Depositary receipts: Overview, definition, and example
What are depositary receipts?
Depositary receipts are financial instruments issued by a bank or financial institution that represent shares of a foreign company traded on a local stock exchange. They allow investors to buy and sell foreign securities in their domestic market without dealing with the complexities of foreign currency or international regulations. Essentially, depositary receipts act as a bridge between the foreign market and local investors by simplifying the process of investing in foreign companies.
There are two main types of depositary receipts: American Depositary Receipts (ADRs), which are traded in U.S. markets, and Global Depositary Receipts (GDRs), which can be traded on markets outside of the U.S. The underlying foreign shares are held by a depositary bank, and the depositary receipt represents ownership of those underlying shares.
Why are depositary receipts important?
Depositary receipts are important because they allow domestic investors to gain exposure to foreign companies without the need to directly purchase shares on foreign exchanges. They also provide foreign companies with a means to access capital from investors in other countries. For businesses, issuing depositary receipts can expand their investor base and enhance their global presence. For investors, depositary receipts provide a way to diversify their portfolios with international assets, while still benefiting from the convenience and liquidity of local markets.
Additionally, depositary receipts simplify the regulatory and currency-related challenges involved in buying and selling foreign stocks, making international investments more accessible.
Understanding depositary receipts through an example
Imagine a U.S.-based investor who wants to invest in a large European company but does not want to deal with the complexities of purchasing shares on a European exchange. Instead, the company issues American Depositary Receipts (ADRs) in the U.S. markets, which represent the underlying European shares. The U.S. investor can then purchase these ADRs on the New York Stock Exchange (NYSE) just like any other U.S. stock, without needing to deal with foreign currencies, taxes, or regulations specific to the European market.
In another example, a company based in India might issue Global Depositary Receipts (GDRs) to allow investors in countries around the world to invest in its shares. These GDRs could be traded in London, giving international investors access to the Indian market while avoiding the complexities of investing directly in India.
An example of a depositary receipts clause
Here’s how a clause about depositary receipts might appear in a contract or offering document:
“The Issuer agrees to issue American Depositary Receipts (ADRs) representing the common shares of the company. Each ADR shall represent [number] common shares and will be listed for trading on the New York Stock Exchange. The Depositary will act as the custodian of the underlying shares and handle all related administrative duties.”
Conclusion
Depositary receipts are a valuable financial instrument that facilitates the internationalization of both investments and capital markets. They allow investors to easily purchase foreign stocks and enable companies to raise capital from global investors without navigating the complexities of foreign markets. Whether in the form of ADRs or GDRs, depositary receipts offer both convenience and liquidity, making them an essential tool for international investment. By providing a simpler way to trade foreign securities, depositary receipts enhance portfolio diversification and give investors broader access to global opportunities.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.