International

Equity Market
Prof. Rishika Nayyar
FORE School of Management
 Market Structure, Trading Practices, and
Costs
• Primary markets
• Shares offered for sale directly from the issuing company.
• Secondary markets
• Provide market participants with marketability and share valuation.
• Investors or traders who buy shares from the issuing firm in the primary market may not
want to hold them indefinitely.
• The secondary market allows share owners to reduce their holdings of unwanted shares and
purchasers to acquire the stock.
• Establishes fair market prices for existing issues.
• Firms would have a difficult time attracting buyers in the primary market without
the marketability provided through the secondary market.
 Market Structure, Trading Practices, and
Costs
• A trade (buying and selling) in a secondary market takes places via an agent, known as broker.
• Market Order or Limit Order.
• Market Order: Executed at the best price available in the market when the order is
received, that is, the market price.
• In Market Order, the broker buys/sells shares immediately at the market price.
• Limit Order: An order away from the market price that is held in a limit order book until it can
be executed at the desired price.
• In limit order, the broker buys/sells shares at a price desired by the investor, when and if he can.
If immediate execution is more important than the price, then market order is used.
 Market Structure, Trading Practices, and
Costs
• Secondary markets are structed as “Dealer Markets” or “Auction Markets”.
• Dealer Markets: Dealers stand ready to buy and sell the stocks on their own account; make the
market by quoting the offer or ask price (price at which they are ready to sell) and bid price
(price at which they are ready to buy).
• This market provides greater liquidity to investors as there are many market makers, connected
through a telecommunication network. Also called Over the Counter (OTC) market.
• The investors who accept the prices quoted by the dealers can do the transaction electronically.
• The investors (buyers and sellers) are never brought together and the order is executed through
the dealers only.
• Example: National Association of Security Dealers Automated Quotation System (NASDAQ)
 Market Structure, Trading Practices, and
Costs
• NASDAQ: a computer linked system that shows the bid (buy) and ask/ offer (sell) prices of all
dealers in a security.
• Auction Market: There is a single specialist in an auction market, in a centralized location who
controls the liquidity and trading activity by pairing the matching bids and offers.
• In other words, each stock traded on the exchange is represented by a specialist , who makes a
market by holding an inventory of the security.
• Each specialist has a designated station (desk) on the exchange trading floor where trades in his
stock are conducted. Floor brokers bring the flow of public market orders for a security to the
specialist’s desk for execution.
 Market Structure, Trading Practices, and
Costs
• Through an auction process, the “crowd” of floor brokers may arrive at a more favorable market
price (via competitive bid and offer prices) for their clients between the specialist’s bid and ask
prices and thus transact among themselves.
• The specialist also holds the limit order book.
• In executing these orders, the specialist serves as an agent.
• Limit order prices receive preference in establishing the posted bid and ask prices if they are
more favorable than the specialist’s.
• The specialist must fill a limit order, if possible, from the flow of public orders before trading
for his own account.
The New York Stock Exchange (NYSE) is an example of an auction market.
 Trading in International Equities

• During the 1980s world capital markets began a trend toward greater global integration.
• This trend was caused by diversification, reduced regulation, improvements in computer and
communications technology, and an increased demand from MNCs for global issuance.
• Some of the major effects that greater global integration has had on the world’s equity markets.
• Cross-listing of shares
• American Depository Receipts (ADRs)
• Global Registered Shares
 Cross-listing of shares

• Refers to a firm having its equity shares listed on one or more foreign exchanges, in addition to
the home country stock exchange.
• Done by both MNCs and non-MNCs.

Why cross-list?
• Provides a means for expanding the investor base for a firm’s stock, thus potentially increasing
its demand. Increased demand for a company’s stock may increase the market price.
Additionally, greater market demand and a broader investor base improve the price liquidity of
the security.
 Cross-listing of shares

• Establishes name recognition of the company in a new capital market, thus paving the way for
the firm to source new equity or debt capital from local investors as demands dictate.
Especially important reason for firms from emerging market countries with limited capital
markets to cross-list their shares on exchanges in developed countries with enhanced capital
market access.
• Brings the firm’s name before more investor and consumer groups. Local consumers (investors)
may more likely become investors in (consumers of) the company’s stock (products) if the
company’s stock is (products are) locally available. “Liability of Origin”.
• Cross-listing into developed capital markets with strict securities regulations and information
disclosure requirements may be seen as a signal to investors that improved corporate
governance is forthcoming. “Institutional Borrowing”
 Cross-listing of shares

