CIBC's Elliot Scherer explains why the Big Six bank was the perfect seedbed for the country's first Canadian depositary receipts
As the American comedian Dave Chapelle once famously quipped: “Modern problems require modern solutions.” So when the CIBC team thought about how to make investing in large U.S. stocks more accessible and less risky for Canadians, they needed to reinvent a near-century-old financial instrument.
“Depositary receipts were originally introduced in the U.S. as American depositary receipts in the 1920s,” Scherer, managing director and head of Sales at CIBC’s Wealth Solutions group, told Wealth Professional. “They’re securities that represent a specific number of shares in a foreign company’s stock, and they trade on an exchange just as any domestic share would.”
ADRs were the inspiration behind Canadian depositary receipts (CDRs), which officially debuted to investors on the NEO Exchange on July 27th. A first-in-Canada product, the launch of CDRs came after three years of collaboration and innovation.
“It took having a team made up of people with the right skillset, experience and quite frankly the perseverance to see the project to completion,” Scherer said.
A brand-new security type
“I was often asked by leaders across the bank, this solution seems so obvious, why has this never been done before?” Scherer said. While the solution is elegant and addresses a client need, CIBC needed to combine features from various existing securities in the marketplace and create a brand-new security type, which is clearly challenging.
Depositary receipts hadn’t been issued in Canada before because the conventional use-case for them wasn’t applicable in Canada. This is because Canadian investors are already able to freely buy U.S. listed securities and Canada shares the same time zones as the U.S.
Instead, the team at CIBC used CDRs to solve a different well-known problem for Canadian investors: when the U.S. stocks they invest in appreciate, the returns are often dampened by downward moves or weakness of the greenback relative to the loonie. Because of that currency dislocation, a 40% rise in Apple’s stock price, for example, may register as just 26% in a Canadian portfolio, according to CIBC materials explaining the new CDRs.
Aside from that, Canadians looking to invest in the likes of Amazon.com have historically had to allocate a large part of their investment portfolios to even one share of the stock, which is valued in the thousands of dollars. Because of the way CIBC structured the CDRs, Canadian investors have the opportunity to get Canadian dollar-denominated, fractional share exposure to mega-cap stocks on U.S. exchanges.
Creating the Canadian take
CIBC was the ideal incubator for CDRs, Scherer said, because it had the perfect complement of experts to put the product in place. He had previously led CIBC’s institutional equity derivatives sales team, where the team worked with clients including ETF issuers to structure ETFs that provide exposure to commodities and other equity indices.
“We had a lawyer with experience in drafting prospectuses for mutual funds and for structured notes,” Scherer said. “We had an engineer with derivative operations expertise to help us understand the ‘guts’ and inner workings of complex securities, a former stock exchange executive, as well as structurers and traders who have experience structuring ETFs, FX Forwards and market-making ETFs.”
CIBC also had two critically important and committed partners who worked on the project with them. “Having a partner like the NEO Exchange also really helped us a lot – they were able to think outside the box as we worked on the project,” Scherer said. “We were also fortunate that CIBC Mellon was keen to work with us as the custodian as we were able to leverage their global operational expertise.”
While a few Canadian ETFs already allow Canadian investors to get access to high-priced U.S. tech stocks, CDRs let investors get more specific exposures – buying Amazon.com without having to buy a basket of other names like Facebook or Google, for example. Having a CDR, Scherer added, allows investors to get other entitlements that come with buying shares, like shareholder votes or getting dividends on the dividend schedule. While CIBC charges no management fees for CDRs, the bank earns modest fees from managing the foreign exchange hedging program, which Scherer said is capped at 0.6% per annum.
The first CDRs for Canadian investors will provide access to Alphabet, Amazon.com, Apple, Netflix, and Tesla. Initial reception to the first CDRs has been positive: in their first few weeks of trading, Scherer said each of the Big Six bank distribution channels and online brokerage platforms put through orders, indicating strong resonance among the DIY crowd. Advisors, small institutions and family offices have also expressed interest, and CIBC has high hopes for their adoption.
“We are obviously planning to launch many more CDRs as the market develops and demand warrants,” Scherer said. “We want to be there to support the ongoing need and interest for Canadians to diversify and certainly didn't work on this project for three years to stop after launching a handful of tickers.”