Depositary Receipts

A Depositary Receipt (DR) is a financial instrument that represents ownership of shares in a foreign company, allowing investors to trade in those shares on domestic stock exchanges. It is issued by a domestic bank (called a depositary bank) that holds the underlying shares of the foreign company in trust. Depositary receipts enable investors to invest in foreign companies without dealing directly with overseas markets, currencies, or regulations.
These instruments have become an important tool in international finance, promoting cross-border investment, liquidity, and capital mobilisation.

Definition

A Depositary Receipt is a negotiable certificate issued by a bank to represent shares of a foreign company that are deposited with a custodian in the company’s home country. Each depositary receipt corresponds to one or more shares—or a fraction of a share—of the foreign company.
Holders of depositary receipts enjoy the same economic and ownership rights (such as dividends and capital appreciation) as regular shareholders, though voting rights may be limited depending on the structure.

Purpose and Importance

Depositary receipts were created to:

• Facilitate foreign investment by simplifying access to overseas equities.
• Enable companies to raise capital in international markets.
• Overcome regulatory and currency restrictions on cross-border trading.
• Increase global visibility and liquidity for companies.

They benefit both investors and issuing companies by bridging global markets.

Structure and Mechanism

The issue of a depositary receipt involves several key participants and steps:

1. Foreign Company (Issuer):
   • A company based outside the investor’s country that wishes to list or make its shares accessible to foreign investors.
2. Custodian Bank:
   • A bank in the issuer’s home country that holds the actual shares of the company.
3. Depositary Bank:
   • A financial institution in the investor’s country that issues the depositary receipts based on the shares held by the custodian.
4. Investors:
   • Buy and sell the depositary receipts on domestic exchanges in their own currency.

Process:

• The foreign company deposits its shares with the custodian bank.
• The depositary bank issues depositary receipts to investors in the target market.
• These receipts trade like ordinary shares and can be bought or sold on the domestic stock exchange.
• Dividends declared by the foreign company are collected by the depositary bank, converted into the local currency, and distributed to DR holders.

Types of Depositary Receipts

1. American Depositary Receipt (ADR):
   • Issued in the United States and traded on American exchanges such as NYSE or NASDAQ.
   • Denominated in U.S. dollars.
   • Popular among non-U.S. companies seeking access to American investors.
   • Example: ADRs of Infosys, Tata Motors, and HDFC Bank.
2. Global Depositary Receipt (GDR):
   • Issued and traded in international markets, typically outside the U.S. (such as in London or Luxembourg).
   • Denominated in freely convertible currencies, such as U.S. dollars or euros.
   • Example: GDRs of ICICI Bank, Larsen & Toubro, and Reliance Industries.
3. European Depositary Receipt (EDR):
   • Issued for trading on European exchanges, such as the London Stock Exchange (LSE) or Luxembourg Stock Exchange.
4. Indian Depositary Receipt (IDR):
   • Issued in India by Indian depositary banks against shares of foreign companies.
   • Enables Indian investors to invest in overseas companies using Indian rupees.
   • Example: Standard Chartered Bank issued the first IDRs in India in 2010.

Features of Depositary Receipts

• Tradable on Stock Exchanges: Can be bought and sold like ordinary shares.
• Denominated in Local Currency: Transactions take place in the investor’s domestic currency.
• Dividends in Local Currency: Dividends are received in local currency, though they originate from foreign earnings.
• Fractional Representation: Each receipt may represent one, multiple, or fractional shares.
• Regulatory Compliance: Issuance is governed by the securities laws of both the home and host countries.

Advantages

For Investors:

• Simplified access to foreign equities without dealing with foreign exchanges or currencies.
• Lower transaction and administrative costs compared to direct foreign investments.
• Exposure to international markets for portfolio diversification.
• Liquidity and transparency through trading on local exchanges.

For Companies (Issuers):

• Access to a larger pool of international investors.
• Enhanced global visibility and corporate reputation.
• Opportunity to raise foreign capital at competitive costs.
• Potential for improved valuation through global demand.

Disadvantages

• Currency Risk: Exchange rate fluctuations can affect returns.
• Regulatory Complexity: Subject to compliance with multiple jurisdictions.
• Limited Voting Rights: DR holders may not have full shareholder voting privileges.
• Conversion Costs: Fees involved in issuing, converting, or redeeming DRs.

Example of Working

Suppose Company A, based in India, wants to raise capital from U.S. investors. It deposits its shares with a custodian bank in India. The U.S. depositary bank issues ADRs representing those shares. American investors buy these ADRs on the New York Stock Exchange in U.S. dollars. Dividends paid by Company A are received in rupees, converted to dollars by the depositary bank, and distributed to ADR holders.

Regulatory Framework in India

In India, Global Depositary Receipts (GDRs) and American Depositary Receipts (ADRs) are governed by:

• Foreign Exchange Management Act (FEMA).
• Companies Act, 2013.
• Securities and Exchange Board of India (SEBI) regulations.
• Depositary Receipts Scheme, 2014, which simplifies the framework for issuing DRs.

For Indian Depositary Receipts (IDRs), regulations are laid down under the Companies (Issue of Indian Depositary Receipts) Rules, 2004.

Importance in Global Finance

Depositary receipts play a pivotal role in integrating global capital markets by:

• Facilitating cross-border capital flows.
• Enabling foreign listings of domestic companies.
• Providing investors access to global investment opportunities.
• Supporting emerging market companies in raising foreign capital.