Depositary Receipts 

Depositary Receipts (DRs) are financial instruments that enable investors to hold shares in foreign companies without the complexities of trading on international stock exchanges. They serve as a bridge, allowing local investors to easily access global markets. This article delves into the concept, functioning, types, and examples of depositary receipts, along with their benefits and associated risks. 

What Are Depositary Receipts? 

A Depositary Receipt is a negotiable financial instrument issued by a bank, representing shares in a foreign company. These receipts allow investors to own equity in foreign corporations while trading on their domestic stock exchanges. For instance, an investor in the United States can invest in a European company through an American Depositary Receipt (ADR) without the need to engage directly with European markets.  

Historically, DRs were introduced to overcome challenges such as currency exchange complexities, regulatory differences, and logistical issues associated with foreign investments. Today, they are widely used to facilitate cross-border investments, making it easier for investors to diversify their portfolios internationally. 

Understanding Depositary Receipts 

Depositary Receipts function as a conduit between local investors and foreign companies. They eliminate the need for investors to open accounts in foreign countries or navigate unfamiliar legal and regulatory frameworks. Instead, a depositary bank issues these receipts after acquiring foreign company shares through a custodian bank in the company’s home country.  

Key features of DRs include: 

• Local Trading: DRs are traded on domestic exchanges like regular stocks, providing investors with the familiarity and convenience of their local market infrastructure. 

• Denominated Currency: They are often denominated in local currencies (e.g., US$ for ADRs in the U.S.), mitigating the need for investors to deal with foreign currencies. 

• Simplified Transactions: Investors benefit from reduced fees and streamlined processes compared to direct foreign investments, as the depositary bank handles the complexities of international transactions. 

Working of Depositary Receipts 

The issuance and functioning of depositary receipts involve several steps: 

1. Collaboration: A depositary bank collaborates with a custodian bank in the foreign company’s home country.
2. Custody of Shares: The custodian bank holds the underlying shares of the foreign company.
3. Issuance of DRs: The depositary bank issues DRs representing these shares to investors in the local market.
4. Trading: Just like regular stocks, investors can trade these DRs on their domestic exchange.

For example, an ADR issued by a U.S. bank represents shares of a non-U.S. company but is traded on U.S. exchanges like NASDAQ or NYSE. Dividends and capital gains are paid in US$, making it convenient for American investors.  

Types of Depositary Receipts 

There are several types of depositary receipts tailored to different markets: 

1. a) American Depositary Receipts (ADRs)

• Issuance: Issued by U.S. banks for foreign companies. 

• Trading Platforms: Traded on U.S. exchanges like NYSE or NASDAQ. 

• Currency: Denominated in US$. 

• Example: Diageo PLC (NYSE: DEO), a UK-based company, trades via ADRs on the NYSE. 

1. b) Global Depositary Receipts (GDRs)

• Issuance: Issued for trading on international markets outside the U.S., such as the London Stock Exchange. 

• Currency: Denominated in US$ or Euros. 

• Example: A U.S.-based company listing its shares on the London Stock Exchange through GDRs. 

1. c) European Depositary Receipts (EDRs)

• Issuance: Issued by European banks, allowing investors to invest in non-European companies. 

• Trading Platforms: Traded on European stock exchanges. 

• Currency: Typically denominated in Euros. 

• Example: A Japanese company issuing EDRs to be traded on the Frankfurt Stock Exchange. 

1. d) Sponsored vs Unsponsored DRs

• Sponsored DRs: These are issued with the cooperation of the foreign company, often providing investors with benefits like voting rights. 
• Unsponsored DRs: These are issued by brokers without direct involvement from the foreign company, which may limit certain shareholder privileges. 

Examples of Depositary Receipts 

1. a) Diageo PLC

Diageo PLC, a UK-based beverage company, trades on the NYSE under the ticker DEO through ADRs. Each ADR represents four ordinary shares of Diageo, allowing U.S.-based investors to gain exposure to this global brand without trading directly on European exchanges. 

1. b) Alibaba Group

Alibaba Group Holding Ltd, a Chinese multinational conglomerate specialising in e-commerce and technology, offers ADRs on the NYSE under the ticker BABA. This allows investors in the U.S. to participate in Alibaba’s growth without dealing with the complexities of foreign markets.