Building a bourse for a man of the world

Listing unsponsored depositary receipts for foreign companies on the local bourse, as Elmer Funke Kupper suggests, would greatly benefit the local market… and finally help BHP Billiton and Rio Tinto realise an effective arbitrage.

Elmer Funke Kupper has revived the ASX ambition of allowing Australian investors to trade foreign company securities on the Australian exchange.

The plan to list unsponsored depositary receipts was one of Funke Kupper’s first initiatives when he became chief executive of the ASX in late 2011 but was thwarted when the Australian Securities and Investment Commission opposed the concept.

Funke Kupper raised the idea again overnight in London, suggesting that ASIC’s concerns about UDRs might be overcome by limiting the ability to trade them to institutional investors.

An obvious reason for ASIC’s reservations about the scheme the ASX proposed in 2012 was that the receipts are unsponsored – they would be listed without the underlying company’s endorsement -- and therefore there would be no-one responsible for ensuring that the Australian market is informed. It may also have been concerned that retail investors would be confused by the UDR structure.

Provided the UDRs were based on shares traded in jurisdictions with similar disclosure requirements to this market, of course, institutional investors would have the capacity to keep track of the companies disclosures in their home markets, hence Funke Kupper’s suggestion that ASIC’s reservations might be dealt with by restricting the nature of the investors who could trade them.

The appeal of the UDR concept, apart from the obvious increase in trading activity the ASX would hope to generate by effectively listing foreign companies on its platform, is that it would give Australian institutions access to Australian dollar-denominated trading in those foreign companies’ securities.

The mechanics of UDRs involve a market maker buying the underlying securities in their home market and delivering them to a depositary (which was originally to be BNY Mellon) which would then issue the UDRs into the ASX’s CHESS clearing house.

The UDRs would mirror the economics of the home market security in terms of dividends or capital management and could be converted directly into the underlying security if the investor wanted to.

When the idea was first floated the stocks nominated were companies like Apple, Google, Microsoft, Roche, HSBC, Xstrata and Anglo American. Introducing UDRs for companies that Australian investors are familiar with could broaden and deepen the range of high-quality companies listed in this market and reduce its over-exposure to the major banks and big miners.

It would also leverage the ASX’s infrastructure and create an international dimension and international connectivity to the local exchange.

It might also finally help the two dual-listed entities in this market – BHP Billiton and Rio Tinto – get an effective arbitrage going to narrow the price differentials between their Australian and London-listed securities.

While those discounts are in the single figures at the moment, at various times of the years they have been as much as 20 per cent or more, with the home market securities (Australia in BHP’s case, London in Rio’s) generally trading at a premium. It’s been a source of frustration and complication for the boards and executives of the two dual-listed companies.

Part of the explanation for why different forms of securities with common economic exposures should trade differently rather than having those pricing arbitraged away is probably liquidity – there’s greater liquidity in their home markets.

Fluctuating currency relativities would also play a role, as would differences in tax regimes and Australia’s dividend imputation system in particular.

It may be that the sheer complexity of the processes needed to execute arbitrage strategies undermines their appeal.

Being able to trade both the Limited and Plc versions of the dual-listed stocks would presumably help to produce a more efficient arbitrage (and add substantially to the capitalisation of the Australian market).

If ASIC’s original reservations about the UDR concept were related mainly to the prospect of retail investor confusion and insufficient protection, limiting direct trading in the UDRs to institutional investors would probably address those concerns.

Fund managers are creative enough to find a way to eventually package UDRs to give retail investors an exposure to them while taking on the investor protection role themselves.

There’s a lot of upside for the Australian market, the ASX and investors within the UDR concept if unsophisticated investors can be distanced from the potential downside -- enough to make it worthwhile for ASX and ASIC to have another close look at it.

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