A depositary receipt (DR) is a type of negotiable (transferable) financial security that is traded on a local stock exchange but represents a security, usually in the form of equity that is issued by a foreign publicly listed company. The DR, which is a physical certificate, allows investors to hold shares in equity of other countries. One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies, investors and traders global investment opportunities since the 1920s.
Since then, DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) (the other most common type of DR), European DRs and international DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE) or the American Stock Exchange, while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated in U.S. dollars, but can also be denominated in Euros. How Does the DR Work?
The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. Let us look at an example of how an ADR is created and traded.
The Benefits of Depositary Receipts
The DR functions as a means to increase global trade, which in turn can help increase not only volumes on local and foreign markets but also the exchange of information, technology, regulatory procedures as well as market transparency. Thus, instead of being faced with impediments to foreign investment, as is often the case in many emerging markets, the DR investor and company can both benefit from investment abroad.
AMERICAN DEPOSITORY RECEIPTS
ADRs were primarily created to increase investment access to widely known and often multinational companies. They are typically formed by a depository bank depositing ordinary shares of a foreign company into a trust and issuing receipts of interest in the underlying shares on a domestic exchange. The bank will act as a custodian for the trust handling dividend distribution, currency exchange, proxies, tax reporting, and regulatory filings. It receives a management fee for these services, either from the shareholders or the issuing company.
Trading of ADRs occurs by brokers purchasing/selling outstanding ADRs in the domestic market, or on the foreign markets if no shares are available domestically. In the case of purchases in the foreign market, the broker then deposits the foreign shares with the bank in exchange for newly created ADRs. In the case of sales in the local market, the broker will cancel the ADR causing the depository bank to sell the shares in the foreign market and deliver the proceeds in the investor’s currency. Units in the trust are listed on large exchanges primarily in countries with developed capital markets, as if they were shares of a company domiciled in the same country as the exchange. The listing company of the ADR must adhere to the same regulatory requirements and disclosures as the other listed issuers on the exchange. In effect, shares of a foreign company can be purchased on a U.S. stock exchange in the same manner as stock of a U.S. company.
So why have the middlemen (trust)? Many investors do not have efficient means of diversifying into foreign companies because of the administrative and implementation issues. Often, trading in foreign markets is more expensive relative to U.S. exchange transaction costs, as well as difficult to execute due to time zone differences. Also, foreign exchanges do not usually have the same regulatory requirements that...