• Cross-listing may mitigate the possibility of a hostile takeover of the firm through the broader
investor base created for the firm’s shares.
Challenges-
• Obligates the firm to adhere to the securities regulations of its home country as well as the
regulations of the countries in which it is cross listed.
• An Indian firm cross-listing in the US means that the firm must meet the reporting and
disclosure requirements of the Securities and Exchange Commission (SEC); reconcile its
financial statements to the US standards.
 American Depository Receipts
• Foreign stocks can be traded directly on a national stock market, but frequently they are
traded in the form of a depository receipt.
• Depositary Receipts (DR) were created in 1927 to assist U.S. investors seeking to
purchase shares of non-U.S. corporations.
• Since then, DRs have grown into widely accepted flexible instruments that serve as an
effective option for companies seeking to further tap global capital markets and expand
their equity base outside their home market.
• An ADR is a receipt representing a number of foreign shares that remain on deposit with the
U.S. depository’s custodian in the issuer’s home market.
 American Depository Receipts

• The bank serves as the transfer agent for the ADRs, which are traded on the listed exchanges in
the United States or in the OTC market.
• Similarly, Singapore Depository Receipts trade on the Singapore Stock Exchange.
• Global Depository Receipts (GDRs) allow a foreign firm to simultaneously cross-list on several
national exchanges.
• Many GDRs are traded on the London and Luxembourg stock exchanges.
 Benefits of ADRs over Stock

• ADRs are denominated in dollars, trade on a U.S. stock exchange, and can be purchased
through the investor’s regular broker.

Trading in the underlying shares would likely require the investor to: set up an account with a
broker from the country where the company issuing the stock is located; make a currency
exchange; and arrange for the shipment of the stock certificates or the establishment of a
custodial account.

• Dividends received on the underlying shares are collected and converted to dollars by the
custodian and paid to the ADR investor, whereas investment in the underlying shares requires
the investor to collect the foreign dividends and make a currency conversion.
 Benefits of ADRs over Stock

• Moreover, tax treaties between the United States and some countries lower the dividend tax rate
paid by nonresident investors.
• Consequently, U.S. investors in the underlying shares need to file a form to get a refund on the
tax difference withheld. ADR investors, however, receive the full dollar equivalent dividend,
less only the applicable taxes.
• ADR trades clear in three business days as do U.S. equities, whereas settlement practices for the
underlying stock vary in foreign countries.
• ADRs frequently represent a multiple of the underlying shares, rather than a one-for-one
correspondence, to allow the ADR to trade in a price range customary for U.S. investors. A
single ADR may represent more or less than one underlying share, depending upon the
underlying share value.
 DR Issuance Process

• Investor contacts broker and requests the purchase of a DR issuer company’s shares. If existing
DRs of that company are not available, the issuance process begins.
• To issue new DRs, the broker contacts a local broker in the issuer’s home market.
• The local broker purchases ordinary shares on an exchange in the local market.
• Ordinary shares are deposited with a local custodian.
• The local custodian instructs the depositary to issue DRs that represent the shares received.
• The depositary issues DRs and delivers them in physical form or book entry form through
Euroclear/Clearstream (as applicable).
• The broker delivers DRs to the investor or credits the investor’s account.
 DR Cancellation Process

• The investor instructs the broker to cancel DRs.

• The broker delivers the DRs to the depositary for cancellation and instructs the depositary to
deliver the ordinary shares to a local custody account.
• The depositary cancels the DRs and instructs the local custodian to release and deliver the
underlying shares to the seller’s broker in the issuer’s home market.
• The local custodian delivers the underlying ordinary shares as instructed to the local broker. The
local broker safe-keeps the ordinary shares or delivers them to or on behalf of the new investor.
 Types of ADRs- Sponsored and Unsponsored

• Sponsored ADRs are created by a bank at the request of the foreign company that issued the
underlying security.
• The sponsoring bank often offers ADR holders an assortment of services, including investment
information and portions of the annual report translated into English.
• The depository fees of sponsored ADRs are paid by the foreign company.
• Sponsored ADRs are the only ones that can be listed on the U.S. stock markets.

