What are Depository Receipts?
A Depository Receipt (DR) is a negotiable financial instrument issued by a bank that represents a foreign company’s publicly traded securities. It is a well-established method by which foreign companies or institutions gain access to global markets. DRs allow investors to hold shares of companies that are listed on stock exchanges in foreign countries. Depository receipts are a more convenient and inexpensive method as compared to purchasing stocks directly from foreign markets. For example, the Depository Receipt of Infosys is listed on the New York Stock Exchange. Through this, investors in the US can easily buy shares of the Indian IT company.
How Does it Work?
Suppose a company listed in India wishes to raise funds by selling a particular stake to overseas investors. The company will have a local Domestic Custodian that holds certain shares on behalf of it. Now, let us imagine that a firm in the United States is willing to buy or invest in equity shares of this Indian company. The Domestic Custodian will then inform its counterpart in the US, which is known as an Overseas Depository Bank (ODB). An ODB is basically a bank established outside India that acts as a custodian of equity shares of the issuing company (in electronic form).
Thus, the ODB will update/inform the US-based investor and provide an acknowledgment that it will hold a specific quantity of shares of the Indian company on their behalf. This ‘acknowledgement’ that the ODB provides to the foreign investor is known as a Depository Receipt. In this case, the DR will be listed on the US stock exchange and can be traded.
Types of Depository Receipts
- American Depository Receipt (ADR): An ADR is a negotiable certificate issued by a US depository bank that represents a specified number of shares held of a foreign company’s stock. In simple terms, an ADR represents shares of a foreign company that is being traded in the US stock markets. As of April 16, there are around 15 Indian ADRs being traded on the US stock markets. ADRs and their dividends are priced in US Dollars.
- Global Depository Receipt (GDR): A GDR is a certificate issued by a bank that represents shares of a foreign company on two or more global markets. GDRs usually trade on US stock exchanges, as well as European and Asian exchanges. GDRs and their dividends are priced in the local currency of the exchanges where the shares are traded.
We also have Indian Depository Receipts (IDRs), which are denominated in Indian rupees and are issued by a Domestic Depository in India. [A domestic depository is a custodian of securities registered with market regulator SEBI]. IDRs are issued against the underlying equity of a company to enable foreign firms to raise funds from the Indian market. On the other hand, IDRs allow Indian citizens or firms to invest in the shares of foreign companies.
Advantages of Depository Receipts
- Depository receipts allow investors to easily diversify their portfolio and purchase shares of foreign companies.
- DRs provide investors with benefits such as voting rights and dividends. It opens up certain markets that investors would not have access to earlier.
- Depository receipts offer more convenience and are less expensive than purchasing stocks in foreign markets. They help reduce administrative costs that are levied when investors try to acquire shares of foreign companies.
- DRs allow large international companies to raise capital very easily from global markets.
Disadvantages of Depository Receipts
- Many depository receipts may not be listed on a stock exchange. In some cases, only institutional investors would be trading them.
- There may not be many buyers and sellers of ADRs, which leads to low liquidity.
- A country wherein a foreign company is located may experience a recession or other socio-political issues. Due to these economic risks, the value of a depository receipt (that represents the foreign company’s shares) could fluctuate.
- Fluctuations in exchange rates (or conversion expenses, foreign taxes) could heavily impact the value of depository receipts.