Big losses in Russia-linked stocks prompt investors to reconsider other depositary receipts.

Big losses in Russia-linked stocks prompt investors to reconsider other depositary receipts.

The Uncertainty of Global Investors in Securities Linked to Geopolitical Hot Spots

Russian Depositary Receipts

London/New York, Aug 14 (ANBLE) – Global investors are losing confidence in securities linked to shares of companies in the world’s geopolitical hot spots, investors and analysts said, after Moscow moved to de-list Russian depositary receipts from foreign exchanges in retaliation for Western sanctions over the war in Ukraine.

Depositary receipts, or DRs, are certificates issued by a bank representing shares in a foreign company traded on a local stock exchange. DRs reduce currency and liquidity risk for buyers, who see them as one of the surest ways to invest in companies in countries ranging from Brazil to China.

However, recent events in Russia have shaken investors’ trust in DRs. Many foreign investors have been unable to trade Russian securities due to Moscow’s actions. This has caused them to write down the value of depositary receipts of Russian companies to zero. Now, investors and analysts are concerned about the possibility of similar reactions by other governments and the potential risks these pose to current prices.

The Intersection of Politics, Investment, and Risk

“Political instability and rapidly shifting geopolitical alliances can, in a very short amount of time, result in frozen and inaccessible capital,” warns Peter C. Earle, an economist with the American Institute for Economic Research. The time has come for investors to consider the combination of three crucial factors: the size of their exposure to foreign securities, the likely return on those investments over time, and the potential for geopolitical conflicts.

According to data from Citigroup, $2 trillion in DRs were traded in the first half of 2023. Companies raised $4.7 billion in the same period, compared to $2.8 billion in the first half of 2022. This growth in DR activity indicates continued portfolio globalization and diversification, despite geopolitical concerns in select markets and sectors.

DR Programs by Country

Among the ten most traded DR programs in 2022, five were issued by Chinese companies. However, the current loss of confidence in DRs could lead to a drain of foreign capital from firms in emerging economies. To mitigate this risk, some advisers suggest global banks that issue DRs should better communicate potential risks to investors. It is important for investors to reassess their exposure to countries at war or unstable governments if they seek to outperform broad stock market returns.

“The geopolitical risk of owning a GDR (global depositary receipt) right now is under-appreciated by most western investors… GDRs should now be viewed as riskier, investors should reassess allocation levels and require a risk premium,” advises Christopher Day, managing director of U.S.-based Doliver Advisors. This sentiment is echoed by Michael Ashley Schulman, partner and chief investment officer at Running Point Capital Advisors, who emphasizes the need to understand the legal and jurisdictional exposure associated with DRs.

Moscow’s Shakedown and the Flaw in DRs

Moscow’s recent actions have highlighted a major flaw in DRs. These instruments provide investors with indirect ownership of shares, which makes them vulnerable to possible trading bans or restrictions in other jurisdictions. Grzegorz Drozdz, a market analyst at investment firm Conotoxia Ltd, warns of the threat that such instruments may face in the future.

While some believe that Russia is an extreme case and losses sustained by Russian DR holders are unlikely to trigger a retreat from other DR markets, investors are advised to exercise caution. Malcolm Dorson, senior portfolio manager at Global X, suggests reviewing risk tolerance levels. He reminds us that DR programs, due to their additional layer between companies and investors, carry slightly more risk than regular equity securities. In normal circumstances, governments are incentivized to keep DR investors happy as they allow international investors access to markets, providing capital and investment opportunities for these companies and countries.

In conclusion, the uncertainty surrounding DRs linked to geopolitical hot spots is causing global investors to question the potential risks associated with these securities. The recent example of Russian DRs being de-listed and frozen has highlighted the need for investors to reassess their exposure and consider the intersection of politics, investment, and risk. While geopolitical tensions remain, investors should carefully evaluate the level of risk they are willing to take on when investing in securities from countries in conflict or with unstable governments.