How will it impact U.S. investors’ investing decision on Foreign Private Issuers (“FPI”)1?
Global View On U.S. Investments in Foreign Private Companies Listed in the U.S.:
After reading the Financial Times article “Business leaders warn that three-decade era of globalization is coming to an end,” we were inspired to investigate the global relationship of commerce and accessing capital in the United States market. How much would it cost to untangle and create economic impact on the global economy and disrupt the frugality of 3.3 billion employed globally?
– According to the World Federation of Exchanges, the global industry association for exchanges and clearing houses, currently there are roughly 250 market infrastructure providers, with 59,400 listed companies on WFE stock exchanges. The total combined market capitalization is about $122.94 trillion, representing 30% of the global wealth[1] at $418.3 trillion USD at the end of 2021.
– U.S. exchanges make up 6,326 public companies, of which 1,442 companies are classified as foreign private issuers. The total market capitalization of companies listed on the NYSE and Nasdaq represents roughly $50 trillion. FPIs represent 22.7% of the total number of listed companies, with a combined market capitalization of roughly $15.7 trillion. FPIs represent 31% of the total market capitalization of the two U.S. Exchanges. It is not insignificant. When unpacking the data in greater detail:
A. NYSE[2] currently lists 2,529 companies with a combined market cap of $27.7 trillion, of which roughly 500 or 20% are foreign private issuers.
B. Nasdaq currently lists 3,797 companies with a combined market cap of $22 trillion, of which 849 or 22.3% are foreign private issuers.
C. Trading liquidity – According to the Year End 2021 Report published by Citi [3] Depositary Receipt Services, Depositary Receipts (DRs) continue to be the equity instrument of choice for investors to invest in FPIs– the market value of DRs held by institutional investors has increased from $478bn in Q3 2009 to over $1.1tn as of Q3 2021. DR trading value is roughly $8.0tn. Major top 10 DR investors by value included Capital Group, T. Rowe Price, BlackRock, Fidelity, Fisher, Invesco, JPMorgan, Morgan Stanley, and Vanguard. Most fund managers are attracted to foreign companies due to attractive high growth rate, geopolitical advantages, and diversification.
D. As some institutional investors must follow investment policy guidelines, certain fund investors may be limited by their investment mandates to only allocate investments to U.S. companies, similar to a domestic index focused fund.
E. Investors in Depositary Receipts continue to be dominated by mutual funds, investment managers, hedge funds, brokers, pension funds and sovereign wealth funds. The perception that foreign private issuers as a group experience a valuation discount is unfounded. According to a University of Florida research paper that tracked “Foreign Companies Going Public in the U.S. from 1980 to 2021”, the research paper indicated that FPIs on average generate 18%[4] returns on an annual basis, with the most recent five years averaging 25% in returns.
F. In 2020 and 2021, a total of 88 ADR IPOs raised roughly $45 billion in the U.S. China-based companies have represented 50% of the ADR IPOs in the U.S over the last two years.
G. In 2022 YTD (1H), there were roughly 34 IPOs, of which 5 or 14% were of FPIs.
– Despite the global political tension and continuing implications of the pandemic impacting the financial markets globally in many regions, companies continue to seek capital sources with the deepest pool of liquidity and investor diversification.
Why Do Foreign Private Companies Access U.S. Exchanges?
As with many foreign private issuers listing in the U.S. via American Depositary Receipts (ADR), most foreign private issuers come from 43 diverse countries, including the UK, Germany, France, Norway, Denmark, Belgium, Ireland, Sweden, Israel, Italy, South Africa, Turkey, Australia, Brazil, Columbia, Mexico, Argentina, Korea, China, Singapore, and Indonesia.
A total of 491 FPIs are believed to have registered with the SEC in the last ten years. The diversification of investors, visibility, status, accessibility to customers, reduced cost of financing, and widely used acquisition currencies are factors that draw foreign businesses to list their shares in the United States.
