock in its home market, adjusted to the ratio of the ADRs to foreign company shares. • Thus, the ADR price also reflects the exchange rate between the two markets. • Example: • ADR ratio of 1:2 for a Japanese company (i.e., each ADR represents 2 shares of the underlying stock) • This stock trades in Japanese market at 1,000 yen per share and the exchange rate is 95 yen to the dollar. • Given this information, this ADR would trade in the U.S. at $21.05 or (1,000 x 2)/95 = $21.05

36. 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. Everything else equal: • A strong foreign currency will increase the price of the ADR. • A weak foreign currency will decrease the price of the ADR.

37. 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)

38. Depository Receipt Web-Site • The 3 major U.S. banks offering DR programs with their web sites are as follows: • (1) JP Morgan: • http://www.adr.com/ • (2) Bank of New York • http://www.adrbnymellon.com/ • (3) Citibank • http://www.citiadr.idmanagedsolutions.com/www/front_page.idms • For a description of the role of commercial banks please refer to Appendix 1

39. ADR Example • Bridgestone: World’s largest tire and rubber company. • Japanese company, founded in 1931 by Shojiro Ishibashi who used an English translation of his surname for the company. Ishibashi = stone bridge. • ADR trades OTC in the United States with an underlying ratio of 1:2 (i.e., 1 adr = 2 shares). Initially listed as an ADR in January 1983. • Visit: • https://www.adr.com/ • https://www.adr.com/DRDetails/Overview?cusip=108441205

40. (5) Demutualization of Stock Exchange Since the turn of this century an increasing number of stock exchanges have become public traded, for profit, organizations Historically stock markets were private organizations. However, in February 2001, Germany’s stock exchange, the Deutsche Stock Exchange went public; In July 2001, both the London Stock Exchange and Euronext went public; On March 8, 2006, the NYSE went public. Visit the following sites: 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 Implications of publically traded exchanges: Inclusion of exchanges in investor portfolios. Facilitates mergers and take-overs (hostile or friendly) of exchanges.

41. (6) Consolidations Among Exchanges On September 22, 2000, the 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. On July 7, 2011, the stockholders of NYSE Euronext agreed to a merger with the Deutsche Exchange Currently, Brussels is examining possible anti-trust issues and has yet to approve the merger. On November 11, 2011, the Tokyo Stock Exchange announced that they had agreed to purchase the Osaka Securities Exchange for $1.68 billion. Merger will be completed by January 2013 and combined company will be called the Japan Exchange Group.

42. Stock Exchange Consolidations • In 2006 and 2007, NASDAQ attempted hostile takeovers of the London Stock Exchange. • Both takeover attempts were rejected by LSE shareholders. • 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.

43. (7) Electronic Trading Systems • Beginning in 1980, stock exchanges with traditional on-exchange trading floors have been moving towards electronic trading systems. • NASDAQ actually began as an electronic (telephone platform) in 1971. • It is assumed that electronic systems provide greater efficiency (including less mistakes), more transparency (quotes can be seen by everyone), greater liquidity (through a wider base of participants), a greater likelihood that buyers and sellers will find one another, and lower costs. • Some of the world’s major exchanges have moved to full electronic trading: • London, 1997.; Tokyo, 1999 • However, the NYSE (US) has yet to move to a full electronic trading platform. Today the NYSE is a blend of an open outcry auction (with traders shouting orders) and electronic trade execution.

44. First 20 Stock Exchanges to Become Fully Electronic

45. Appendix 1 Role of commercial banks in the depository receipt process

46. 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.” • 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

47. Appendix 2 Stock Exchange Reports to Shareholders

48. 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