What is a Depositary Receipt
A depositary receipt is a negotiable certificate issued by a bank representing shares in a foreign company traded on a local stock exchange. The depositary receipt gives investors the opportunity to hold shares in the equity of foreign countries and gives them an alternative to trading on an international market.
Breaking Down Depositary Receipt
Depositary receipts exist all over the world, but the most common is the American depositary receipt, which first came about in the 1920s. In the U.S., American depositary receipts typically trade on the AMEX, NYSE or Nasdaq. For example, when an investor purchases an American depositary receipt, the receipt is listed in U.S. dollars and a U.S. financial institution overseas holds the actual underlying security.
Among other advantages, depositary receipts provide investors with the benefits and rights of the underlying shares, which may include voting rights, and open up markets that investors would not have access to otherwise. For example, ICICI Bank Ltd. is listed in India and is typically unavailable to foreign investors. However, the bank has an American depositary receipt issued by Deutsche Bank that trades on the NYSE, which most U.S. investors can access, providing it much wider availability among investors.
When a foreign-listed company wants to create a depositary receipt abroad, it typically hires a financial advisor to help it navigate regulations. The company also typically uses a domestic bank to act as custodian and a broker in the target country to list shares of the firm on an exchange, such as the NYSE, in the country where the firm is located.
Pros and Cons of Depositary Receipts
Depositary receipts can be attractive to investors because they allow investors to diversify their portfolios and purchase shares in foreign companies in a more convenient and less expensive manner than purchasing stocks in foreign markets. For companies, depositary receipts provide a simple way to raise capital globally and encourage international investment.
However, investors may find that many depositary receipts are not listed on a stock exchange, and they may find only institutional investors are trading them. Other potential downsides to depositary receipts include their relatively low liquidity and the risks attending securities that are not backed by a company. The depositary receipt may be withdrawn at any time, and the waiting period for the shares being sold and the proceeds distributed to investors may be long. They may also come with significant administrative fees.