To encourage more foreign firms to enter the U.S. market, the Securities Exchange Act of 1933 was amended to provide FPIs with greater flexibility in disclosure obligations. Companies headquartered outside of the United States face fewer disclosure requirements. FPI can choose between U.S. GAAP and IFRS, whereas U.S. companies must use U.S. GAAP in a world that has adopted IFRS. Other advantages of being a foreign private issuer include the following exemptions from SEC reporting and governance requirements:
1. No Quarterly or Current Reports – issuers need not to file quarterly reports. However, U.S. exchanges requires the filing of semiannual unaudited interim financial information.
2. Section 16 Reporting and Short Swing Relief.
3. SEC Proxy Rule Exemption. Governed by home country proxy rules.
4. Dodd-Frank Act Exemptions. Say-on-pay and golden parachute disclosures.
5. Reduced executive compensation disclosures.
6. Form 20-F annual report: FPI may file the report up to 120 days after the end of the fiscal year.
7. Exemption from Regulation FD. Though, most FPI comply with Reg FD as a “best practice” even though they are exempt.
8. NYSE and Nasdaq corporate governance exemptions. FPI listed on U.S. Exchanges are generally exempt from most of the exchanges’ corporate governance rules, other than SEC Audit Committee requirements. FPIs are required to disclose how their corporate governance rules materially differ from those of U.S. companies. In some instances, some FPI voluntarily adopt general SEC and U.S. exchange requirements due to potential market advantages or investor preferences.
The benefit of encouraging foreign companies to list in the United States is to bring global opportunities to U.S. based investors. Such companies include AstraZeneca, Sanofi SA, TSMC, BP, Credit Suisse, Petrobras, Nomura, Shinhan and Sony. The benefits of foreign listings in the U.S. include but are not limited to:
– Trading and settlement in USD are convenient to a broader range of U.S. investors.
– Foreign companies must comply with U.S. investor protection rules and regulations.
According to Hugo Rogers, Chief Investment Officer at Deltec Bank & Trust, as a fund manager responsible for client investments, ADR provides greater liquidity trading in the U.S. market, price discovery, with higher disclosure requirements than the home country market, better coverage, and higher multiples.
In exceptional circumstances, some foreign companies prefer to go public in the United States market with a full Form S-1 registration. Coupang, a South Korean company, decided to list as a domestic U.S. filer on the NYSE, because their shareholder structure may have breached the exemption from registering as a foreign private issuer. Half of Coupang’s voting securities were owned by U.S. residents of record before the company’s IPO. Foreign companies that file under the domestic U.S. path must make more disclosures due to this decision and must allocate greater resources to meet these ongoing requirements.
Tensions with Chinese Companies Listed in the U.S.:
Chinese companies are distinctively different from other foreign private issuers. China[5] based companies have dominated the ADR IPO program in the last 5 years. There has been a lot of focus on the SEC new rule that allows it to delist foreign stocks for failure to meet audit requirements. The provisions of a new law, the Holding Foreign Companies Accountable Act (HFCAA) which would cause the delisting of Chinese companies from American stock exchanges if their audit records remain unavailable for inspection by the PCAOB for three consecutive years.
The law was passed in 2020 after Chinese regulators repeatedly denied requests from the Public Company Accounting Oversight Board (PCAOB), which was created in 2002 to oversee the audits of public companies, to inspect the audits of Chinese firms that list and trade in the United States. The U.S. Securities and Exchange Commission (SEC)[6] has added over 80 firms including China’s JD.com, Alibaba, and Baidu, to a list of entities facing possible delisting from U.S. exchanges as reported by the media. The HFCAA list at this moment only includes China-U.S. listed companies.
The idea of delisting Chinese ADRs can have a devastating impact on financial markets, economies, and investors globally. There are over 250 Chinese ADRs with a combined market capitalization roughly $1.5 trillion. Any potentially forced de-listings would cause short-term valuation adjustment and asset relocations by investors. It might result in short term financial pain. It would potentially affect the global workforce with hundreds, if not thousands of job losses, due to limited access to capital. It would also potentially impact U.S. financial service providers, which include, lawyers, accounting firms, bankers, investor relations agencies, stock exchanges, data providers, etc. It would also potentially cause the loss of millions in potential earnings.
