Asia's new ADR market faces liquidity challenge

It's early days for the region's first American depositary receipts – launched last month by Singapore Exchange – but the strong demand for China A-shares should help to attract investors.
Asia's new ADR market faces liquidity challenge

Singapore Exchange (SGX) boosted its reputation as a pioneer by launching Asia's first American depositary receipts (ADRs) on October 22, but supporters of the programme admit that volumes and liquidity must grow if the products are to attract more investors.

Nevertheless, market participants on a panel last week organised by Bloomberg and SGX in Hong Kong, were upbeat on the new market's potential. The panel included executives from: BNY Mellon Depositary Receipts, the depositary bank for SGX's ADR programme; Credit Suisse; agency broker and electronic trading platform provider Instinet; and SGX itself.

The launch marks the first time that investors can act on news flow about these companies during Asian trading hours, as some of these US-listed Asian companies do not have Asian home exchanges.

Some market observers argue that the products will not hold much appeal for retail investors for arbitrage purposes. While institutions will use ADRs for arbitrage, particularly of dual-listed stocks, doing so could be too expensive for retail investors, said one attendee after the panel event. 

Rick Aston, SGX's head of product sales, agrees that retail investors are very unlikely to get involved in arbitrage trading, so that will likely be the domain of institutional traders. However, Singapore and regional retail investors will make up a significant portion of the trading activity, he adds, since these are well-known companies in the region, and for many, this will be the sole trading venue in the Asian timezone.

The first day saw $10 million in ADR volume traded, and since then around $5 million has been traded daily, says Aston. That is a reasonable level given the early stage of the market, he says, and it's in keeping with the exchange's pre-launch expectations.

Interestingly, he adds, there has been more activity in the initial 10 dual-listed names than SGX anticipated – and these tend to have narrower spreads than single-listed names, which encourages more volume and thus liquidity. It's certainly more challenging for the single listings to attract liquidity, he says.

SGX has always had ambitions to be an Asian gateway and has almost achieved that on the derivatives side, says Aston. However, it has further progress to make on other products. 

The exchange has not been able to rely on initial public offerings and trading of domestic securities to drive revenues to the same degree as, for example, its counterpart in Hong Kong, so has had to be creative in its offerings. This approach has often led it to list products that are 'borrowed' from other markets – ADRs are another such example.

Aston says providing trading opportunities in “pan-Asia companies” – which initially are big China-focused names, such as search engine provider Baidu, China Eastern Airlines and PetroChina – should help SGX attract more international trading members to trade. 

The huge demand for China A-shares is likely to be a big plus factor for ADRs, agrees Steven Hersey, director of prime services trading at Credit Suisse in Hong Kong. These products provide an avenue for buying A-shares and also for shorting them, he says, making them useful for both hedging and arbitrage. “We expect to be very busy on these names, and this will be great for the region.”

Other panellists were also optimistic about the market's prospects. Kym Graham, Asia-Pacific head of sales at Instinet, says there's been a “wait-and-see attitude” among his institutional clients, but interest is definitely high.

“Some [of these] companies are very under-held by Asian investors,” he says. “US investors are the biggest holders, which means companies have to travel to the US to see their shareholders – they would like to have closer proximity to investors. To have trading opportunities like this in the Asian timezone should help build liquidity.”

There are challenges, of course. The “number one trading barrier” for the nascent ADR market is “the convergence process”, says BNY Mellon's Joe Oakenfold – that involves sourcing stocks in a timely fashion from the US. “The real nervousness now is about getting stock in place at the right time,” he says, pointing out that this is necessary for T+3 settlement. But he says liquidity will build and volumes are set to far outweigh their current levels.

Another area that will need sorting out is that of voting rights, says Hersey. Those buying ADRs on SGX cannot at present obtain voting rights on the stocks, he notes. “Hopefully this will be fixed sometime soon,” he adds. 

Looking ahead, SGX plans to also work with depositary banks other than BNY Mellon and to list ADRs from more costly or hard-to-access markets, such as India, Korea and Taiwan. 

The exchange also intends to expand the range of ADRs to small- and mid-cap names, though the challenge for less traded stocks will be liquidity, says Hersey. There's plenty of supply of Baidu shares in the US, for example, but some other names are less liquid and so harder to borrow, he says, although he sees the situation improving.

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