Trading places: growth in OTC markets

Here’s a trick question: what fast-growing exchange trades the shares of German chemical company BASF, shoe manufacturer adidas, European aviation powerhouse Air France-KLM, and Latin American retailer Wal-Mart de México?

No, it’s not London, Shanghai or any of those other bourses that have caused so much angst among commentators concerned about companies forgoing US exchanges. All of the corporations listed above trade as American depositary receipts (ADRs) on a tiered trading platform recently launched by the US over-the-counter (OTC) markets.

Officials at Pink OTC Markets, as the umbrella entity is now known, are billing their OTCQX market tiers as a way for foreign issuers and smaller US companies to avoid onerous SOX 404 audits and other SEC requirements while still reaching moneyed US investors in their home market. At the same time, the platform allows reputable companies to distinguish themselves as investment-worthy securities different from the morass of questionable and distressed examples that trade on Pink OTC’s other tier, Pink Sheets, or on OTC Bulletin Board.

‘We separate them out from the rest of the swamp that trades over the counter,’ says Tim Ryan, director of OTCQX. ‘We’re providing a mechanism for those companies that are opting out of SEC filing to continue to provide excellent and timely disclosure to the marketplace rather than going completely dark. It’s a way to give them more visibility as well as a respected market tier.’

The idea is catching on. Since launching in March 2007, Pink OTC has signed up about 30 companies to its two OTCQX tiers. These are PremierQX, for issuers big enough to be listed on a national stock exchange, and PrimeQX, for companies with audited financials that aren’t big enough for PremierQX.

Five smaller US issuers have listed and 25 non-US companies have undertaken an ‘international OTCQX visa program’. Among them are BG Group, Computer Services and Roche. The 30 companies represent a small percentage of the 8,500 securities traded on the Pink OTC markets, which are run by a private, largely unregulated firm that allows companies to trade without meeting most SEC reporting requirements.

Growing concerns
Those 30 companies represent the fastest-growing segment of Pink OTC’s activity. In January of this year, OTCQX dollar volume represented 5 percent of the market. That rose to 7 percent in February, and shot up to 13 percent in March, totaling more than $1 bn in trading volume.

‘We think there’s going to be a tipping point,’ Ryan says. ‘A lot of companies have been sitting on the sidelines the first year to see how companies are doing in terms of trading performance. Now we’re demonstrating that it works, we’re getting more applications and the activity is really picking up. We’d like to have at least 100 international companies by the end of the year, and 25 domestic companies.’

To qualify for OTCQX, foreign issuers are required to provide their home country disclosure in English on the OTCQX website. All listing companies must also seek an OTC-approved financial adviser to sponsor their listing. The advisers, usually investment bankers or securities attorneys, serve as ‘gatekeepers’ whose role is modeled on nominated advisers – or ‘nomads’ – on London’s Alternative Investment Market (AIM). Domestic OTCQX issuers use designated advisers for disclosure; these are charged with ensuring the disclosure can be ‘trusted in the marketplace,’ Ryan says. Non-US issuers on the International OTCQX are called principal American liaisons.

The SEC does not allow IPOs on the OTC markets, but they can serve as a trading platform for companies that have issued shares on the private market but are not yet ready to list on NASDAQ or the NYSE. The OTC markets can also serve as a destination for companies that are looking to de-list from other exchanges to cut back on compliance costs. Companies seeking to deregister must winnow the number of shareholders on record to below 300, usually through buybacks or a reverse split.

‘We’ve come up with a system tailored to smaller companies to provide disclosure without going bankrupt in the process,’ Ryan says. ‘One company was trading on the American Stock Exchange and deregistered because of the cost, which can be as much as $1 mn a year to comply with SEC requirements. The company will probably save around $750,000, depending on which kind of adviser it uses. We don’t require a SOX Section 404 internal audit.’

Non-domestic bliss
For foreign companies, the platform allows US shareholders a way to trade securities without paying costly broker fees assessed for overseas trading. It can also have intangible benefits for the stock that extend beyond the OTC markets. Some studies show that trading on a US platform can actually improve the worldwide value of the company: Wal-Mart de México, for instance, has seen its volume increase some 25 percent in Mexico since listing on the OTCQX, Ryan says.

Thomas Kudsk Larsen, head of North American IR for Swiss pharmaceutical giant Roche, switched his company over to the OTCQX from the Pink Sheets in November. He says it’s too early to gauge the impact on market volume, but his company likes the idea. ‘The stock trades at a higher level of visibility,’ he explains. ‘It’s about distinguishing yourself in the market. You separate the blue chips from the not-so-blue chips, and make disclosure materials available on the website.’

Roche trades on the SWX Swiss Exchange back home, but allowing the stock to trade in the US as well makes sense because the company has ‘a huge investor base in the US,’ Larsen says. More than $30 bn of the company’s $160 bn market cap is owned by US investors, and the company’s largest investor is the Capital Group, based in Los Angeles. ‘A reason for us to be here is that it shows our commitment to the financial markets,’ Larsen says.

Frontera Resources, a Texas energy company, went public on AIM in March 2005, and that remains its primary market. But it chose to list on the Pink Sheets in October and switched to the OTCQX in February because ‘a lot of people were asking us about how to buy Frontera stock,’ says Liz Williamson, Frontera’s vice president of IR and corporate communications.

The company used Roth Capital Partners as an adviser and has seen trading volume steadily increase. ‘It’s more difficult for people in the US to trade international stocks,’ Williamson points out. ‘Some brokerage houses don’t have international desks, while some people don’t want to take the time to understand the international markets, or pay the high commissions. It’s expensive and time-consuming. It made sense to open a US portal.’

Another reason to list here, according to Ryan, is that liquidity on AIM is not as high as some investors might like, and the spread can be wider than on some US exchanges. This has prompted companies to stick to the US.

Future tense?
In the months to come, Pink OTC is expecting big things from its elite new tiers. Their success could help solve a problem that has been raising hackles from Capitol Hill to Wall Street: the growing number of companies forgoing US markets and listing overseas to avoid onerous regulation. While the OTC listing ‘doesn’t solve the IPO process,’ Ryan says, companies ‘can do follow-on offerings.’

The OTCQX also allows an attractive middle ground for companies, which Ryan hopes will lure a sufficient number of high-quality firms to allow the top-tier listers to comprise around 15 percent of the 8,500-company-strong OTC market. ‘It really brings their market back to the US,’ he says. ‘I think the investment community recognizes the opportunity of these companies that have gone through these hoops and are worthy of investment.’

The leading exchanges don’t appear to be losing sleep over these developments. An NYSE spokesperson who does not wish to be named says OTCQX is among a number of new listing alternatives offered, but ‘none of them provide the same kind of benefits across the board to multiple stakeholders offered by the NYSE.’

Most companies still want to be on the major exchanges, as listing there signals a high financial standing and stringent governance standards. They also offer access to the deepest pools of liquidity. ‘Despite all the recent trends and changes in the exchange business, those benefits still hold up very strongly,’ the NYSE spokesperson concludes.