Legal Aspects of Cross-Border Securities Listing via American Depositary Receipts (ADRs)

Introduction
The emergence of securities markets initially involved purely national transactions governed by individual countries' systems. However, globalization has led to a rise in transnational transactions and cross-border listings on foreign exchanges. Securities listing serves as a precursor to capital market transactions. Cross-border securities transactions often necessitate listing on the foreign stock exchange. According to the International Disclosure Standards for Cross-border Offerings and Initial Listings by Foreign Issuers, a cross-border offering or listing occurs when it is directed at one or more countries other than the company's home country, allowing foreign investors to participate.
 
Terminology
Some misuse the terms "cross-listing" and "dual listing" to describe cross-border listings. These terms can be misleading. Cross-listing doesn't necessarily imply a primary or secondary listing across borders. Dual listing can apply not only to cross-border situations but also when two independent companies merge their operations while maintaining separate listings on different exchanges. Therefore, "cross-border listing" serves as a more accurate term.
Cross-Border Listing Methods
Cross-border listing can be achieved directly or indirectly. Direct listing involves listing ordinary shares on the foreign exchange, allowing investors to trade and settle them directly. This grants foreign investors the same legal status as other shareholders. Indirect listing utilizes depositary receipts. Introduced by J.P. Morgan in 1927, depositary receipts were created to facilitate American investment on the London Stock Exchange. A depositary receipt is a document issued by a destination country's bank representing securities issued in the origin country. The underlying shares are typically deposited with a foreign affiliate of the depository bank, a correspondent bank, or its trust company. Given that depositary receipts enable the internalization of foreign securities and provide benefits similar to domestic securities, they represent the most common form of cross-border listing.
 
Depositary Receipts
Depositary receipts share a similar legal nature to securities, with the key difference being that the underlying asset for a depositary receipt is another security. The most common types are Global Depositary Receipts (GDRs) and American Depositary Receipts (ADRs). These share the same issuance and cancellation processes, with the only distinction being the geographical location of the listing.
 
Focus on American Depositary Receipts (ADRs): The United States has attracted the most cross-border listings from international issuers. Consequently, this article focuses on ADRs. ADRs are transferable documents and derivative instruments valued in US dollars. American depository banks hold foreign securities in the origin country and convert all profits and other payments to ADR holders in the US into US dollars. Previously, both sponsored and unsponsored ADRs were issued. However, unsponsored ADRs are no longer issued due to concerns regarding control over transactions, hidden costs, and other associated problems.
 
ADR Levels: ADRs have four levels, categorized by their degree of penetration in the US market. Each level has distinct requirements and conditions that become more stringent with each higher level.
 
Research Methodology and Legal Framework
This article employs a descriptive-analytical approach to explain the legal mechanisms of cross-border listing via ADRs.Deposit agreements, tripartite agreements between the issuer, depository bank, and ADR holder, form the basis for ADR issuance today.
Key Legal Questions: This article examines the following key legal questions:

What is the legal role of the depository bank, and what is the legal nature of the deposit agreement?
What is the legal relationship between the depository bank and the investor?

 
Legal Relationships:

Issuer and Depository Bank: The deposit agreement obligates depository bank representatives to hold the foreign issuer's securities. While the term "deposit" is used, the agreements don't function as true deposits due to their underlying mechanisms.
Depository Bank and Investor: The depository bank acts as the issuer's agent and issues ADRs. Towards investors, the depository bank is obligated to perform services specified in the agreement for designated fees. This creates an agency relationship between the issuer and depository bank and a service contract between the depository bank and ADR holders.

 
Issuer's Obligations: While the deposit agreement primarily governs the relationship between the issuer and depository bank, the issuer also has obligations towards ADR holders. The most important obligation is guaranteeing the validity of both the underlying securities and the ADRs themselves.
 
Conclusion
The legal nature of these agreements doesn't fall under a single, specific type of contract. Instead, they represent a combination of various contracts with unique characteristics. Although deposit agreements appear to be private contracts, the parties have limited freedom in their execution and implementation due to the public aspects that prevail within them. Consequently, these agreements are subject to public law regulations and the oversight of the Securities and Exchange Commission (SEC).