Depositary receipt
Depositary receipt (DR) is a negotiable financial instrument issued by a depositary bank that represents ownership of shares in a company incorporated in another jurisdiction. A depositary receipt enables investors to buy, sell, and hold interests in foreign companies through securities traded on a domestic or international stock exchange without directly owning the underlying shares in the issuer's home market. Each depositary receipt represents one or more underlying shares held in custody by a custodian bank on behalf of the depositary bank.
Depositary receipts facilitate cross-border investment by allowing investors to trade foreign securities in familiar markets, currencies, and settlement systems. They also enable companies to access international capital markets, broaden their shareholder base, improve liquidity, and enhance global visibility without relocating their primary stock exchange listing.
The depositary bank issues depositary receipts after receiving the underlying shares from a custodian bank located in the issuer's home jurisdiction. Holders of depositary receipts generally receive economic benefits associated with the underlying shares, including dividends and certain other shareholder rights, subject to the terms of the deposit agreement and applicable laws.
The two principal forms of depositary receipts are American depositary receipts (ADRs), which are traded in the United States, and global depositary receipts (GDRs), which are traded in one or more international markets outside the issuer's domestic exchange.
Depositary receipts play an important role in international finance by facilitating cross-border capital formation, improving market accessibility, and supporting global portfolio diversification.
History
Depositary receipts were introduced during the early twentieth century to enable investors to purchase foreign securities through domestic financial markets.
As international capital markets expanded, depositary receipt programs became widely used by companies seeking to raise capital outside their home jurisdictions. Today, depositary receipts are an established mechanism for international equity investment and cross-border securities issuance.
Objectives
The principal objectives of depositary receipts are to:
- facilitate international investment;
- improve access to foreign securities;
- expand capital-raising opportunities;
- increase market liquidity;
- broaden the shareholder base;
- simplify cross-border securities trading.
These objectives support greater integration of global financial markets.
Structure
A typical depositary receipt program involves:
- the issuing company;
- a depositary bank;
- a custodian bank;
- the underlying ordinary shares;
- investors.
The custodian bank holds the underlying shares while the depositary bank issues the corresponding depositary receipts.
Operation
The operation of a depositary receipt generally involves the following steps:
- the issuing company deposits ordinary shares with a custodian bank;
- the depositary bank issues depositary receipts representing those shares;
- the receipts are listed on one or more stock exchanges;
- investors buy and sell the receipts through the exchange;
- dividends and other shareholder entitlements are distributed through the depositary bank.
Types
American depositary receipt
An American depositary receipt (ADR) is a depositary receipt traded on securities markets in the United States.
ADRs enable U.S. investors to purchase shares of foreign companies using U.S. market infrastructure and settlement systems.
Global depositary receipt
A Global depositary receipt (GDR) is a depositary receipt traded on one or more international securities exchanges outside the issuer's domestic market.
GDRs facilitate investment by international investors across multiple jurisdictions.
Example
Suppose ABC Corporation, incorporated in India, wishes to raise capital from international investors.
The company deposits 20 million ordinary shares with a custodian bank in India.
A depositary bank issues 10 million depositary receipts, with each receipt representing 2 underlying shares.
Investors purchase the depositary receipts through an international stock exchange while the underlying shares remain held by the custodian bank.
Relationship with depositary bank
The depositary bank administers the depositary receipt program.
Its responsibilities generally include:
- issuing and cancelling depositary receipts;
- maintaining shareholder records;
- distributing dividends;
- administering corporate actions;
- facilitating investor communications.
Relationship with custodian bank
The custodian bank safeguards the underlying shares on behalf of the depositary bank.
It also assists in implementing corporate actions affecting the underlying securities.
Relationship with stock exchange
Depositary receipts are generally listed and traded on a Stock exchange.
Exchange trading provides:
- price discovery;
- liquidity;
- transparent trading;
- regulatory oversight.
Relationship with securities market
Depositary receipts form part of the broader Securities market.
They enable companies and investors to participate in international capital markets through standardized securities.
Relationship with depositary receipt index
A Depositary receipt index measures the performance of a portfolio of depositary receipts.
Such indices are commonly used as benchmarks for international investment funds and exchange-traded products.
Applications
Depositary receipts are widely used for:
- international equity offerings;
- cross-border capital raising;
- institutional investing;
- portfolio diversification;
- international portfolio management;
- passive investment strategies.
They facilitate efficient access to foreign equity markets.
Advantages
Depositary receipts provide several important benefits.
They simplify international investing, broaden investor access to foreign companies, improve market liquidity, support international capital formation, reduce administrative complexity, and enable trading through familiar domestic market infrastructure.
They also assist companies in expanding their international investor base.
Limitations
Depositary receipts remain subject to market risk, currency risk, political risk, regulatory differences, and taxation issues. Investors may also incur depositary bank fees, and certain shareholder rights may differ from those associated with direct ownership of the underlying ordinary shares.
Liquidity may vary among individual depositary receipt programs.
Importance
Depositary receipts are an important instrument of international finance because they connect companies seeking access to global capital with investors seeking international investment opportunities. By simplifying cross-border securities trading and improving market accessibility, depositary receipts contribute significantly to the development and integration of global capital markets.