• An Unsponsored ADR is created by a US depository bank without the cooperation or

participation of the non-US company. Unsponsored ADRs can even be created without the
consent of the non-US company whose stock underlies the American Depositary Receipt.
 Types of ADRs- Sponsored and Unsponsored

• Consequently, the foreign company may not provide investment information or financial reports
to the depository on a regular basis or in a timely manner.
• The depository fees of unsponsored ADRs are paid by the ADR investors.
 Types of ADRs

Level I Level II Level III

Description Unlisted program in Listed on a U.S. Shares offered and
the U.S. exchange listed on a U.S.
exchange

Trading OTC NASDAQ, AMEX, NASDAQ, AMEX,

NYSE NYSE
SEC Registration Form F-6 Form F-6 Forms F-1 and F-6
U.S. Reporting Exempt under Rule Form 20-F Form 20-F
Requirements 12g5-2(b)
 Global Registered Shares

• A "Global Registered Share" is a security that can be traded and transferred across applicable
borders without the need for conversion. This means that identical shares can be traded on
different stock exchanges in different currencies.
• For example, the same share purchased on the SIX Swiss Exchange can be sold on the New
York Stock Exchange or vice versa.
• Limited Success.
 International Equity Market Benchmarks

• As a benchmark of activity or performance of a given national equity market, an index of the

stocks traded on the secondary exchange (or exchanges) of a country is used.
• India: BSE Sensex
 Empirical issue: Factors Affecting
International Equity Returns
• Macroeconomic conditions
• Exchange rate changes
• Industrial Structure.
 Foreign Direct Investment
• Cross border investment made by a resident in one economy (the direct investor) with the objective of establishing a
lasting interest in an enterprise (the direct investment enterprise) that is resident in a country other than that of the
direct investor (OECD, 2008 Page 50)
• Investment made to acquire lasting interest in enterprises operating outside of the economy of the
investor. The investor´s purpose is to gain an effective voice in the management of the enterprise.
• Some degree of equity ownership is almost always considered to be associated with an effective voice in
the management of an enterprise; the BPM5 suggests a threshold of 10 per cent of equity ownership to
qualify an investor as a foreign direct investor.
• An important characteristic that distinguishes FDI from foreign portfolio investment is that it is
undertaken with the intention of exercising control over an enterprise.
Balance of Payment: Fifth Edition (BPM5) (Washington, D.C., International Monetary Fund, 1993)
 Foreign Direct Investment

• Can be in the form of Greenfield Investments or Cross-border Mergers and Acquisitions.

• Infosys acquisition of US-based Product Design and Development Firm, Kaleidoscope
Innovation.
• Acquisition of Indian Ocean Pty limited by JSW Energy ltd. in South Africa.
• Acquisition of Oil fields by ONGC in Russia, Mozambique.
• Acquisition of Mirren (South Africa) by Cipla ltd.
• Alkem Labs acquisition of anti-nausea drug (Marinol) and other API assets from AbbVie Inc.
• Mahindra & Mahindra tractor assembly plant in the US; drawing up plans for tractor
manufacturing plant.
 O FDI (USD M illion)
Figure 1:
3000000 45% 50% World OFDI
40% 45%
2500000
35% 35% 40% flows and
35%
2000000
26%
29%28%31%
25%
28%
30% rising share
1500000
15%16%15%16%14% 15%
17%
15%
19% 25%
20%
of emerging
14%
1000000 12%
6% 8% 9% 9% 9% 15%
10%
markets
5% 5% 5%
500000
5% (1990-2018)
0 0%

World Emerging Markets Emerging Markets (% of world)

600000 60%
Figure 2:
500000 51% 50% BRICS
46% 45%
400000 41% 39%39%
42% 37% 40% OFDI flows
OFDI (USD Million)

35%37% 34% in relation to

33%
300000 30% 30% 30% 30%
21%
23%
26%
28%
Emerging
200000
17%
14%
20% 20%
Markets
12% 12% 13%
100000 9% 10%
6% 8% 9%
0 0%
Source:
UNCTAD FDI
Statistics (
https://unctad.o
Emerging markets BRICS BRICS (% of Emerging markets)
rg/en/Pages/stat
istics.aspx
)
 Four questions related to FDI

• How? Joint Venture/ Wholly Owned Subsidiary, Greenfield/Merger & Acquisition.

• Why? Motives of FDI
• When? Timing
• Where? Location Choice
 What explains FDI?

