Deferred depository receipt

What Is a Depositary Receipt?

A Depositary Receipt (DR) is a negotiable financial instrument issued by a bank that represents ownership of shares in a foreign company. These receipts allow investors to buy and sell foreign securities on their local stock exchange, simplifying international investment. Depositary Receipts belong to the broader category of international investing, enabling investors to gain exposure to global companies without directly dealing with foreign markets, currencies, or regulatory frameworks. They act as a bridge, facilitating cross-border investment and capital raising.⁴³

While the term "Deferred Depository Receipt" is not a standard or widely recognized financial instrument in the same vein as common forms like American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs), the underlying concept revolves around the broader category of Depositary Receipts. A Depositary Receipt program simplifies the process for foreign companies to access capital from international investors and for investors to diversify their portfolio diversification with international assets.⁴¹, ⁴²

History and Origin

The concept of the Depositary Receipt emerged to address the complexities and logistical challenges of cross-border stock ownership. The first American Depositary Receipt (ADR) was pioneered by J.P. Morgan in 1927 for the British retailer Selfridges Provincial Stores Limited (now Selfridges plc.).³⁹, ⁴⁰ This innovation allowed American investors to purchase shares of a foreign company without the need to trade on international exchanges, which was often impractical for the average person at the time.³⁸ The ADR was initially listed on the New York Curb Exchange, the predecessor to the American Stock Exchange.³⁷

Over the decades, Depositary Receipts evolved significantly. In 1955, the U.S. Securities and Exchange Commission (SEC) established Form S-12, a registration requirement for depositary receipt programs, later replaced by Form F-6, which standardized the regulatory framework.³⁶ The adoption of Rule 144A in April 1990 further expanded the market by giving rise to private placement depositary receipts available to qualified institutional buyers.³⁵ Following the success of ADRs, other forms like Global Depositary Receipts (GDRs) emerged, with Citibank introducing the first GDR in December 1990 for Samsung Corporation, enabling simultaneous capital raising in the U.S. and Europe.³⁴ This evolution has cemented Depositary Receipts as a vital tool in global capital markets.

Key Takeaways

• Depositary Receipts are financial instruments issued by banks that represent shares of a foreign company, allowing them to be traded on local exchanges.³², ³³
• They simplify international investing by removing the need for investors to deal directly with foreign stock exchanges, currencies, and regulatory complexities.³¹
• ADRs are specific to the U.S. market, while GDRs are traded on international exchanges outside the U.S.²⁹, ³⁰
• Depositary Receipts provide foreign companies with access to a broader base of international investors and facilitate equity capital raising.²⁷, ²⁸
• Holders of Depositary Receipts generally receive dividends in their local currency and can have shareholder rights similar to direct share ownership.²⁶

Formula and Calculation

Depositary Receipts themselves do not typically involve a complex financial formula for their value beyond a direct representation of the underlying shares. The pricing of a Depositary Receipt is generally tied to the price of the foreign company's stock in its home market, adjusted for the prevailing foreign exchange rates and the specific ratio of the Depositary Receipt to the underlying shares.²⁵

For example, if one Depositary Receipt represents ( N ) underlying shares, and the price of one underlying share in its home currency is ( P_{foreign} ) with an exchange rate of ( E ) (local currency per foreign currency unit), then the theoretical price of the Depositary Receipt (( P_{DR} )) would be:

$P_{DR} = N \times P_{foreign} \times E$

The ratio ( N ) (DRs to foreign company shares) allows Depositary Receipts to be priced at an amount more aligned with typical local market share prices, even if the underlying foreign share price is very high or very low.²³, ²⁴

Interpreting the Depositary Receipt

Understanding a Depositary Receipt involves recognizing its function as a proxy for direct foreign stock ownership. Investors interpret the price movements of a Depositary Receipt just as they would a domestic stock, as the price generally tracks the underlying foreign security's price in its home market.²² This allows for straightforward analysis using standard financial metrics.

When evaluating a Depositary Receipt, it is important to note its trading characteristics, such as the exchange it is listed on (e.g., NASDAQ or NYSE for ADRs), its liquidity, and the disclosure requirements of the issuing company. For example, sponsored Depositary Receipts, issued in cooperation with the foreign company, typically offer more transparency and shareholder benefits compared to unsponsored ones. The ratio of the Depositary Receipt to its underlying shares is also a key factor, as it determines how many foreign shares each receipt represents.²⁰, ²¹

Hypothetical Example

Consider an American investor, Sarah, who wishes to invest in "GlobalTech," a rapidly growing technology company based in Japan. Instead of navigating the Japanese stock exchange, setting up a foreign brokerage account, or dealing with currency conversions, Sarah can purchase an American Depositary Receipt (ADR) representing GlobalTech's shares.

