Depository Receipts: Features, Difference Between GDR, IDR and ADR

Introduction

A depositary receipt (DR) is a negotiable certificate issued by a bank. It represents shares in a foreign company traded on a local stock exchange and allows investors to hold shares in the equity of foreign countries. It gives them an alternative to trading on an international market. A depositary receipt was originally a physical certificate that allowed investors to hold shares in the equity of other countries. Example: American depositary receipt (ADR), which has been offering companies, investors, and traders global investment opportunities since the 1920s.

Features of Depositary Receipt 

• Foreign Investor Participation: It is a mechanism for raising funds by tapping foreign investors who otherwise may not be able to participate in the domestic market.
• Trade on Local Exchange: A depositary receipt (DR) is a negotiable certificate representing shares in a foreign company traded on a local stock exchange
• Benefits for Investors: Depositary receipts allow investors to hold equity shares of foreign companies without the need to trade directly on a foreign market.
  • Depositary receipts provide investors with the benefits and rights of the underlying shares, which can include voting rights and dividends.
  • Depositary receipts are more convenient and less expensive than purchasing stocks directly in foreign markets.
• Portfolio Diversification: Depositary receipts allow investors to diversify their portfolios by purchasing shares of companies in different markets and economies.
• Simplifying International Investing:  A depositary receipt avoids the need to trade directly with the stock exchange in the foreign market.
  • Investors transact with a major financial institution within their home country. 
• Mitigating  Risks: Diversifying using depository receipts along with other investments prevents a portfolio from being too heavily concentrated in one holding or sector.

Difference Between GDR, IDR and ADR

Disadvantages of Depository Receipts

• Low Liquidity: Depositary receipts may suffer from low liquidity, resulting in delays when buying or selling, and may entail substantial administrative fees.
• Limitations of Depositary Receipts: A drawback of depositary receipts is their limited listing on stock exchanges.
  • Further, mostly traded by institutional investors, posing a challenge for individual investors.
• Currency Risks: Dividend payments in euros are converted to U.S. dollars, factoring in conversion costs and foreign taxes as per the deposit agreement, which could be influenced by exchange rate fluctuations, affecting dividend value.
• Economic Risks: Investors remain exposed to economic risks tied to the foreign company’s country, such as recessions, bank failures, or political turmoil,

Conclusion

• Depositary receipts provide investors with a convenient means to invest in foreign companies without directly trading on foreign exchanges. 
• While DR offers benefits such as diversification and access to international markets, investors should be aware of potential drawbacks including limited liquidity, currency risk, and exposure to economic risks in the foreign company’s country. 
• To make informed decisions when incorporating depositary receipts into their investment portfolios understanding these factors is essential for investors.