• Trade barriers
• Monopolistic advantages (intangible assets) Market imperfections
• Vertical integration (Backward and Forward)
• Shareholder diversification services (from firm’s internationally diversified cash flows).
 An eclectic paradigm of FDI- OLI Theory

According to the eclectic paradigm, FDI takes place when three conditions are satisfied-

1. Firms possess superior ― “O”- ownership specific advantages, such as possession of intangible
assets or the advantages of common governance, vis-à-vis that of firms from other nationalities
2. Provided condition (1) is satisfied, it should be more efficient for the firm to “I”- internalize
these advantages or to create an internal market (firm hierarchy) than to sell or license them to any
foreign firm.
3. Provided condition (1) and (2) are satisfied, it should be in the interest of the firm to utilize
these advantages in conjunction with the “L”- immovable locational advantages of the foreign
markets.
 Investment Development Path

Dynamic relationship between FDI and the level of economic development of a country.

Net Overseas Investment

Position (NOI) as
predicted by IDP
(Dunning, 1981; Duning
and Narula, 1993)
 EMNEs- A misfit?

• Linkage, Leverage, Learning (LLL) framework.

• Springboard Perspective.

Papers Discussion-

1. Mathews, J. A. (2006). Dragon multinationals: New players in 21st century globalization. Asia Pacific
journal of management, 23(1), 5-27.
2. Hennart, J.-F. (2018). Springing from where? How emerging market firms become multinational
enterprises. International Journal of Emerging Markets, 13(3), 568–585.
3. Luo, Yadong, and Rosalie L. Tung. "International expansion of emerging market enterprises: A
springboard perspective." (2007): 481-498.
 Political Risk and FDI

• Unquestionably this is the biggest risk when investing abroad.

• A more important question than normative judgments about the appropriateness of the foreign
government’s existing legislation is, “Does the foreign government uphold the rule of law?”
• A big source of risk is the non-enforcement of contracts.
• Range from the outright expropriation of foreign assets to unexpected changes in the tax laws
that hurt the profitability of foreign projects.
• Macro risk- All foreign operations are put at risk due to adverse political developments.
• Micro risk- Selected foreign operations are put at risk due to adverse political developments.
 Political Risk and FDI

• Transfer risk
• Uncertainty regarding cross-border flows of capital. Unexpected imposition of capital
controls, inbound or outbound, and withholding taxes on dividend and interest payments
• Operational risk
• Uncertainty regarding the host country’s policies on a firm’s operations. Unexpected
changes in environmental policies, sourcing/local content requirements, minimum wage
law, and restriction on access to local credit facilities.
• Control risk
• Uncertainty regarding expropriation. restrictions imposed on the maximum ownership share
by foreigners, mandatory transfer of ownership to local firms over a certain period of time
(fade-out requirements), and the nationalization of local operations of MNCs.
 Measuring Political Risk

• The host country’s political and government system

• A country with too many political parties and frequent changes of government is risky.
• The track records of political parties and their relative strength
• If a party has a strong nationalistic ideology and/or socialist beliefs, it may implement
policies that are detrimental to foreign interests. On the other hand, a party that subscribes
to a liberal and market-oriented ideology is not very likely to take actions to damage the
interests of foreign concerns.
• Integration into the world system
• If a country is politically and economically isolated and segmented from the rest of the
world, it would be less willing to observe the rules of the game. North Korea, Libya, Iraq.
 Measuring Political Risk

• Ethnic and religious stability

• Domestic peace can be shattered by ethnic and religious conflicts, causing political risk for
foreign business.
• Regional security
• Real and potential aggression from a neighboring country is a major source of political risk.
• Key economic indicators
• Political risk thus is not entirely independent of economic risk. For example, persistent
trade deficits may induce a host country’s government to delay or stop interest payments to
foreign lenders, erect trade barriers, or suspend the convertibility of the local currency,
causing major difficulties for MNCs.
 Managing Political Risk

• Minimize exposure
• Form joint ventures with local companies.
• Local government may be less inclined to expropriate assets from their own citizens.
• Join a consortium of international companies to undertake FDI.
• Local government may be less inclined to expropriate assets from a variety of countries
all at once.
• Finance projects with local borrowing
 Managing Political Risk

• Insurance
• The Overseas Private Investment Corporation (OPIC), a U.S. government federally-owned
organization, offers insurance against:
1. The inconvertibility of foreign currencies.
2. Expropriation of U.S.-owned assets.
3. Destruction of U.S.-owned physical properties due to war, revolution, and other
violent political events in foreign countries.
4. Loss of business income due to political violence.