Dual Listed Companies (DLC) & American Depositary Receipts (ADR) Arbitrage

by Irving Rivera on September 11, 2012 · 2 comments

DLC and ADR Arbitrage

Dual Listed Companies (DLC) and American Depositary Receipts (ADR) are two very different types of financial assets with unique capital structures. However, the same principals of relative value arbitrage still apply for both of them and in this article I will show how you can take advantage of the arbitrage opportunities ADRs and DLCs have to offer.

What are Dual Listed Companies (DLC)?

A dual-listed company is a corporation with two equity listing in the publicly traded markets, usually on different countries. These trading shares have the same ownership rights over the future cash flow of the company and voting rights. Dual-listed companies are create when multiple business which to preserve their national identity while operating under a single entity throughout the signing of equalization agreement. Some of the reason industry chose to become DLCs are: join ventures projects, mergers and acquisitions, tax treatments, international ownerships rights , liquidity, governance structures, currency risk, market exchanges listing requirements, political risks, access to capital, regulations and bonding benefits.

DLCs shares are very similar to american depositary receipts is but they should not be confused because their cross listing abilities.

What are American Depositary Receipts (ADR)?

An American depositary receipts is a special type of investment trust that allows for the domestic investment of foreign equities. These trading shares are held by a trustee, usually a bank, in a form of a certificate of deposit much like and fund where the ordinary shares bought in the international markets rest at specified redemption ratio. This kind of financial product give us the advantages of owning no-us companies without the high exposure to currency, liquidity and listing risks; at the little price of a custodian and duty fees.

How to Arbitrage American Depositary Receipts and Dual Listed Companies

Perhaps one of the most famous examples of DLC arbitrage, also known as international arbitrage, is the failure of Long Term Capital Management with Royal Dutch Shell. Never the less like any other arbitrage strategy properly executed can become very profitable. The basic structure of this trade is short the relative overvalue stock, ADR or primarily listed DLC, while simultaneously owning the underprice share of the same. However, things get a little bit more complicated with the arbitrage of American Depositary Receipts because the different redemption ratios. But fear not, because in today’s case study I will present you with the proper equations and formulas that will calculated the profitability of international arbitrage.

Case Study Time

Develop an excel spreadsheet that can calculate the expected total return of ADR and DLC arbitrage trade.

The Bottom Line

The most dangerous risk of this kind of statistical trade is the duration risk, the time that it takes for the position to converges, exposing you to possible margin calls due to the volatility in political situations, currencies and market sentiment.

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Do you own any positions in ADR or DLC in your portfolio?