Depositary Receipt

A Depositary Receipt (DR) is a type of financial security that represents a stake in a foreign company that is held by a depositary bank. These receipts enable investors to hold shares in equity in a corporation in another country, without the need to worry about cross-border and cross-currency transactions. Depositary Receipts are a mechanism for companies that wish to raise capital from investors based in different countries while also expanding their shareholder bases.

Types of Depositary Receipts

American Depositary Receipt (ADR)

American Depositary Receipts are DRs issued by U.S. depositary banks representing shares of a foreign (non-U.S.) company. These shares trade on U.S. stock markets such as the New York Stock Exchange (NYSE) and NASDAQ. ADRs make it easier for U.S. investors to invest in foreign companies, as transactions are conducted in U.S. dollars and under U.S. law. ADRs are further classified into different levels:

  1. Level I ADRs: These are traded “over-the-counter” but not on U.S. exchanges. They have minimal reporting requirements and are less regulated.

  2. Level II ADRs: These are listed on U.S. stock exchanges and have stricter regulatory requirements, including the need to file with the U.S. Securities and Exchange Commission (SEC).

  3. Level III ADRs: These allow foreign companies to raise capital through the issuance of new shares. Companies issuing Level III ADRs must comply with full SEC reporting requirements.

Global Depositary Receipt (GDR)

Global Depositary Receipts are similar to ADRs but are traded on international markets outside the U.S. GDRs grant the same benefits of ease of transaction and reduced complexity. These are generally traded on European exchanges such as the London Stock Exchange and Luxemburg Stock Exchange.

European Depositary Receipt (EDR)

European Depositary Receipts are akin to GDRs, but specifically designed for the European market. They are typically traded on European stock exchanges and represent shares in non-European companies.

International Depositary Receipt (IDR)

International Depositary Receipts are generic terms used for depositary receipts that can be listed anywhere in the world and not confined to a specific country or region.

Key Participants in DR Issuance and Trading

Issuer Company

The foreign company whose shares are represented by the depositary receipts. The company gains the benefit of being able to attract investment from foreign investors.

Depositary Bank

A depositary bank is a financial institution that creates DRs by holding the actual shares in custody, usually in the company’s home country but trading them in another. Some well-known depositary banks include:

Custodian Bank

The custodian bank holds the original shares of the foreign company. This bank is usually located in the country of the issuing company and collaborates with the depositary bank to facilitate the process.

Advantages and Disadvantages

Advantages

  1. Access to Global Markets: Investors can diversify their portfolios to include international securities without the complications of foreign trading systems.

  2. Simplicity: Trading in DRs simplifies the process of purchasing foreign shares since all transactions are processed as if they were local investments, mitigating exchange rates and regulations.

  3. Liquidity: DRs generally offer higher liquidity due to their listing on multiple exchanges.

  4. Capital Raising: Issuer companies can tap into foreign capital markets and reach a broader investor base.

Disadvantages

  1. Regulatory Compliance: Issuing DRs often requires satisfying regulatory standards in multiple jurisdictions, which can be complex and costly.

  2. Exchange Rate Risk: Although transactions are conducted in the investor’s local currency, fluctuations in exchange rates can affect the value of the DR.

  3. Costs: There might be various fees including issuance fees, custody fees, and exchange fees, which can reduce the overall gains.

Tax Implications

Tax treatment for income received from DRs can be different from one country to another, as well as between the issuing country and the investor’s domicile country. Typically, dividends from DRs may be subject to foreign tax withholding, and it’s crucial for investors to be aware of tax treaties that might mitigate double taxation.

Trading Depositary Receipts

Depositary Receipts are traded in the same manner as domestic stocks. Investors buy and sell DRs using a brokerage account, and transactions occur during the exchanges’ trading hours where the DRs are listed.

Example of Companies Utilizing DRs

  1. Alibaba Group Holding Limited (Ticker: BABA) trades its ADRs on the NYSE.
  2. Gazprom has GDRs listed on the London Stock Exchange.
  3. Tata Motors trades its ADRs on the NYSE.

Conclusion

Depositary Receipts serve as a valuable tool for both investors and companies. They enable the seamless integration of global markets, providing companies with access to foreign capital while offering investors a straightforward method to diversify and invest internationally.