Although China and U.S. regulators are both working toward solving the PCAOB inspection issues, the publicity surrounding the issue has focused attention on to the quality of financial reporting compliance by foreign private issuers.
Is the FPI Program Still Viable?
J.P. Morgan’s (JPM) predecessor firm Guaranty Trust pioneered the ADR concept. In 1927, it created and launched the first ADR, enabling U.S. investors to buy shares of the famous British retailer Selfridges and helping the luxury department store tap into the global markets. The ADR was listed on the New York Curb Exchange. The Modern Portfolio theory (MPT) was introduced as part of a diversification strategy to manage risk and return in a portfolio of assets. Since Economist Harry Markowitz introduced the MPT in 1952, investing in foreign companies has become an attractive way to achieve portfolio diversification. In the early days of 1954, John Marks Templeton launched his Templeton Growth Fund, Ltd, which was among the first funds to invest in Japan in the mid-60s.
According to Ray Dalio’s new book[7], Principles for Dealing with a Changing World Order, the market should prepare for shifts through market cycles in order to anticipate emerging new powers. With the United States’ national debt now exceeding $30 trillion, Japan, China, the United Kingdom, Luxembourg, Ireland, and other countries have been lending money to the U.S. government. The United States borrows money from other countries to help fund its government budget and deficits. If any of the lenders stops buying U.S. treasuries and begin selling U.S. treasuries, the U.S. will be negatively impacted by the depreciation of the U.S. dollar. By devaluing the U.S. dollar, general consumer goods prices rise while purchasing power falls, altering the dynamic of the economy.
Despite short-term political tensions, in the short and medium term it is unlikely that the global economy – interconnected through trade, technology, supply chains, and commerce – will become untangled.
Foreign private issuers, as part of the diversification thesis, continue to be a significant part of the investing landscape today. The number of companies provided investors with the opportunity to access global assets at a higher standard set by U.S. regulators, and as a stamp of approval of investable products by protecting global investors, FPIs listed in the United States account for 22.7 percent of all public companies listed in the United States. This gives American investors direct access to companies that meet the highest regulatory standards set by U.S. regulators. Though a location may create short-term obstacles to improving transparency and making the necessary reforms for better corporate governance, greater transparency will undoubtedly raise the overall standards for all public corporations.
As the market evolves in response to rising interest rates and significant developments in the global economy, we believe FPI will continue to provide a wider access point for investors to diversify and profit from opportunities and assets outside of the United States while reducing investment risks.
The data indicates a solid support for FPI to continue U.S. listings that seek to access U.S. capital without sacrificing valuation, which is relevant to the question of whether FPI is still feasible in the current geopolitical situation.
Contacts:
Sam Van
Head of Corporate Advisory, Deltec Investment Advisers Limited,
Marc Iyeki
Senior Advisor, Deltec Investment Advisers Limited,
About Deltec:
Deltec is a global financial and insurance services group for innovators, entrepreneurs, and their networks.
Deltec empowers SMEs, their founders, and investors to accelerate in their industries and grow their wealth with access to robust financial and insurance capabilities through its member companies, across private and corporate banking, fiduciary expertise, fund administration, investment management, digital asset financial services, insurance for new and emerging risks and merchant banking.
[1] https://www.credit-suisse.com/about-us/en/reports-research/global-wealth-report.html
[2] https://www.statista.com/statistics/1277216/nyse-nasdaq-comparison-number-listed-companies/#:~:text=In%20total%2C%20as%20of%20March,market%20capitalization%20than%20the%20Nasdaq.
[3] https://depositaryreceipts.citi.com/adr/common/file.aspx?idf=5842
[4] https://site.warrington.ufl.edu/ritter/files/IPOs-Foreign.pdf
[5] https://insight.factset.com/foreign-ipos-in-the-u.s.-on-track-for-record-breaking-year
[6] https://www.sec.gov/hfcaa
[7] https://www.youtube.com/watch?v=xguam0TKMw8
