Cross-Listed International Stocks: Another Investing Alternative

February 15, 2012

Jeffrey P. Ryan
CFA, Senior Equity Researcher, Schwab Equity Ratings®, Schwab Center for Financial Research

If you're only investing in the stocks of US companies, you may be missing opportunities to grow your portfolio. Not only are you excluding three-fourths of the global economy, you could be missing the potential for higher rates of growth abroad, the potential to lower overall risk in your portfolio and potential currency diversification as well.

In earlier articles about how to invest in international stocks, John Wightkin described three primary methods: purchasing ordinary common shares directly in their primary foreign market, purchasing American Depositary Receipts (ADRs) on a US exchange or the over-the-counter market, or purchasing foreign stocks via the US OTC market.

But there's a fourth alternative: purchasing cross-listed international stocks, which are listed on one or more foreign stock exchanges in addition to their domestic exchanges. These stocks may provide certain trade-execution benefits that can't always be obtained through the trading channels mentioned above. Currently, these opportunities are generally limited to Canadian stocks, but stocks from more countries may be cross-listed in the future.

Cross-listed stocks differ from ADRs and other depositary-receipt securities (e.g. European Depositary Receipts and Global Depositary Receipts) in that they don't involve the creation of a depositary relationship by a third party. Instead, the company lists its common shares directly on a US (or other) exchange as well as its domestic exchange. Cross-listed stocks that trade on the New York Stock Exchange (NYSE), the NYSE AMEX (formerly the American Stock Exchange) and the NASDAQ Global Market System (NASDAQ GMS) also differ from those traded in the OTC market, for reasons I'll explain below.

Blue skies and stock exchanges

Securities traded on US markets are generally subject to stringent registration requirements imposed by regulatory agencies and organizations like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority.

One category of registration requirements, known as "blue-sky laws," regulates the offering and trading of stocks. These laws were originally passed by state legislatures in an effort to help protect investors against fraud. Because blue-sky laws apply at the state level, a security that isn't registered in all states must trade in the OTC market. The security can't be sold in a particular state unless the security is registered under the blue-sky laws of that state.

But stocks meeting the listing requirements of the NYSE, NYSE AMEX or NASDAQ GMS are considered to have met the blue-sky laws of all 50 US states and US territories by virtue of their registration on those exchanges. As a result, securities traded on those markets may be sold anywhere in the United States.

Approximately 100 Canadian stocks are listed on the Toronto Stock Exchange (TSE) and the NYSE, NYSE AMEX or NASDAQ GMS. As an example, let's look at Canadian National Railway Company (ticker CNI, NYSE). Clients can log in to our Stocks Research page and enter CNI's ticker symbol in the box at the top, you'll see the Stock Summary page for the stock. CNI's stock is rated relative to other Canadian stocks by Schwab Equity Ratings International (as shown by the statement "Within the Country of Canada"), but note that it trades on the NYSE as well as the Toronto Stock Exchange. 

Source: www.schwab.com, as of February 8, 2012.

The rationale for cross-listing

Listing a company's stock on a national exchange like the NYSE can be a significant effort¹. Not only does a company need to meet requirements regarding the number of shareholders, shares outstanding, market capitalization, minimum price and certain financial criteria specified by the exchange, but it must file its financial statements and other documents with the SEC and abide by the provisions of a number of other US regulations, including the Sarbanes-Oxley Act ("SarbOx").

So why would an international company choose to cross-list its shares? And is there any benefit to US investors as a result?

Academic researchers have identified a number of possible motives for cross-listing².  Three of the major ones are:

• Improved liquidity: A listing on a more-liquid stock market can potentially increase a stock's liquidity, seeking to reduce the issuing company's financing costs. Plus, having shares trade in multiple time zones and currencies provides issuing companies more liquidity and an increased ability to raise capital.
• Information quality: A firm's willingness to cross-list its stock on a market with stringent disclosure requirements and strong investor-protection laws can provide outside investors with information they may need to determine the quality of the firm's accounting information and financial statements (for example, by reconciling its financial results to US generally accepted accounting principles).
• Investor protection: This motivation, described in academic research as "bonding," is based on the idea that registration on a US exchange acts as a mechanism that voluntarily commits the firm to a higher standard of corporate governance and investor protection, as exemplified by SarbOx. Bonding therefore might make firms attractive to risk-averse investors who might otherwise be reluctant to invest.

Motivations that affect firms may also represent potential benefit to investors, though evidence that quantifies those benefits is mixed. But from a trade-execution standpoint, there are some benefits to buying a cross-listed stock on a national exchange.

The fact that a stock is quoted in US dollars means that it's not necessary to convert a foreign currency price quote to US dollars. A number of order types, including stop and stop-limit orders which can be used to set buy or sell prices for stocks, are accepted for cross-listed stocks, but not for OTC stocks or ADRs traded in the OTC market. ADR holders must also pay annual custody fees to the financial institution that establishes the ADR, while cross-listed securities are not subject to such fees.

Dividends are paid in US dollars, rather than the foreign currency. (At Schwab, transactions conducted on US exchanges are settled through the Depository Trust and Clearing Corporation, which handles currency conversions for dividends. Transactions conducted by Schwab clients on foreign exchanges are settled through Citigroup, which does not convert foreign currency-denominated dividends.) Dividend reinvestment, however, is not available for cross-listed stocks.

Note that the US and Canadian shares are not "fungible"—buying a cross-listed stock requires that you hold the stock in US dollars and receive US dollar-denominated dividends. In addition, the US and Canadian prices of cross-listed stocks tend to move very closely together.

Conclusion

Purchasing cross-listed stocks represents a fourth method for Schwab clients to consider when investing internationally. While generally limited to Canadian stocks, as mentioned previously, cross-listing allows Schwab investors to utilize the power of Schwab Equity Ratings International to select stocks while simultaneously allowing them to invest in a low-cost, flexible way.

The tax implications for buying cross-listed stocks are the same as an ADR, OTC or a foreign ordinary. If you pay tax in a foreign jurisdiction, you get a tax credit against your US tax bill. Regarding trading costs, OTC trades at Schwab (whether involving common foreign shares or an ADR) involve a $50 foreign transaction fee on top of the regular commission—a fee that can be avoided when buying a cross-listed stock. (For more information, see Schwab's Fees and Minimums, where you can find the latest Charles Schwab Pricing Guide.)

In order to find cross-listed Canadian stocks, use the International Stock Screener to screen for A- and B-rated stocks in Canada. When viewing the results, make a note of the name of any company that's rated but does not display an OTC or ADR symbol. Then use the Research tab to enter the company name, and look for the Schwab Equity Ratings International letter grade in the blue diamond shape and the "Within the Country of Canada" note near the grade.

1. See the full New York Stock Exchange standards at: usequities.nyx.com/regulation/listed-companies-compliance/listings-standards/us.

2. Pamela C. Moulton, Li Wei, "A Tale of Two Time Zones: The Impact of Substitutes on Cross-Listed Stock Liquidity," Journal of Financial Markets, Vol. 12, November 4, 2009.