What is the Depository Receipts?
A negotiable instrument that’s issued by a lender to behave like shares in a foreign public business and allows investors to trade in the global markets is called a depositary receipt.
It is a type of physical certificate through which investors can hold stocks in the equity of different nations.
The American depositary receipt (ADR) is among the most frequent types of DRs, which has been supplying investors, businesses, and dealers an opportunity for global investment since the 1920s.
They were essentially made to reduce the complexities of investing in foreign securities.
In older times when investors wanted to purchase shares in a foreign company what they will need to perform would be to exchange their money into foreign currency then opening a foreign exchange account. This would let them buy shares via the broker account on a foreign stock market.
The debut of depositary receipts obviates the entire process and makes it less complex, simpler, and more suitable for the investors to invest in foreign firms.
Firstly, an investor is required to communicate a broker in a local bank when he/she’s interested in buying of depositary receipts.
Before making a decision to purchase stocks, the local bank (which is called the depositary bank) in the investor’s home country is likely to make a valuation of overseas security.
The broker in the depositary bank will secure the stocks either on the local stock exchange or in the overseas stock exchange by employing another agent in a foreign exchange (custodian bank).
After the procurement of these shares, the depositary bank will ask the stocks to be delivered to the custodian bank.
After receiving the stocks by the custodian bank it will be issued to the depositary bank as a depositary receipt that’s traded on the bank’s local stock exchange.
A notification is delivered to the agent, who will deliver it into the investor and debit card the charges from the investor’s account once the depositary bank receives the depositary receipts from the custodian bank.
Depositary Receipts are of these forms:
1) American Depositary Receipt (ADR)
This depositary receipt is listed only on American stock exchanges and may only be traded at the U.S. Dividends are paid to the investors in U.S. dollars.
EDRs are only listed on European stock exchanges and may only be sold and bought in Europe. It pays dividends in euros. It can be mentioned that these depositary receipts are the European equivalent of ADRs.
3) Global Depositary Receipt (GDR)
Any depositary receipt which is not generated from your home state is referred to as a global depositary receipt.
The following are a Few of the advantages of depository receipts;
1) Less international regulation
Investors are not needed to worry about international trading policies and global laws because these DRs are traded on a local stock market.
2) Exposure to international securities
During depositary receipts, investors can diversify their investment portfolios. They do so by gaining exposure to international securities in addition to securities provided by local companies.
It offers the companies with a means to raise more capital by tapping into the international markets and attract more foreign investors around the world.
Limitations of DRs
The following are some limitations of DRs;
1) Limited access for most investors
Sometimes, depositary receipts might not be listed on stock trades, and therefore only institutional investors may invest in them that may be the companies or organizations that execute trades on behalf of the customers.
2) Higher risk from forex exchange rate fluctuations
There’s a greater risk owing to volatility in foreign currency exchange rates because if an investor purchases a depositary receipt that represents stocks in a British company so its worth is going to be affected by the gap in the exchange rate between the British pound as well as the currency in the buyer’s home country.
3) More administrative and processing fees, and taxes
Administrative and processing fees might be greater in this whole procedure of depositary receipts since one needs to compensate for custodial services from the custodian bank and also there would be high taxes that should be paid.
For example, ADRs get the same dividend taxes and capital gains as like other stocks in the U.S. However, the investor is required to pay the overseas country’s regulations and taxes in addition to regular taxes in the U.S.