Posted in Finance Articles, Total Reads: 3411
, Published on 09 July 2011
A depository receipt is a negotiable financial instrument issued by a bank to represent a foreign company's publicly traded securities. The depositary receipt trades on a local stock exchange. It is a physical certificate which allows investor to hold shares in equity of other countries. American Depository Receipt (ADR) is one of commonly used depository receipt. DRs have spread to other parts of the globe in the form of global depositary receipts (GDRs) European DRs and International DRs. ADRs are typically traded on a U.S. national stock exchange, such as the New York Stock Exchange (NYSE), while GDRs are commonly listed on European stock exchanges such as the London Stock Exchange. Generally ADRs and GDRs are denominated in US dollars.
How does the DR work?
If a foreign company wants to get its publicly traded shares on foreign stock exchange, they will have to take the route of Depository receipts. Indian companies like Infosys, ICICI bank have their ADRs traded in US market.
For example, an Indian company wants to list its publicly traded shares on NYSE in the form of ADRs. First it has to satisfy all the requirements set by NYSE for listing as ADRs. Before the Indian company’s share are traded freely on the exchange, a US broker through an international office or a local brokerage house in India, would purchase the domestic shares from the Indian market and then have them delivered to the local (Indian) custodian bank of the depository bank. The depository bank is the American institution which will issue the ADRs. Let’s assume in this case depository bank is Bank of America. Bank of America after confirmation from the custodian bank in India that it has received the shares, issues shares in United States. Bank of America issues ADRs to the US broker who purchased it initially. Each ADRs equivalent share is determined by the ADR ratio which can be anything. ADRs can be traded like any normal shares in the US market. All ADR transactions of the Indian company takes place in US dollars and settled in US dollars. Holder ADRs also have right to dividends and voting rights.
The price of ADRs is governed by the underlying share in the domestic market. If there is price difference between ADR and domestic share, it leads to arbitrage opportunity which ultimately brings both ADRs and domestic shares at the same price equivalent.
From a company’s point of view depository receipt provides a mechanism to raise capital in the foreign market if they to opt to raise DR. It increases prestige of the local company in the foreign country. Often local companies find it difficult to get into foreign market due to restrictions and barriers posed by the foreign country. DRs provide a way to encourage investment from abroad without having to worry about barriers to entry that a foreign investor may face.
From investors points of view, investing in DRs provide them an opportunity to diversify their portfolio exposed to global risk not only to local risk. Often investors find it difficult to invest in foreign country market due to changing regulatory procedures. With the help of DRs they can directly buy these shares from their own markets. For example, if a US national wants to invest in shares of Infosys, he cannot directly buy them from Indian market. But with the help of Infosys ADRs trading in US market, he can directly buy them from US market.
Hence DRs give opportunity for foreign investment while bypassing the unnecessary risks of investing outside your own borders.
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