What is a Depositary Receipt (DR)? A depositary receipt is a negotiable certificate issued by a bank. It represents shares in a foreign company traded on a local stock exchange. Investors can hold shares in the equity of foreign countries through it. It’s an alternative to trading on an international market.
Originally, a depositary receipt was a physical certificate allowing investors to hold shares in the equity of other countries. The American depositary receipt (ADR) is one of the most common types and has offered global investment opportunities since the 1920s.
Depositary receipts provide a way for investors to buy shares in foreign companies. In our in-depth tutorial, we explore ADR Basics and the global spread of depositary receipts. Global Depositary Receipts (GDRs), European DRs, and international DRs are different forms of depositary receipts. While ADRs are traded on U.S. national stock exchanges, 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 they can also be denominated in euros.
A GDR operates in a reverse manner to an ADR. A U.S.-based company can list its stock on the London Stock Exchange via a GDR by entering into a depositary receipt agreement with a London depository bank, which then issues shares in Britain based on the regulatory compliance for both countries. Depositary receipts offer several advantages to investors. They allow for portfolio diversification, enabling investors to purchase shares in foreign companies and construct a portfolio with a wide variety of stocks across multiple industries. This diversification prevents a portfolio from being overly concentrated in one holding or sector. Investors gain benefits and rights of the underlying shares, including voting rights and dividends, through depositary receipts. They also provide access to markets that would otherwise be inaccessible. Additionally, depositary receipts are more convenient and less expensive than purchasing stocks in foreign markets, reducing administration and duty costs. They help international companies raise capital globally and encourage international investment. However, there are disadvantages to depositary receipts. Many are not listed on a stock exchange and are only traded by institutional investors. They may also have relatively low liquidity, leading to delays in entering and exiting positions and potentially significant administrative fees in some cases. Currency risk is not eliminated for the underlying shares in another country with depositary receipts like ADRs. Dividend payments in euros are converted to U.S. dollars, net of conversion expenses and foreign taxes, in accordance with the deposit agreement. Exchange rate fluctuations could impact the value of the dividend payment. Investors still face economic risks due to the potential for recession, bank failures, or political upheaval in the country where the foreign company is located. The value of the depository receipt would fluctuate as a result, along with any heightened risks in the foreign country. There are also risks associated with attending securities that aren’t backed by a company.The depositary receipt can be withdrawn at any time. However, the waiting period for the shares being sold and the proceeds distributed to investors can be long.
Frequently Asked Questions: How is a depositary receipt transaction accomplished? A foreign-listed company usually hires a financial advisor to assist in navigating regulations when creating a depositary receipt abroad. The company also generally uses a domestic bank as the custodian and a broker in the target country. The domestic bank will list shares of the firm on an exchange, like the New York Stock Exchange (NYSE), in the country where the firm is located. How are depositary receipts taxed? Dividends and gains earned on American depositary receipts are paid in U.S. dollars, net of expenses and foreign taxes. Most banks withhold to cover foreign taxes, but the full income is still reportable and potentially taxable on your U.S. tax return, which may result in double taxation unless preventive steps are taken. What is a ‘sponsored’ ADR? A depositary bank works with a foreign company and its custodian bank for a sponsored American depositary receipt. ADRs are otherwise issued by brokers or dealers that own common stock in the foreign company. Unsponsored ADRs are not commonly available on exchanges. The Bottom Line: You can avoid trading directly with foreign stock exchanges by purchasing depositary receipts. But DRs have both pros and cons. They are convenient and can be less expensive than direct trading as fees are often reduced. However, your investment can be affected by economic risks and circumstances in the foreign country, and DRs are not particularly liquid. Trades you make may be subject to some delays, so ensure you can withstand these circumstances.