Suppose GlobalTech's shares trade at ¥1,000 per share on the Tokyo Stock Exchange. A U.S. depositary bank issues ADRs for GlobalTech, with each ADR representing 5 shares of GlobalTech (a 1:5 ratio). If the exchange rate is ¥120 to US$1, the theoretical price of one GlobalTech ADR would be:

$\text{ADR Price} = 5 \text{ shares} \times ¥1,000/\text{share} \div ¥120/\text{US\$1} = \text{US\$41.67}$

Sarah can buy and sell these GlobalTech ADRs on a U.S. exchange just like any domestic stock, denominated in U.S. dollars. If GlobalTech announces dividends, the depositary bank converts the yen dividends into U.S. dollars and distributes them to Sarah, simplifying the entire investment process. This hypothetical example demonstrates how Depositary Receipts facilitate access to foreign markets.

Practical Applications

Depositary Receipts are widely used in global finance for several practical applications:

• International Investment Access: They provide domestic investors with a convenient way to invest in foreign companies without direct cross-listing on foreign exchanges. This is particularly beneficial for individual investors who might find direct international trading cumbersome.
• ¹⁸, ¹⁹ Capital Raising for Foreign Companies: Foreign companies use Depositary Receipts, especially sponsored programs, to raise capital from a broader, more diverse investor base in international markets. This expands their access to funding beyond their home country.
• ¹⁷ Portfolio Diversification: For investors, Depositary Receipts offer a straightforward means to diversify their portfolios across different geographic regions and industries, potentially reducing country-specific risk.
• ¹⁶ Regulatory Compliance Simplification: Depositary banks, often with the assistance of a custodian bank in the foreign company's home country, handle the complexities of foreign security custody, currency conversion, and some local tax issues, easing the burden on investors. The U.S. Securities and Exchange Commission (SEC) provides guidance for investors on understanding American Depositary Receipts, including associated fees. Thi¹⁴, ¹⁵s guidance helps ensure investors are aware of the mechanics and requirements. For more details, investors can refer to the SEC Investor Bulletin on American Depositary Receipts.

Limitations and Criticisms

While Depositary Receipts offer significant advantages, they also come with certain limitations and criticisms:

• Currency Risk: Although Depositary Receipts trade in local currency, they are still exposed to foreign exchange rates fluctuations. The value of the Depositary Receipt can be impacted by changes in the exchange rate between the foreign company's home currency and the currency in which the receipt is traded.
• Limited Information and Liquidity (for Unsponsored DRs): Unsponsored Depositary Receipts are issued by banks without the direct involvement or permission of the foreign company. These typically trade on the over-the-counter market, often have fewer regulatory compliance requirements, and may offer less transparency and liquidity compared to sponsored programs. Thi¹³s can result in limited financial information being available to investors.
• Fees: Investors in Depositary Receipts, especially ADRs, may incur various fees charged by the depositary bank, including custody fees, dividend distribution fees, and conversion fees. The¹²se fees can impact overall investment returns.
• Double Taxation: In some cases, investors may face double taxation on dividends from foreign companies—once in the foreign country and again in their home country—though tax treaties can often mitigate this.
• G¹¹eopolitical and Economic Risk: Investing in Depositary Receipts inherently exposes investors to the economic and political risks of the foreign company's home country.

Depositary Receipt vs. American Depositary Receipt (ADR)

The terms Depositary Receipt and American Depositary Receipt are related but not interchangeable. Depositary Receipt is the broader, overarching term for any negotiable financial instrument issued by a bank that represents shares in a foreign company and trades on a local stock exchange. It enco¹⁰mpasses various types of receipts designed for different markets globally.

An American Depositary Receipt (ADR) is a specific type of Depositary Receipt that is exclusively traded on stock exchanges within the United States, such as the NYSE or NASDAQ, or on the over-the-counter market. ADRs ar⁸, ⁹e denominated in U.S. dollars and allow U.S. investors to invest in non-U.S. companies. While a⁷ll ADRs are Depositary Receipts, not all Depositary Receipts are ADRs; for example, Global Depositary Receipt (GDRs) are traded on markets outside the U.S., often in Europe. The con⁵, ⁶fusion often arises because ADRs are one of the most common and well-known forms of Depositary Receipts globally.

FAQs

Q: Why do companies issue Depositary Receipts?
A: Companies issue Depositary Receipts to gain access to international capital markets and attract a broader base of investors beyond their domestic market. This helps them raise equity capital more efficiently.

Q: D³, ⁴o Depositary Receipts pay dividends?
A: Yes, holders of Depositary Receipts are generally entitled to receive dividends and other distributions from the underlying shares. The depositary bank converts these payments into the local currency of the Depositary Receipt and distributes them to the holders.

Q: W²hat is the role of a depositary bank?
A: A depositary bank issues the Depositary Receipts, holds the underlying foreign shares through a custodian bank in the foreign company's home country, and handles administrative duties such as dividend distribution and currency conversion.

Q: A¹re Depositary Receipts suitable for all investors?
A: Depositary Receipts can be a convenient way to achieve portfolio diversification and invest in foreign companies. However, investors should be aware of factors like currency risk, potential fees, and the specific disclosure requirements associated with different types (e.g., sponsored vs. unsponsored) before investing.