Understanding Depositary Receipts

Key takeaways
* Depositary receipts (DRs) are negotiable certificates issued by banks that represent shares of foreign companies and trade on local exchanges.
* American Depositary Receipts (ADRs) let U.S. investors buy foreign stocks in U.S. dollars; Global Depositary Receipts (GDRs) serve a similar role for other markets.
* DRs simplify access to international equities and can lower transaction costs, but they carry liquidity, currency, and sovereign risks.

What is a depositary receipt?

A depositary receipt (DR) is a bank-issued certificate that represents ownership of shares in a foreign company. DRs let investors buy and sell interests in those foreign shares on their domestic exchanges without directly trading on the foreign market.

How DRs work

• A custodian bank in the issuer’s home country holds the underlying shares.
• A depositary bank in the investor’s country issues receipts against those shares. Each receipt typically represents one or more underlying shares.
• Receipts trade in the local market currency and settle through local clearing systems, while the custody of the actual shares remains with the foreign custodian.

American Depositary Receipts (ADRs)

• ADRs are depositary receipts issued by U.S. banks that trade on U.S. exchanges (NYSE, Nasdaq, AMEX) or over-the-counter.
• They are quoted and settled in U.S. dollars, and dividends and capital gains are paid in dollars (after conversion and any tax withholdings).
• Because U.S. banks must obtain and publish certain financial information from the foreign issuer, ADRs can make it easier for U.S. investors to evaluate foreign companies.

Global Depositary Receipts (GDRs) and other variants

• GDRs are commonly used to list shares on European exchanges (for example, the London Stock Exchange) and are often denominated in U.S. dollars or euros.
• The mechanics are similar to ADRs but adapted for the target market and regulatory regimes.
• Other regional or international DR structures exist to facilitate cross-border listing and capital raising.

Example

A foreign bank or company listed in its home market can make its shares accessible to U.S. investors by issuing ADRs through a U.S. depositary bank. For instance, a bank listed in India might have ADRs issued by a Western depositary bank that trade on the NYSE, enabling broad access to U.S. investors who otherwise could not easily buy the Indian-listed shares.

Benefits

• Easier access to foreign companies without the need to open foreign brokerage accounts.
• Trades and dividends are processed in the investor’s local currency, simplifying settlement.
• Potential cost savings compared with direct purchases on foreign exchanges (lower administrative and transaction overhead).
• Can provide voting rights and dividend benefits associated with the underlying shares, depending on the deposit agreement.
• Helps issuers raise capital internationally and increases their investor base.

Drawbacks and risks

• Liquidity: Some DRs trade thinly, which can make buying or selling at favorable prices difficult.
• Currency risk: Although DRs are quoted in the investor’s currency, the underlying business and dividends are exposed to foreign-exchange fluctuations; conversion fees and taxes can reduce returns.
• Political and economic risk: Events in the issuer’s home country (recession, regulatory change, instability) can materially affect the value of the DR.
• Administrative and custodial costs: Fees and withholding taxes may be charged when dividends are converted and remitted to DR holders.
• Program changes: Deposit agreements can be altered or DR programs withdrawn, which may delay access to underlying shares or proceeds.

Common questions

How is a depositary receipt program established?
* A foreign issuer engages advisers and a depositary bank in the target market. The custodian holds the underlying shares while the depositary issues receipts subject to regulatory and listing requirements in the host market.

How are DRs taxed?
* Dividends and capital gains on DRs are generally reportable in the investor’s tax jurisdiction. Foreign withholding taxes may be deducted at source; investors may be able to claim foreign tax credits depending on local tax rules.

What is a sponsored vs. unsponsored ADR?
* Sponsored ADR: The foreign company formally partners with a U.S. depositary bank and complies with reporting and disclosure requirements—these are the most common ADRs listed on exchanges.
* Unsponsored ADR: Issued without the issuer’s direct involvement, often created by brokers or banks; unsponsored ADRs are typically less common on major exchanges and may offer less information to investors.

Bottom line

Depositary receipts provide a practical way for investors to access foreign equities through domestic markets, combining convenience with international diversification. They simplify currency handling and regulatory access, but they do not eliminate underlying currency exposure, liquidity issues, or geopolitical and operational risks. Evaluate a DR’s liquidity, fees, tax implications, and the political/economic context of the issuer before investing.