What Is a Depositary Receipt?
A depositary receipt (DR) 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.
The DR, which was originally a physical certificate, allows investors to hold shares in the 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 that time, 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), 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.
[Important: You can gain more insight about depositary receipts from our in-depth tutorial on ADR Basics.]
How Depositary Receipts Work
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.
ADR holders do not have to transact in foreign currencies because ADRs trade in U.S. dollars and clear through U.S. settlement systems. The U.S. banks require that the foreign companies provide them with detailed financial information, making it easier for investors to assess the company's financial health compared to a foreign company that only transacts on international exchanges.
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.
- A depositary receipt (DR) 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.
- 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.
American Depositary Receipts
In the United States, investors can gain access to foreign stocks via American depositary receipts (ADRs). The main difference is that ADRs are issued only by U.S. banks for foreign stocks that are traded on a U.S. exchange. The underlying security of the ADRs is held by an American financial institution overseas rather than by a global institution. ADRs help reduce the administration and duty costs that would otherwise be levied on each transaction. They are a great way to buy shares in a foreign company while obtaining any dividends and capital gains in American dollars.
ADRs do not reduce or get rid of the currency and economic risks for the underlying shares in another country, however. Dividend payments in euros are converted to American dollars, net of conversion expenses and foreign taxes. This is done in accordance with the deposit agreement. ADRs are listed on various stock exchanges, such as the New York Stock Exchange, the American Stock Exchange, and Nasdaq, as well as trading over the counter.
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.